Why prices are what they are.
The story so far In the last lesson you spent your weekends fixing up old bikes. Now you have a few ready to sell, and you've rented a table at the Saturday market. Each bike cost you about $30 in parts. If you charge too much, people walk past. If you charge too little, they sell out in ten minutes and you could have made more. So what's the right price?
Finding the price where the number of things people want to buy matches the number for sale.
Almost every price you'll ever pay, from rent to concert tickets to stocks, is set this way.
Buyers want more when the price drops (demand). Sellers want to sell more when the price rises (supply). The price ends up where the two match: equilibrium.
Pricing analysts set prices for companies. Commodity traders buy and sell things like oil and wheat, betting on where prices go next.
What you're looking at: a sketch of a market, with no real numbers. Price goes up the side and quantity (how many get bought and sold) goes along the bottom. The blue demand line slopes down, the orange supply line slopes up, and the price tag settles where they cross: the equilibrium.
Drag the price.
Watch the market react.
This chart is the bike market in your whole town, not just your table. Up the side is the price of a bike. Along the bottom is how many bikes change hands in a month.
- Blue line, demand: how many bikes buyers want at each price. It slopes down, because the cheaper bikes are, the more people want one.
- Orange line, supply: how many bikes sellers bring at each price. It slopes up, because higher prices make it worth fixing and selling more.
Drag the price and watch the two numbers. Where the lines cross, they're equal. Then try the buttons to see what moves the lines.
What you're looking at: a made-up but realistic bike market for your whole town. Price per bike goes up the side ($0 to $200) and bikes per month along the bottom (0 to 100). Blue is demand, orange is supply, and the big dot where they cross is the equilibrium. The dashed line across is the price you picked, and its two small dots show how many bikes buyers want and sellers bring at that price. The faded stripe between them is the shortage or surplus. After a market shake, dashed curves show where the lines were before.
Two minutes. Just listen.
Tap any line to jump to it.
Market Stall
You'll run your stall for six Saturdays. Each bike costs you $30 in parts. Each week, pick a price, open the stall, and watch how many buyers stop. Read the news each week, because it changes how many people want bikes. Your score is how close you get to the most profit you could possibly have made.
What you're looking at: the game board. Your stall is on the right with the bikes you have ready, and buyers walk in from the left each Saturday. How many of them buy depends on the price you set.
The logic, step by step.
The two laws
The law of demand says that when a price goes up, people buy less of it. The law of supply says that when a price goes up, sellers offer more of it. The amount buyers want at a given price is called the quantity demanded. The amount sellers offer is the quantity supplied.
Price goes up → quantity supplied goes up
- Demand
- The whole blue line in the chart above: every possible price, each paired with how many bikes buyers want.
- Quantity demanded
- One point on that line. In the worked example below, at a price of $50, buyers want 50 bikes.
- Supply
- The whole orange line: every price, paired with how many bikes sellers bring.
- Quantity supplied
- One point on it. At $50, sellers bring 80 bikes.
Equilibrium
The market settles at the one price where those two amounts are equal. Every bike brought to market finds a buyer, and every buyer willing to pay that price gets a bike.
- Equilibrium
- In the worked example below, it's a price of $40: buyers want 60 bikes and sellers bring 60 bikes. None left over, nobody left out.
Worked example: solve it like an exam
- Read the equations. Exams often describe demand and supply as equations. Here, P is the price in dollars and Q is a number of bikes. Demand is Qd = 100 − P, which means "at a price of P, buyers want 100 minus P bikes." At $20 they'd want 80 bikes, and at $50 they'd want 50. Supply is Qs = 2P − 20, so at $50 sellers would bring 2 × 50 − 20 = 80 bikes.
- Set them equal. Equilibrium is where the two amounts match, so write 100 − P = 2P − 20. Add P and 20 to both sides to get 120 = 3P. Divide by 3: P = $40.
- Find the quantity. Put $40 back into either equation. Demand: 100 − 40 = 60 bikes. Supply: 2 × 40 − 20 = 60. They match, so the answer checks out.
- Try a price that's too low. At $30, buyers want 100 − 30 = 70 bikes, but sellers only bring 2 × 30 − 20 = 40. That's 30 more bikes wanted than exist, called a shortage. Buyers compete for the few bikes, so the price rises.
- Try a price that's too high. At $50, buyers want 50 but sellers bring 80. That's 30 bikes nobody buys, called a surplus. Sellers cut prices to get rid of them, so the price falls.
- Shortage
- At $30: buyers want 70 bikes, sellers bring 40. 70 − 40 = 30 bikes short.
- Surplus
- At $50: sellers bring 80 bikes, buyers want 50. 80 − 50 = 30 bikes left over.
Price limits set by law
A price ceiling is a legal maximum price, like rent control. When it's set below the equilibrium price, more people want apartments at that rent than there are apartments, so you get a shortage. A price floor is a legal minimum price, like the minimum wage (the price of an hour of work). In the simple model, a floor set above equilibrium means more people want jobs than employers want to fill. Real-world studies disagree about how big that effect is, and exams love asking you to argue both sides.
- Price ceiling
- Say the town banned selling bikes for more than $30, below the $40 equilibrium. Buyers want 70 bikes but sellers bring only 40, so there's a 30-bike shortage.
- Price floor
- Say a law said bikes must sell for at least $50. Sellers bring 80 but buyers want 50, so 30 bikes go unsold.
Shift or slide?
If only the price of bikes changes, you slide along the lines you already have. For example, when bikes get cheaper, buyers move down the demand line and buy more. But if something other than the price changes, the whole line shifts to a new spot. For example, when school starts, more kids need bikes at every price, so the whole demand line moves right. Things that shift demand include buyers' incomes, what's popular, how many buyers there are, what people expect to happen, and the prices of related things. A substitute is something you'd buy instead, like a scooter: if scooters get cheaper, fewer people want bikes. A complement is something used together, like a helmet: if helmets get cheaper, more people want bikes. For a normal good, like bikes or restaurant meals, people buy more when their income goes up. Things that shift supply include the cost of parts, new tools, how many sellers there are, what sellers expect, and taxes. Exams test this difference all the time.
- Slide (movement along the line)
- Bikes drop from $50 to $40, and buyers go from wanting 50 bikes to 60. Only the price changed, so it's the same line.
- Shift (the line moves)
- School starts. Now at $40, buyers want more than 60 bikes, and the same is true at every other price. Something besides the price changed, so the whole line moves right.
Elasticity
Price elasticity of demand measures how strongly buyers react to a price change. Some things people buy no matter what, like gas or medicine. If their price goes up, people still buy about the same amount. That's called inelastic. Other things have lots of alternatives, like a certain brand of chips. Raise the price a little and many people switch. That's elastic. To measure it, divide the percent change in how much people buy by the percent change in price. If the price rises 10% and sales drop 20%, elasticity is 2010 = 2, which counts as elastic (anything above 1 is). Used bikes are fairly elastic, which is why your stall price mattered so much.
- Price elasticity of demand
- % change in bikes bought% change in price = 20%10% = 2. That's above 1, so bike demand is elastic.
Consumer and producer surplus
Say a buyer would have paid up to $150 for one of your bikes, and you charge $100. They got a $50 deal. That extra value to the buyer is called consumer surplus. The bike cost you $30, so selling at $100 leaves you $70 more than you needed. That's producer surplus. This kind of surplus is a different idea from the surplus of unsold bikes above: here it means the extra value each side gets from a sale. At equilibrium, the two added together are as big as they can be. On exam graphs they show up as two triangles.
- Consumer surplus
- The most the buyer would pay minus what they paid: $150 − $100 = $50.
- Producer surplus
- What you got minus your cost: $100 − $30 = $70.
Bees find the equilibrium too.
Put a big patch of flowers next to a small one and watch the bees. At first they crowd the big patch. Soon it's so busy that each bee gets less nectar, so some drift to the small patch. They keep shifting until every bee gets about the same reward, wherever it is.
What you're looking at: an illustration, not data. A big flower patch and a small one, with bees moving between them until each bee gets about the same nectar. Buyers and sellers even out across a market the same way.
Ecologists call it the "ideal free distribution." Economists call it equilibrium. Same idea: when one spot pays better, newcomers rush in until the advantage disappears. It's why a hot new food truck soon has three copycats parked next to it, and why easy profits in any market never last long.
The page you'd copy down.
- Demand: how much buyers want at each price. Slopes down.
- Supply: how much sellers offer at each price. Slopes up.
- Equilibrium: the price where quantity demanded = quantity supplied. The market "clears."
- Shortage: price below equilibrium. Buyers want more than exists. Price tends to rise.
- Surplus: price above equilibrium. More for sale than buyers want. Price tends to fall.
- What shifts demand: buyers' incomes, what's popular, the number of buyers, prices of substitutes (things you'd buy instead, like scooters) and complements (things used together, like helmets), and what people expect to happen.
- What shifts supply: the cost of materials, technology, the number of sellers, expectations, and taxes.
- Normal good: something people buy more of when their income goes up, like bikes or restaurant meals.
- Own price changes = movement along the curve. Anything else = shift of the curve.
Fill in the blanks
Grab a friend or a study group.
The concert ticket auction
Write down the most you'd pay for a ticket to your favorite artist. One person is the seller with 3 tickets. Start at $300 and lower the price until 3 people say "buy." That price is your group's equilibrium. Anyone who wrote a higher number got a deal. How big was each person's deal (their consumer surplus)?
Shift or slide?
Take turns making up news headlines, like "Gas hits $6 a gallon" or "A new e-bike costs half as much." Everyone else races to say whether demand or supply moves, which way, and what happens to the price of regular bikes. Loser buys the snacks.
Stall showdown
Both play Market Stall. Compare your prices on the Saturday the big-box store opened. Who read the news better, and how much profit did it cost the other person?
Just you and the prices around you.
These stay on this device. Nobody else sees them.
Exam-style questions.
Written the way a college exam would ask them. Each right answer on the first try is worth 10 xp.
On the job: you're the pricing analyst
A sneaker brand is launching a shoe. Market research estimates demand of Q = 50,000 − 200P pairs. The factory can make 20,000 pairs for the launch, no more.
Your task: what launch price sells exactly 20,000 pairs? What happens to resale prices if the brand prices it at $120 instead?
See a model answer
Set demand equal to supply: 50,000 − 200P = 20,000, so 200P = 30,000 and P = $150.
At $120: demand is 50,000 − 200(120) = 26,000 pairs, but only 20,000 exist. That's a shortage of 6,000. Those buyers bid on resale sites, pushing resale prices toward $150 or higher. The brand leaves about $30 a pair, or $600,000, on the table, and resellers collect it.
Why a brand might do it anyway: sold-out launches and long lines build hype. That's a marketing choice with a real, measurable cost, and your job is to put a number on it.
Supply and demand show up everywhere next.
What you're looking at: a map of where this lesson fits in the course. Read it left to right: what comes before, this lesson in the middle, and the later lessons that build on it.
- Before · Unit 8Scarcity and trade-offs
- You are hereSupply and demand
- Next · Unit 9Inflation and GDP
- Later · Unit 9Interest rates
- Later · Unit 11Pricing and break-even
- Later · Unit 14Stock and bond prices