Tying It Together

I bet you’ve noticed some similarities between this chapter, which analyzed supply and seller’s decisions, and the previous chapter, which analyzed demand and buyer’s decisions. There’s a good reason for this—the forces driving supply and demand are very closely related. This is best illustrated by a simple thought experiment involving a brief detour to Mars.

But let’s start on Earth. Think about a simple transaction, such as when you pull into my gas station and buy 10 gallons of gas for $30. (I don’t actually own a gas station, but let’s pretend for a moment that I do.) If you’re like most economics students, you’ll analyze this by noting that you are buying gas and I am selling gas. Consequently, we can analyze this transaction by exploring your demand for gas and my supply of gas.

Now consider how a Martian—who understands neither money nor gas—might view the same transaction. She might think that I am trying to buy your dollar bills and you are willing to sell them to me. How will I pay for your dollar bills? Why, with gas, of course. Viewed this way, I am the buyer who has a demand for your dollar bills, and you are the seller who is willing to supply them to me if I’m willing to pay you enough gallons of gas. While the Martian’s perspective seems funny, there’s a certain logic to it.

Neither the Martian’s nor the Earthling’s interpretation is wrong. You are just as much a buyer of gas as you are a seller of dollar bills. And I am just as much a seller of gas as a buyer of dollar bills. When you think about it this way, it’s no surprise that the same principles that animate our study of demand are also essential to understanding supply.

This similarity makes learning supply and demand a lot easier. In reality, there’s only one set of principles governing the decisions you make as both a buyer and a seller. In our analysis of both supply and demand decisions, we used the same four core principles of economics to analyze how to make good decisions. Figure 8 highlights how these same foundations lead to some striking parallels between making good decisions as a seller and making good decisions as a buyer. It also highlights crucial differences, the most important of which is that we usually consider demand to be motivated by a desire by consumers to maximize economic surplus, while businesses on the supply side are trying to maximize profits.

Figure 8 | The Parallels Between Demand and Supply

The table has two columns and eight rows. The column headers are Demand and Supply. The table reads as follows:

Your objective: Demand, Maximize economic surplus, which is the difference between the benefit you get and the price you pay; Supply, Maximize profits, which is the difference between your revenues and your costs.

To decide on your quantity, follow the: Demand, Rational Rule for Buyers: Buy one more item if the marginal benefit exceeds (or is equal to) the price; Supply, Rational Rule for Sellers in Competitive Markets: Sell one more item if the price exceeds (or is equal to) the marginal cost.

Implying that: Demand, Your demand curve is your marginal benefit curve; Supply, Your supply curve is your marginal cost curve.

Curve slopes: Demand, Demand curves slope down. Because of diminishing marginal benefit; Supply, Supply curves slope up. Because of increasing marginal cost.

The market: Demand, The market demand curve is the sum of the quantity each individual consumer demands, at each particular price; Supply, The market supply curve is the sum of the quantity each individual business supplies, at each particular price.

A rise in price causes: Demand, A movement along the demand curve, reducing the quantity demanded; Supply, A movement along the supply curve, raising the quantity supplied.

A fall in price causes: Demand, A movement along the demand curve, raising the quantity demanded; Supply, A movement along the supply curve, reducing the quantity supplied.

Curves are shifted by: Demand, Shifts in demand curves are caused by changes in: Income, Preferences, Prices of substitutes or complements, Expectations, Congestion or network effects, The type and number of consumers (shifts market demand only) and not by a change in market price; Supply, Shifts in supply curves are caused by changes in: Input prices, Input prices, Prices of substitutes-in-production and complements-in-production, Expectations, The type and number of sellers (shifts market supply only) and not by a change in market price.