The Model of Supply and Demand

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When people's actions are based on self-interest, people respond to incentives, that is, to costs and benefits. When the costs of an activity are raised or the benefits reduced, people do less of the activity. Economists have found that they can use this simple idea of action based on costs and benefits to construct a model (or theory) that explains how many markets work. This model, the model of supply and demand, is perhaps the most basic of the models economists use to explain the world around us.

Given the model's importance in the way modern economists think, it is surprising that one does not find the model in the writings of Adam Smith, David Ricardo, Thomas Malthus, or John Stuart Mill, though all of these pioneers in economics used the words "supply" and "demand" frequently. The modern supply-and-demand model did not appear until 1890, when Alfred Marshall published his Principles of Economics.

After you complete this unit, you should be able to:

  • Define demand, supply, inferior good, normal good, substitute, complement, law of demand, price taker, price searcher, market-clearing price.
  • Distinguish between changes in demand and changes in quantity demanded.
  • Distinguish between changes in supply and changes in quantity supplied.
  • Predict how changes in factors such as income, prices of substitutes, prices of inputs, etc. affect the supply and demand curves and equilibrium quantity and price.
  • Explain why we can treat the demand curve as positions of buyer equilibrium and the supply curve as positions of seller equilibrium.

Copyright Robert Schenk