2. Supply and Demand

In a market economy, prices are not set by any single person. They emerge from the interaction of two forces: supply and demand.

Demand describes how much of a good buyers are willing and able to purchase at each possible price. The law of demand states: when price rises, quantity demanded falls; when price falls, quantity demanded rises -- all else equal. This gives demand its downward-sloping curve on a graph.

Supply describes how much of a good sellers are willing and able to offer at each possible price. The law of supply states: when price rises, quantity supplied rises; when price falls, quantity supplied falls -- higher prices reward producers. This gives supply its upward-sloping curve.

The point where the two curves intersect is the equilibrium price (also called the market-clearing price). At this price, there is no surplus (excess supply) and no shortage (excess demand).

Curves can shift -- not just move along -- when conditions change:

• Demand shifts right (increases) when incomes rise, the product becomes popular, a substitute becomes more expensive, or consumers expect future price increases.
• Supply shifts right (increases) when production costs fall, technology improves, or more producers enter the market.
• Supply shifts left (decreases) when raw materials become scarce, costs rise, or a natural disaster disrupts production (e.g., a frost destroying the orange crop).

Price elasticity of demand measures how sensitive quantity demanded is to a price change. Necessities (insulin, electricity) tend to be inelastic -- demand changes little even when price rises sharply. Luxuries or items with many substitutes tend to be elastic.

⚠️ Common misconception: 'supply' and 'demand' are not single numbers -- they are entire relationships between price and quantity, shown as curves. A change in price moves you ALONG the curve; only a change in an outside factor SHIFTS the curve.

💡 Tip: scarcity + high demand = higher price; abundance + low demand = lower price. This simple rule answers most GED® supply-and-demand questions.