Supply, equilibrium and shifts
The law of supply, how supply and demand set the price, and Mankiw's three steps for working out what an event does to a market.
FinanceEveryday economicsAbout 6 min: 3 reading, 3 practiceUpdated
General education, not financial advice.
- State the law of supply and name what shifts supply
- Find the equilibrium price and explain surpluses and shortages
- Use the three steps to predict how an event changes price and quantity
Builds toward: Run your own money. Budget so there's room to save, spot and clear costly debt, compare savings and loan offers, and see what interest and inflation do to your money.
Everyday economics: news, prices and choices: lesson 6 of 11
- Everyday economics
- Trade-offs and opportunity cost 5 min
- Thinking at the margin and incentives 5 min
- Models and the circular flow 5 min
- Positive and normative statements 6 min
- Demand and what shifts it 5 min
- Supply, equilibrium and shifts 6 min
- What money is 5 min
- What GDP counts 6 min
- Real and nominal GDP 5 min
- Measuring unemployment 5 min
- The costs of inflation 6 min
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Pairs with any introductory economics textbook; for example N. Gregory Mankiw, Principles of Macroeconomics (6th ed.), chapter 4
What it is
The quantity supplied is how much sellers are willing and able to sell at a given price. The law of supply: other things equal, when the price of a good rises, the quantity supplied rises too. A higher price makes selling more profitable. The supply curve slopes upwards.
What shifts supply. A change in the good's own price is a movement along the supply curve. These shift the whole curve, in Mankiw's list:
- Input prices. If sugar gets dearer, making ice cream costs more, so supply falls (the curve shifts left).
- Technology. The mechanised ice-cream machine cut labour costs and raised supply.
- Expectations. A firm expecting higher prices later may store some output and supply less today.
- The number of sellers.
Equilibrium. Where the supply and demand curves cross, the quantity buyers want equals the quantity sellers offer. That price is the equilibrium price (or market-clearing price); the quantity is the equilibrium quantity. In Mankiw's ice-cream market, it is 2.00 a cone and 7 cones.
Quick check
Tap an answer to check it.
At a price of 2.50, sellers offer 10 cones and buyers want 4. What is the situation?
- A shortage is when buyers want more than sellers offer
Show answer
A surplus of 6 cones: the price will tend to fall. Quantity supplied is above quantity demanded.
Why it matters
Markets move towards equilibrium.
- If the price is above equilibrium, there is a surplus (excess supply): sellers cut prices to sell their stock.
- If the price is below equilibrium, there is a shortage (excess demand): sellers can raise prices without losing sales.
Text description
A supply-and-demand graph for ice-cream cones. The upward-sloping supply curve and the downward-sloping demand curve cross at the equilibrium E: a price of 2.00 and 7 cones. A dashed line at a price of 2.50 crosses demand at 4 cones and supply at 10 cones; the gap of 6 cones between them is the surplus, which pushes the price down towards 2.00.
Either way, the price moves until the market clears. Mankiw calls this the law of supply and demand.
Mankiw's three steps for analysing an event:
- Does it shift supply, demand, or both?
- Which way: right (increase) or left (decrease)?
- Compare the old and new equilibrium: what happens to price and quantity?
His examples:
- A hot summer raises the demand for ice cream (shift right): price up, quantity up.
- A hurricane that damages the sugarcane crop raises the price of sugar, an input, so supply falls (shift left): price up, quantity down.
- Both at once: price certainly rises, but quantity could rise or fall, depending on which shift is larger.
| Demand up | Demand down | |
|---|---|---|
| Supply up | Q up, P ? | P down, Q ? |
| Supply down | P up, Q ? | Q down, P ? |
When both curves shift, one of the two outcomes is ambiguous (?): it depends on the sizes of the shifts.
Worked example
A small market for bread rolls. Figures are made up.
| Price | Demanded | Supplied |
|---|---|---|
| 0.20 | 70 | 10 |
| 0.30 | 50 | 30 |
| 0.40 | 40 | 40 |
| 0.50 | 30 | 55 |
- Equilibrium: at 0.40, 40 demanded and 40 supplied.
- At 0.50: 55 supplied, 30 demanded, a surplus of 25. The price tends to fall.
- At 0.20: 70 demanded, 10 supplied, a shortage of 60. The price tends to rise.
Now flour gets dearer. Step 1: an input price, so supply. Step 2: supply falls (shift left). Step 3: at 0.40 there is now a shortage, so the price rises and the quantity sold falls.
Common mistake
Confusing "supply" with "quantity supplied", as with demand. A higher price raises the quantity supplied (along the curve). A cheaper input raises supply (the whole curve shifts right). And when demand rises, price rises and then quantity supplied rises along the supply curve: supply itself has not changed.
Key terms
- quantity supplied
- the amount sellers are willing and able to sell at a given price
- law of supply
- other things equal, the quantity supplied rises when the price rises
- supply curve
- a graph of the relationship between price and quantity supplied
- equilibrium
- the point where quantity supplied equals quantity demanded
- equilibrium price
- the price that balances quantity supplied and quantity demanded
- surplus
- quantity supplied greater than quantity demanded (excess supply)
- shortage
- quantity demanded greater than quantity supplied (excess demand)
Practise the key terms
Tap a card to turn it over. 7 cards.
| Front | Back |
|---|---|
| quantity supplied | the amount sellers are willing and able to sell at a given price |
| law of supply | other things equal, the quantity supplied rises when the price rises |
| supply curve | a graph of the relationship between price and quantity supplied |
| equilibrium | the point where quantity supplied equals quantity demanded |
| equilibrium price | the price that balances quantity supplied and quantity demanded |
| surplus | quantity supplied greater than quantity demanded (excess supply) |
| shortage | quantity demanded greater than quantity supplied (excess demand) |
Practice
Work it through
Using the bread-roll table: at 0.30 a roll, 50 are demanded and 30 supplied.
- 50 − 30
- Where demanded equals supplied, at 0.40
- 55 − 30
Quick quiz
Tap an answer to check it.
A new machine halves the cost of making phone cases. What happens to the price and quantity of phone cases?
- That is a fall in supply
- Technology affects sellers, so supply shifts
Show answer
Price falls, quantity rises: supply shifts right. Better technology lowers costs and raises supply.
A hot summer and a sugar shortage happen together. What can we say for sure about ice cream?
- The supply fall pushes quantity down, the demand rise pushes it up
Show answer
The price rises; the quantity could go either way. Both shifts push price up; their effects on quantity conflict.
What happens when the price is below equilibrium?
- That happens above equilibrium
Show answer
A shortage: sellers can raise prices without losing sales. Buyers want more than sellers offer.
Sort it
Which group does this belong to?
The price of coffee beans rises (for cafés)
An input priceShow answer
Shifts supply. An input price
Coffee becomes fashionable
TastesShow answer
Shifts demand. Tastes
Many new cafés open
The number of sellersShow answer
Shifts supply. The number of sellers
Incomes rise
IncomeShow answer
Shifts demand. Income
A faster espresso machine is invented
TechnologyShow answer
Shifts supply. Technology
In short
- Law of supply: a higher price means a larger quantity supplied.
- Input prices, technology, expectations and the number of sellers shift supply.
- Equilibrium is where the curves cross; surpluses and shortages push the price towards it.
- Three steps: which curve, which way, compare equilibria.
Mastery check
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Check yourself
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What is the equilibrium in Mankiw's ice-cream market?
Show answer
2.00 a cone and 7 cones.
A hurricane raises the price of sugar. What happens to the price and quantity of ice cream?
Show answer
Supply falls, so the price rises and the quantity falls.
What are Mankiw's three steps?
Show answer
Decide which curve shifts, decide which direction, and compare the old and new equilibrium.
Further reading
- N. Gregory Mankiw, Principles of Macroeconomics, 6th ed. (South-Western Cengage, 2012), chapter 4.
- On this site: Demand and what shifts it.
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