Individual Demand Curve and a Supply Curve

Supply and demand are two fundamental aspects of economics. It is the combination of these elements that makes up a market. Therefore, it is paramount to understand both concepts in order to appreciate the mechanisms of economic theory.

Supply is the ability and willingness of merchants to provide commodities for sale. Quantity supplied is a definite amount of goods at established prices. A supply curve depicts the connections between the price and quantity supplied of a good or service within a certain time period.

In order to understand supply curves, one must also comprehend the law of supply, production costs, marginal costs, and profit maximization. The law of supply states that as the price of an item rises the quantity supplied similarly increases. As the price falls, so too does the quantity supplied. In other words, there is a positive relationship between price and quantity supplied.

Another major factor in determining a supply curve are the costs of production. Production costs usually include inputs, or factors of production, and technological advances. Factors of production are divided into two categories: fixed costs and variable costs. Fixed costs are those expenditures that remain constant when changes in output occur; they may include rent, taxes, and interest payments on debts. Variable costs, on the other hand, change along with levels of output. Labor, raw materials, and electricity are examples of variable costs. Rising variable costs force the market price of a product to rise as well. This may affect the quantity supplied. Low production cost relative to market price makes an item profitable and provides an impetus for increased supply. Inversely, high production costs in relation to price render a good unprofitable. This leads to either a reduction in production or a change of business.

Technological advances also impact production costs. Improved technology makes production more efficient. Stated differently, it takes less to produce more. A more efficiently run business typically means lower prices and, consequently, more buyers.

Marginal cost is the additional cost of producing one more unit of a good or service. Marginal costs vary with the amount of output. For example, it may cost one dollar to produce one additional unit, fifty cents to create two items, but three dollars to produce a third. Marginal costs decrease to a certain amount and then rise again. An increase in the cost of input must be examined closely to determine its effect on profits. For this reason, a firm will continue to expand production so long as marginal revenue -- the additional revenue from creating one more unit, exceeds marginal cost.

A firm is primarily in business to make a profit. It follows that a company's objective is to maximize profits. Adjusting production to the level of output where profits are as high as possible accomplishes this goal.

A supply curve illustrates the relationship between price (y axis) and quantity supplied (x axis) for a given period of time. Supply curves slope upward and to the right. This is an indication of the law of supply, the positive correlation between the two variables.

Demand is the desire of consumers to obtain goods and services. It refers to a whole array of prices of a commodity and its corresponding levels of demand. Quantity demanded is a precise quantity of goods requested at a specific price. A demand curve illustrates the relationship between the price and quantity demanded of a good or service within a determined period of time.

In order to understand demand curves, one must also understand the notions of utility, marginal utility, the law of diminishing marginal utility, law of demand, and optimal purchase rule. Economists use the concept of utility to understand consumer choice. Utility refers to consumer preference of goods and services. It states that consumers choose goods and services they value most. Utility, simply stated, is satisfaction. For example, if a consumer chooses steak over chicken, the former is said to have a higher utility than the latter. It is understood that as utility increases so too does consumption.

A related concept of utility is marginal utility. Marginal means extra, additional. Coupling this with utility, marginal utility is the additional benefit derived from consuming one more unit of a commodity. To use the previous example, it is the added satisfaction from consuming another steak.

The law of diminishing marginal utility maintains that as a consumer exhausts more units of a product in a given period, marginal utility decreases. In other words, he or she receives less gratification from each additional item consumed. As satisfaction decreases the quantity demanded accordingly declines. The law of diminishing marginal utility claims that a consumer buys increasing quantities only at decreasing prices.

For example, the first steak that Jones eats gives him a great deal of satisfaction, appeasing his hunger. However, the second provides him with less utility, satiating his hunger, while the third is overindulgence. Jones places a higher demand on the first steak than the second or third. Having said this, Jones will naturally pay more for the first steak than the second, and more for the second than the third.

The law of demand corresponds with the law of diminishing marginal utility. The former states that as prices of a commodity rise, consumer demand falls. Conversely, as prices fall, demand rises. Using Jones as an example, the first steak is worth five dollars to him because it provides the most satisfaction; he wants it dearly. However, Jones buys the second steak for four dollars because it is less fulfilling and, as a result, in less demand.

Optimal consumption choice involves comparing the marginal utility of a purchase with its price. If the marginal utility is greater than the price, the consumer buys more. If the marginal utility is less than the price, the consumer buys less. The optimal consumption choice occurs when both marginal utility and price are equal. In other words, optimal choice is the maximum amount of consumption of a particular good or service given preference and budget constraints.