The interaction of demand and supply will determine the equilibrium in a market. An equilibrium is a situation where the price is such that the quantity that consumers wish to buy is exactly balanced by the quantity that firms wish to supply.
With excess demand, prices will tend to be pushed up, whereas with excess supply, producers have much stock which they want to get rid of, so prices will be low.
Within the economy, firms demand labour and employees supply labour, so why not use demand and supply to analyse the market?
From the firm's point of view, the demand for labour is a derived demand; firms want labour not for their own sake, but for the output that labour produces.
The Price Elasticity of a product tells us how responsive demand is to a change in price. It can be calculated by the formula:
<math>PED = %change in quantity demanded/%change in price</math>
There are many factors affecting the PED of a product:
- habit forming product
- number of substitutes
- proportion of income
- time period
Question Calculate the price elasticity of demand if the change in demand is -5% and the change in price is 7%.
The Cross Price Elasticity of Demand tells us how responsive the demand of one good is to a change in the price of another good. For example, let's say that tea is good A and that coffee is good B. If the price of coffee were to fall by 10%, coffee would become more popular, and XED would tell us that tea and coffee are substitutes.
For substitutes, XED will be positive, and for complements it will be negative.
Income Elasticity of Demand tells us how responsive demand is to a change in consumer income. It can be calculated by the formula:
<math>YED = %change in quantity demanded/%change in consumer income</math>
For normal goods, the YED will be positive, and for inferior goods it will be negative.