Chapter Summary

The supply curve is generally an upward-sloping line that tells what quantity sellers will offer at any given price. The demand curve is generally a downward-sloping line that tells what quantity buyers will demand at any given price. In an unregulated market, the equilibrium price and quantity are determined by the intersection of these two curves.

If price is above its equilibrium level, there will be dissatisfied sellers, or excess supply. This condition motivates sellers to cut their prices. In contrast, when prices are below equilibrium, there will be dissatisfied buyers, or excess demand. This condition motivates sellers to charge higher prices. The only stable outcome is the one in which excess demand and excess supply are exactly zero.

Given the attributes of buyers and sellers, the equilibrium price and quantity represent the best attainable outcome, in the sense that any other price-quantity pair would be worse for at least some buyers or sellers.

The fact that market outcomes are efficient in this sense does not mean they necessarily command society's approval. On the contrary, we often lament the fact that many buyers enter the market with so little income. Concern for the well-being of the poor has motivated governments to intervene in a variety of ways to alter the outcomes of market forces.

Sometimes these interventions take the form of laws that peg prices above or below their equilibrium levels. Such laws can generate harmful, if unintended, consequences. Programs such as rent control, for example, interfere with both the rationing and allocative functions of the price mechanism. They can lead to black marketeering and deterioration of the stock of rental housing. By the same token, price supports in agriculture tend to enrich larger farms while doing little to ease the plight of marginal family farms. It is often possible to design alternative policies that are more effective and less costly.

If the difficulty is that the poor have too little money, the solution is to discover ways of boosting their incomes directly. Legislators cannot repeal the laws of supply and demand. But legislatures do have the capacity to alter the underlying forces that govern the shape and position of supply and demand schedules.

Supply and demand analysis is the economist's basic tool for predicting how equilibrium prices and quantities will change in response to changes in market forces. Four simple propositions guide this task: (1) an increase in demand will lead to an increase in both the equilibrium price and the equilibrium quantity; (2) a decrease in demand will lead to a decrease in both the equilibrium price and the equilibrium quantity; (3) an increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity; and (4) a decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity.

Incomes, tastes, the prices of substitutes and complements, expectations, and population are among the factors that shift demand schedules. Supply schedules, in turn, are governed by such factors as technology, input prices, the number of suppliers, expectations, and, especially for agricultural products, the weather.

Supply and demand analysis is a useful device for understanding how taxes affect equilibrium prices and quantities. In particular, it helps dispel the myth that a tax is paid primarily by the party on whom it is directly levied. In practice, the burden of a tax falls on whichever side of the market is least able to avoid it.