Father Julian C.

Rago Memorial National High School

Feliciano, Balete, Aklan

Applied Economics

Sol Kizziah Mei R. Cabandi, Grade 12-Eagle

Angel V. Quitong, Grade 12-Eagle Emmavi D. Laluma
Christine R. Ruiz, Grade 12-Eagle Teacher
Discussant

Application of Supply and Demand

ECONOMIC THEORY

The most basic laws in economics are the law of supply and the law of demand. Indeed, almost
every economic event or phenomenon is the product of the interaction of these two laws. The law
of supply states that the quantity of a good supplied (i.e., the amount owners or producers offer
for sale) rises as the market price rises, and falls as the price falls. Conversely, the law of demand
says that the quantity of a good demanded falls as the price rises, and vice versa. (Economists do
not really have a law of supply, though they talk and write as though they do.)

One function of markets is to find equilibrium prices that balance the supplies of and demands
for goods and services. An equilibrium price (also known as a market-clearing price) is one at
which each producer can sell all he wants to produce and each consumer can buy all he demands.
Naturally, producers always would like to charge higher prices. But even if they have no
competitors, they are limited by the law of demand: if producers insist on a higher price,
consumers will buy fewer units. The law of supply puts a similar limit on consumers. They
always would prefer to pay a lower price than the current one. But if they successfully insist on
paying less, suppliers will produce less and some demand will go unsatisfied.

Economists often talk of demand curves and supply curves. A demand curve traces the
quantity of a good that consumers will buy at various prices. As the price rises, the number of
units demanded declines. That is because everyones resources are finite; as the price of one
good rises, consumers buy less of that and, sometimes, more of other goods that now are
relatively cheaper. Similarly, a supply curve traces the quantity of a good that sellers will
produce at various prices. As the price falls, so does the number of units supplied. Equilibrium is
the point at which the demand and supply curves intersectthe single price at which the quantity
demanded and the quantity supplied are the same.

Markets in which prices can move freely are always in equilibrium or moving toward it. For
example, if the market for a good is already in equilibrium and producers raise prices, consumers
will buy fewer units than they did in equilibrium, and fewer units than producers have available
for sale. In that case producers have two choices. They can reduce price until supply and demand
return to the old equilibrium, or they can cut production until the quantity supplied falls to the
lower number of units demanded at the higher price. But they cannot keep the price high and sell
as many units as they did before.

Why does the quantity supplied rises as the price rises and fall as the price falls? The reasons
really are quite logical. First, consider the case of a company that makes a consumer product.
Acting rationally, the company will buy the cheapest materials (not the lowest quality, but the
lowest cost for any given level of quality). As production (supply) increases, the company has to
buy progressively more expensive (i.e., less efficient) materials or labor, and its costs increase. It
charges a higher price to offset its rising unit costs.

Are there any examples of supply curves for which a higher price does not lead to a higher
quantity supplied? Economists believe that there is one main possible example, the so-called
backward-bending supply curve of labor. Imagine a graph in which the wage rate is on the
vertical axis and the quantity of labor supplied is on the horizontal axis. It makes sense that the
higher the wage rate, the higher the quantity of labor supplied, because it makes sense that
people will be willing to work more when they are paid more. But workers might reach a point at
which a higher wage rate causes them to work less because the higher wage makes them
wealthier and they use some of that wealth to buy more leisurethat is, to work less. Recent
evidence suggests that even for labor, a higher wage leads to more hours worked.

Or consider the case of a good whose supply is fixed, such as apartments in a condominium. If
prospective buyers suddenly begin offering higher prices for apartments, more owners will be
willing to sell and the supply of available apartments will rise. But if buyers offer lower prices,
some owners will take their apartments off the market and the number of available units will
drop.

History has witnessed considerable controversy over the prices of goods whose supply is fixed in
the short run. Critics of market prices have argued that rising prices for these types of goods
serve no economic purpose because they cannot bring forth additional supply, and thus serve
merely to enrich the owners of the goods at the expense of the rest of society. This has been the
main argument for fixing prices, as the United States did with the price of domestic oil in the
1970s and as New York City has done with apartment rents since World War II.

Economists call the portion of a price that does not influence the amount of a good in existence
in the short run an economic quasi-rent. The vast majority of economists believe that economic
rents do serve a useful purpose. Most important, they allocate goods to their highest-valued use.
If price is not used to allocate goods among competing claimants, some other device becomes
necessary, such as the rationing cards that the U.S. government used to allocate gasoline and
other goods during World War II. Economists generally believe that fixing prices will actually
reduce both the quantity and the quality of the good in question. In addition, economic rents
serve as a signal to bring forth additional supplies in the future and as an incentive for other
producers to devise substitutes for the good in question.

HOW TO DETERMINE THE PRICE MATHEMATICALLY

You can determine the equilibrium price mathematically. In order to determine equilibrium
mathematically, remember that quantity demanded must equal quantity supplied.

The demand for dog treats is represented by the following equation

In the equation, QD represents the quantity demanded of dog treats, and P represents the price of
a box of dog treats in dollars. Because a negative sign is in front of the term 50P, as price
increases, quantity demanded decreases.
 The supply of dog treats is represented by

The quantity supplied of dog treats is represented by Q S in this equation, and P again represents
the price for a box of dog treats in dollars. A positive sign in front of the 150P indicates a direct
relationship exist between price and quantity supplied.

To determine the equilibrium price, do the following.

1. Set quantity demanded equal to quantity supplied:

2. Add 50P to both sides of the equation.

You get

Add 100 to both sides of the equation.

You get

3. Divide both sides of the equation by 200.

You get P equals $2.00 per box. This is the equilibrium price.