In this chapter, we have presented the fundamentals of the demand curve and the supply curve. The next chapter and much of the rest of this book build on these fundamentals. We thus give you fair warning. If you do not understand this chapter and the next, you will be lost!

A key point to know is that a demand curve is a function showing the quantity demanded at different prices. In other words, a demand curve shows how customers respond to higher prices by buying less and to lower prices by buying more. Another key point is that, similarly, a supply curve is a function showing the quantity supplied at different prices. In other words, a supply curve shows how producers respond to higher prices by producing more and to lower prices by producing less.

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The difference between the maximum price a consumer is willing to pay for a product and the market price is the consumer’s gain from exchange or consumer surplus. The difference between the market price and the minimum price at which a producer is willing to sell a product is the producer’s gain from exchange or producer surplus. You should be able to identify total consumer and producer surplus, the total gain from exchange, on a diagram. In future chapters, we will be using total consumer plus total producer surplus to evaluate different institutions and policies.

When it comes to what shifts the supply and demand curves, we have listed some factors in this chapter. Yes, you should know these lists but more fundamentally you should know that an increase in demand means that buyers want a greater quantity at the same price or, equivalently, they are willing to pay a higher price for the same quantity. Thus, anything that causes buyers to want more at the same price or be willing to pay more for the same quantity increases demand. In a pinch, just think about some of the factors that would cause you to want more of a good at the same price or that would make you willing to pay more for the same quantity.

Similarly, an increase in supply means that sellers are willing to sell a greater quantity at the same price or, equivalently, they are willing to sell a given quantity at a lower price. Again, what would make you willing to sell more of a good for the same price or sell the same quantity for a lower price? (Here’s a hint—you might be willing to do this if your costs had fallen.) Supply and demand curves are not just abstract constructs, they also shape your life.

In the next chapter, we will use supply curves and demand curves to answer one of the most crucial questions in economics: How is the price of a good determined?