Chapter 3: Demand and Supply

Markets bring buyers and sellers together so they can interact and transact with

each other.

Let’s start by thinking about markets where there are shortages or surpluses.

Here’s an email I received from Uber on 12/31/2014. Why would the price

fluctuate so much on New Year’s Eve? Why would a believer in free-markets

think that the fluctuations are good?

Shortages occur when buyers want to buy more units than are available for sale

at the current price. Shortages are signals for buyers and sellers to raise the

price of the good in question. If the price rises then both buyers and sellers will

react. Buyers will want to buy fewer units. Sellers will try to supply more units.

These behavioral changes will reduce the shortage.

Surpluses occur when buyers want to buy fewer units than are available for sale

at the current price. Surpluses are signals for buyers and sellers to lower the

price of the good in question. If the price falls then both buyers and sellers will

react. Buyers will want to buy more units. Sellers will no longer want to supply as

many units. These behavioral changes will reduce the surplus.

What happens if buyers want to buy the same number of units as are available

for sale at the current price? In this case there is no signal for price changes. The

market is in equilibrium where the number of units demanded by buyers equals

the number of units supplied by sellers.

Conclusion: surpluses and shortages generally lead to price changes.

Now, for the big question: What causes shortages or surpluses to occur?

Answer: Changes in market conditions.

Changes in market conditions frequently affect only potential buyers or only potential

suppliers. Therefore, economists typically classify these types of changes as “demand

shifters” and “supply shifters.”

Markets work best when they are allowed to respond to shortages and surpluses. Below,

we will develop and use graphs to study market responses. You will learn to predict what