Law of Supply and Demand

Law of Supply and Demand
Today, American farmers are more efficient due to machinery and fertilizers and produce more food
than ever. But, much to their disappointment, they did not make any more money because food prices
fell. They are seeing firsthand the economic law of Supply and Demand.
In free markets [without government controls], supply and demand work together to set prices.
According to the law of supply, producers are willing to produce more of a good if the price is higher.
That is because they will make more money from selling the good. They want to produce less of the
good if the price is lower.
Consumer demand works in the opposite way. Consumers are willing to buy more of a good if the price
is lower. If the price increases, they buy less.
The graph below shows how supply and demand come together to set the price of a good. This price is
called the “equilibrium price” because it is the point at which supply and demand are equal. At this
point consumers are willing to buy exactly as much output as producers are willing to make.
Several factors affect price-setting:
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Competition: If there is only one supplier of a good, consumers have no choice. The supplier
has more freedom to set a high price. If a supplier has no competition, it has a monopoly.
Substitute Goods: If a good is one-of-a-kind, its value is higher. The supplier who has a unique
good can charge more. But if consumers can find a substitute for the good, then the good is no
longer one-of-a-kind. As a result, the price of the good may fall.
Government Action: Some goods are in limited supply. In a free market, the suppliers of those
goods can increase the price to very high levels because demand will always be greater than
supply. In these cases, the government may decide to put limits on suppliers’ abilities to set
prices. It may for example, establish prices.
The Laws of Supply and Demand
Name: ______________________________________________________________________
Assignment: Based on the information on the handout on Supply and Demand, and your own research
on this subject, answer the questions that follow using full sentences in the spaces provided.
1. How do the salary negotiations between sports teams and professional athletes show the laws
of supply and demand?
2. Suppose the athlete is the best player at a particular position? What effect will that have on the
athlete’s salary?
3. What principle of price setting does this demonstrate?