Supply and demand

The "law" of supply and demand states that in a free market, prices of goods tend to rise when supply is low or consumer demand is high, and conversely that prices tend to fall when supply is high or demand is low. Not quite. See the graph at the bottom. Price is thus seen as a function of supply and demand.

Given that producers and merchants have an incentive to make money, they will tend to set their prices so as to make as much profit as possible (whatever the market will bear). For example, if more people want shoes or Furbies, then stores will tend to raise their prices, because the reluctance of consumers to pay the high price will be offset by the increased desire to buy these things. If public demand for shoes or Furbies decreases, store owners will find out about the decreased demand primarily by an immediate drop in sales. In an attempt to keep selling, they may experiment with reducing their prices, finding perhaps that a $100 pair of shoes commands only $80 or that a $50 Furby won't sell for any more than $25.

This can be illistrated with the following graph:

Price |++ **

     |	 ++    **
     |	   ++**
   P0|----**++
     |	 **  | ++
     |**    | 	 ++
     |	     |	   ++
     ------------------------------
            Q0         Quantity

• Supply. + Demand.

Help: Can someone put a real graph in here? Until someone does, just imagine the + and * are lines. The + are the amount that will be bought at a given price (also called a demand curve). The * are the quantity that producers are willing to make at a given price (also called a supply curve). As you can see, more will be purchased when the price is lower (the quantity goes up.). On the other hand, as the price goes up, producers are willing to produce more goods. Where these cross is the equilibrium. This will create a price of P0 and a quantity of Q0 since that is where the two lines cross.

When more people want Furbys, that shifts the demand curve up. This changes the equilbrium point to be at a higher price and quantity. If less people want shoes or Furbys, then the demand curve shifts down. This causes a lower price and quantity equilbrium point.