Generally, as the price of a product increases in an industry, supply increases because more sellers are willing to produce and sell their goods in the market to benefit from increased profits. Therefore, higher market prices lead to higher marginal profits for the seller. Following the same logic, if the price of the product decreases in the market, market supply decreases too. In Marshall’s illustrative graphics, this is represented as an upward sloping curve known as the supply curve.
Figure 2 - Graphical Difference between ‘Change in Quantity Supplied and ‘Change in Supply’.
Just like with the law of demand, there is a difference between changes in the quantity supplied (i.e., movements along the supply curve as shown in Figure 2) and changes in supply (shifts in the supply curve). Changes in supply are caused by factors such as the price of raw materials, the amount of labour and capital available to produce or improvements in technological processes that improve the efficiency of production.
The supply and demand curve
As explained earlier, the laws of supply and demand can be brought together to explain how market prices are defined. This can be illustrated by going back to the UK tea market example and bringing together the supply and demand curves into a single diagram. The y-axis represents the price of tea in the UK market, and the x-axis represents the quantity demanded or supplied (Figure 3).
Figure 3 - supply and demand Graphical Example of Tea Market in the UK.
Suppose that tea producers are setting the price of one tea box at £5 (Point A). In simple terms, producers notice that there is a surplus of tea in the market and that not many people are buying tea boxes. Therefore, the price for tea boxes in the market is reduced to £2 (Point B). At this price, loads of people are buying tea but producers are not making enough profits to keep up with demand rates; there is now a shortage of tea in the UK market. Consequently, producers decide to increase the price per box to £3 where enough people are buying tea for them to sustain production and profits. Therefore, according to the law of supply and demand, the equilibrium price (also known as market clearing price) is £3 per tea box. This is the point where all resources in the market are efficiently allocated; there is no excess or lack of tea in the market, and both buyers and sellers are content with their endowments.
Closing thoughts
The law of supply and demand is the foundation to microeconomic theory. It explains the relationship between price changes, quantity supplied and demanded by sellers and buyers in a market. This law is of importance because it ultimately seeks the agreement between both parties to settle a fair equilibrium price such that all resources are efficiently allocated and there are no shortages or surpluses in a market. Recall that economics is the study of the efficient allocation and distribution of scarce resources in an economy. Therefore, arguably, it is in the law of supply and demand where most economic answers can be found.
Further reading on Perlego
To read more about the law of supply and demand applied to industries like the education sector, read Studies of Supply and Demand in Higher Education by Charles T. Clotfelter and Michael Rothschild.
To read more about the life and contributions of Adam Smith, read What Adam Smith Knew by James R. Otteson.
To read more about Alfred Marshall’s life and contributions, read The Economics of Alfred Marshall: Revisiting Marshall's Legacy by Richard Arena and Michael Quere.
To read more about the life and contributions of Thorstein Veblen, read Veblen: The Making of an Economist Who Unmade Economics by Charles Camic.