Market Basics: Demand, Supply, and Price Determination

Lesson Purpose:

This lesson focuses on suppliers and demanders, the participants in markets; how their behavior changes in response to incentives; and how their interaction generates the prices that allocate resources in the economy. Learning about the reaction of demanders and suppliers to price, and the impact of non-price conditions (the determinants of demand and supply) creates a foundation for understanding the dynamism of markets. Examining the interaction of consumers and producers as they respond to market conditions also generates an appreciation for the role of prices in transmitting information that coordinates the economic response to scarcity.  The dynamics of the market, a vital part of students’ understanding of economics, may be explained with tables and narrative, or with graphs, or both – whatever is best suited to individual learning styles.

Key Terms:

demand quantity demanded(qd) Law of demand demand schedule demand curve demand determinants

supply quantity supplied (qs) Law of supply supply schedule supply curve supply determinants

equilibrium price market price market clearing price market quantity

relative price shortage surplus substitutes complements

Content Standards:

Standard 7: Students will understand that: Markets exist when buyers and sellers interact.  This interaction determines market prices and thereby allocates scarce goods and services.  Students will be able to use this knowledge to:  Identify markets in which they have participated as a buyer and a seller and describe how the interaction of all buyers and sellers influences prices.
Benchmarks:
grade 8:

• Relative price refers to the price of one good or service compared to the prices of other goods and services.  Relative prices are the basic measures of the relative scarcity of products when prices are set by market forces (supply and demand).
• The market clearing or equilibrium price for a good or service is the one price at which quantity supplied equals quantity demanded.
• If a price is above the market clearing price, it will fall, causing sellers to produce less and buyers to purchase more; if it is below the market clearing price, it will rise, causing sellers to produce more and buyers to buy less.

grade 12:

• A shortage occurs when buyers want to purchase more than producers want to sell at the prevailing price.
• A surplus occurs when producers want to sell more than buyers want to purchase at the prevailing price.
• Shortages of a product usually result in price increases in a market economy; surpluses usually result in price decreases.

Standard 8: Students will understand that: Prices send signals and provide incentives to buyers and sellers.  When supply or demand changes, market prices adjust, affecting incentives. 
Benchmarks:
grade 8:

• An increase in the price of a good or service encourages people to look for substitutes, causing the quantity demanded to decrease, and vice versa. This relationship between price and quantity demanded, known as the law of demand, exists as long as the other factors influencing demand do not change.
• An increase in the price of a good or service enables producers to cover higher per-unit costs and earn profits, causing the quantity supplied to increase, and vice versa. This relationship between price and quantity supplied is normally true as long as other factors influencing costs of production and supply do not change.
• Markets are interrelated; changes in the price of one good or service can lead to changes in prices of many other goods and services.

grade 12:

• Demand for a product changes when there is a change in consumers’ incomes or preferences, or in the prices of related goods or services, or in the number of consumers in a market.
• Supply of a product changes when there are changes in the prices of the productive resources used to make the good or service, the technology used to make the good or service, the profit opportunities available to producers by selling other goods or services, or the number of sellers in a market.
• Changes in supply or demand cause relative prices to change; in turn, buyers and sellers adjust their purchase and sales decisions.

Session Objectives:

• Define demand.
• Develop narrative, chart, and graphic models of demand.
• Distinguish between demand and quantity demanded.
• Introduce the Law of Demand.
• Identify the determinants of demand.  Demonstrate changes in demand – in narrative, chart, and graphic format.
• Identify and explain common errors in thinking about demanders’ reactions to price incentives.
• Define supply.
• Develop narrative, chart, and graphic models of supply.
• Compare/contrast the behavior of consumers and suppliers in response to price incentives.  (Emphasize secondary school students’ inexperience with the supplier role.)
• Distinguish between supply and quantity supplied.
• Identify the determinants of supply.  Demonstrate changes in supply – in narrative, chart, and graphic format.
• Identify and explain common errors in thinking about suppliers’ reactions to price incentives.
• Illustrate the determination of a market clearing price/equilibrium price under static and dynamic conditions.
• Illustrate the impact of the invisible hand of competition on supply, demand, and price in markets.

Key Content:

• Quantity demanded (qd) is the number of items that will be purchased at a particular price. 
• Law of demand, also known as “price effect.”
• Demand is the amount of an item people are willing and able to buy at a set of prices during a specific time period. 
• The determinants of demand are number of buyers, income, tastes and preferences, price expectations, and prices of substitutes and complements.
• Demand determinants are also referred to as demand shifters because they change the qd at all prices, as indicated by a change in the position of the demand curve.
• Quantity supplied (qs) is the number of items that will be offered for sale at a particular price, during a specific time period.
• Law of supply
• Importance of profit motive
• Supply is the amount sellers are willing and able to offer for sale at a set of prices.
• The determinants of supply are numbers of producers, expectations, the prices of other things that could be produced, and things that determine costs of production (including resource availability and technology).
• Supply determinants are also referred to as supply shifters because they change qs at all prices, as indicated by a change in the position of the supply curve.
• Suppliers cannot control price; they can only control the quantity they supply.
• Market prices emerge from the interaction of supply and demand.
• The equilibrium, or market clearing, price is the price at which qs = qd.
• Equilibrium prices change in response to changes in the determinants of supply and/or demand.
• In a free market, suppliers are motivated to find the market clearing price because it is the point of maximum total profit.
• In competitive markets, suppliers cannot “set” any price they want:  there is a difference between a price tag and a market price. (Topic 5 explains how market structure affects suppliers’ market power.)
• Both buyers and sellers react to price changes in predictable ways, ensuring that resources are used in their most valuable ways.

Mythconceptions:

• Demand for a good or service is constant.
• Supply of a good or service is constant.
• Supply and demand curves move “up” and “down.”
• Prices in the market are set by suppliers.
• Demand and quantity demanded are the same thing.
• Once price is ‘set’ it remains at that level.
• Markets ‘know our name.’
• Markets function independently.
• Goods and services are equally important to buyers.
• When the price of an item increases consumers will always buy less of the item.

Frequently Asked Questions:

• Why do prices change?
• If people buy more when price falls, why does a price increase indicate that demand increased?
• What determines the demand / supply of a product?
• If people would produce more or work longer for higher pay, why does a price (wage) decrease indicate a supply increase?
• Why do producers supply less of some items at lower prices?  Don’t they need to make more to make enough money?  (Why do producers supply more of some items at higher prices?  Don’t they need to make fewer to make the same amount of money?)
• If price is ‘low’, shouldn’t a supplier just try to sell more?
• Why can’t ‘more’ of an item always be supplied?
• Once price is determined, why / how can it change?
• What is the relationship between price, profit and resource allocation?
• Is it always in the best interest of a business to raise the price of its product(s)?
• Why will some people continue to buy products whose prices continue to rise?

Classroom Activity Options

• Have students conduct surveys and generate their own demand schedules (tables) for a commonly purchased lunch item – slices of pizza, for example. Associate the law of demand with students’ own behavior, as represented in their demand schedules.
• Have students create a supply schedule for the numbers of hours they would work per week at a hard physical task and various rates of pay – digging ditches, for example. Associate the law of supply with students’ own behavior, as represented in their supply schedules.
• Provide practice problems in which students plot demand and supply curves from schedules or charts.
• Conduct a classroom simulation in which students experience the emergence of equilibrium price and quantity from the un-orchestrated interaction of buyers and sellers.
• Provide practice problems – both graphic and narrative – in which students identify the market impacts of changes in the determinants of demand and/or supply.
• Provide practice problems – both graphic and narrative – in which students must distinguish between changes in demand and quantity demanded, and changes in supply and quantity supplied.
• Provide practice problems in which students compose narrative explanations based on graphic models, and graphs based on narratives.

Handouts and Supplemental Materials

Practice problems