Explain law of demand, law of supply and how change in demand and change in supply apply to the market condition and discuss how price ceilings and price floors apply in the market.

The law of demand states that, all other things being equal, there will be an inverse relationship between the price of a good or service and the quantity of that product that people are willing and able to buy. This means that when the price of something goes down, people will (ceteris paribus) buy more of it. The opposite applies if the price goes up.

The law of supply states that, all other things being equal, there will be a direct relationship between the price of a good or service and the quantity of that product that people are willing and able to produce and sell. This means when the price of something goes down, people will (ceteris paribus) sell less of it. The opposite applies if the price goes up.

Between them, these two laws tell us how prices will be set in a free market. In such a market, the supply and demand curves intersect. The point where they intersect is called the equilibrium point. It tells us the price that the market will set and the quantity of the good or service that will be bought and sold at that price.

When either demand or supply changes in a market, the equilibrium point also changes, changing the price and the quantity bought and sold. If the demand rises, the price and the quantity bought and sold will (ceteris paribus) rise as well. In other words, more of the product will be sold and the price for the product will be higher. The opposite applies if demand drops. If supply increases, the price of the product will fall, but people will buy and sell more of the good or service. The opposite applies if supply decreases. In these ways, the laws of supply and demand work to set the equilibrium point for every free market.

Price ceilings and price floors disrupt the workings of the free market. They set arbitrary prices that are either below or above the equilibrium that the market would reach if left to its own devices. A price floor exists when the government mandates that the price for something cannot drop below a certain level. The classic example of this is a minimum wage. When a price floor is set, suppliers want to supply more (because they get a high price paid to them) of a good or service than consumers want to buy (because they have to pay the high price). The result is a surplus of that product. A price ceiling exists when the government mandates that the price for something cannot rise above a certain level. The classic example of this is rent control. When a price ceiling is set, consumers want to buy more (because they don’t have to pay very much) of a good or service than producers want to sell (because they do not get as good of a price for their product). The result is a shortage of that product.

On their own, the laws of supply and demand produce equilibrium points in every free market. When the government intervenes and sets price floors or ceilings, the working of the free market is disrupted and shortages or surpluses arise. Please follow the links below for interactive graphs that illustrate these concepts.