CHAPTER 03

Buyers and Sellers Together Determine the Price of the Good.

What do Starbucks, Nordstrom, and Amazon have in common? If you guessed that they all have headquarters in Seattle, that’s true. But even more interesting is that each company supplies a product much in demand by consumers. Starbucks supplies coffee from coast to coast and seems to be everywhere someone wants a cup of coffee. Nordstrom, a giant retailer with hundreds of department stores, supplies fashion apparel to meet a broad spectrum of individual demand, from the basics to designer collections. Amazon delivers online products to customers all over the world. When stores had to close during the COVID-19 pandemic, demand for Amazon products grew even more.

Notice the two recurring words in the previous paragraph: “supply” and “demand.” Sometimes buyers set the price—through live auctions, on eBay, or at shopgoodwill.com. Other times, sellers set the price and then adjust it based on how well an item sells and how much inventory remains. Buyers and sellers each influence both prices and quantities traded, so that these end up being determined by how buyers’ and sellers’ price-versus-quantity calculations interact.

This chapter describes how markets work and discusses the nature of competition. To shed light on the process, we introduce the formal model of demand and supply. We begin by looking at demand and supply separately. Then we combine them to see how they interact to establish the market price and determine how much is produced and sold.