Demand and Supply - Not that hard after all

The picture on the left explains it all! When people talk about economics, most them say it is one of the toughest subjects and it is hard to understand. Truth be told, there is a secret to learn economics. How? It is by understanding demand and supply thoroughly.

What is demand and supply? According to Moffat (n.d.), demand in economics is the want or desire to possess a good or service provided they have sufficient financial instruments or services to own the goods itself. Supply, however, is the relationship between the quantity of a good or service consumers will offer for sale at a specific price.

Now, lets look at an example on how to read a simple demand-supply graph. 

Let's imagine that the graph on the right is the demand-supply graph for palm oil in the year 2012. The Y-axis represents the price and the X-axis represents the quantity.The curve that is downward slopping is the demand curve while the curve that is upward slopping is the supply curve. The point of intersection of the demand and supply curve is known as the equilibrium point. At this point, both quantity demanded and quantity supplied for palm oil is equal. In addition, the equilibrium point will determine the price of the product or services provided.

Ceteris Paribus
When ceteris paribus is applied, it means that all other factors, besides price, that might affect the supply or demand curve are kept constant. This means that if there is a change in demand or supply when ceteris paribus is applied, it is caused by the change of price of the good or services provided itself. Note that the curve will NOT shift.

The demand and supply curve do shift. They shift due to other determinants, which of course is not the price.

Determinants for demand:

• Festive seasons
• Income of individuals
• Brand
• Availability of substitutes
• Weather
• Complements
• Tastes/Preferences
• Etc

Determinants for supply:

• Technology
• Tax Rates
• Subsidies
• Price of other goods
• Etc

Whether the curve shifts left or right depends on the type of determinants that affect the curve.

Demand-supply curve for Starbucks' coffee
Shift of demand curve to the right

Referring to the graph above where the supply is constant, lets take income of individuals as an example of a determinant for the demand for Starbucks' coffee. Lets assume that your pocket money for a week is RM50. Definitely, your demand for Starbucks' coffee is not high, correct? However, if you are given RM200 a week, you wouldn't mind spending money on coffee from Starbucks despite the price would you? This shows that your demand for Starbucks has increased by a significant amount. Thus, it causes the demand curve to shift towards the right (from Demand to New Demand), increasing the demand for Starbucks (from Q1 to Q2) as well as readjusting the equilibrium price to a higher value (from P1 to P2).

Shift of demand for Starbucks' coffee to the left

On the other hand, referring to the graph above, if your pocket money was RM200 for a week at first and it was then reduced to RM50, you tend to spend less. This means that you are not willing to pay for a cup of coffee from Starbucks. The reduction in income causes the demand curve for Starbucks to shift left since the demand for Starbucks has decreased (from D to D1). The price will eventually fall as well (from P to P1). The shift of the demand to the left or right is easier to be seen when you put yourself in the shoes of the consumers.

Demand-supply curve for the supply of rice

The graph above shows the demand-supply curve for the supply of rice. Lets assume that tax rates is now the determinant for the supply of rice. Take note that the supplier's view is different from the consumer's. As a supplier, you would want to maximise profit while a consumer would want to maximize satisfaction. Assume that the tax rate has increased from 10% to 20% for example. What will you, as a consumer, do? Definitely, you will produce less because the cost of production is now high due to the high tax rate imposed. Therefore, the supply curve shifts to the left (from S0 to St). This causes the price to increase (from P0 to Pt) for a shortage in supply occurs. The effect is reversed if the tax rate is reduced.

The shift of the demand and supply curve can be easily seen when you put yourself in the position of the consumer or the supplier. The effect can also be easily seen. If the demand curve shifts right, the price increases; vice versa.