Supply and Demand

Why this matters

Every company sits between two markets. It buys labour, materials, and energy in one and sells its products in the other, and its profit is what's left between the two prices. Those prices are set by supply and demand. An investor who understands how a market for, say, eggs or steel or memory chips responds to a shock can see why some companies' profits swing wildly while others barely move, and why a year of record profits can be a warning as much as a strength. This track starts here, with the simplest model in economics, because almost everything later is built on it.

Two schedules

Demand describes how much buyers want at each price. Supply describes how much sellers offer at each price. Take a hypothetical market for bags of coffee beans in one city over a week.

Price per bag	Bags buyers want	Bags sellers offer	What happens
$8	14,000	6,000	Shortage: buyers bid the price up
$10	12,000	8,000	Shortage
$12	10,000	10,000	Balanced
$14	8,000	12,000	Surplus: sellers cut prices to clear stock
$16	6,000	14,000	Surplus

Buyers want less as the price rises, since some switch to tea or buy less. Sellers offer more as it rises, since more production becomes worthwhile. At $12 the two match.

The price where the quantity demanded equals the quantity supplied is the equilibrium price. Below it, buyers want more than is available, and competition for the scarce supply pushes the price up. Above it, sellers are left with stock they can't sell, and they cut prices. Nobody sets the $12. It's where the pushing stops.

Moving along a curve, and shifting it

It helps to keep two kinds of change apart.

• A change in price moves buyers and sellers along their schedules. At $14, buyers want 8,000 bags instead of 10,000. Nothing about their tastes has changed. The price has.
• A change in anything else shifts a whole schedule. If a popular study made coffee look healthier, buyers would want more at every price. If a frost destroyed part of the harvest, sellers would offer less at every price.

Price per bag	Bags buyers want	Bags sellers now offer
$12	10,000	6,000
$14	8,000	8,000
$16	6,000	10,000

The new balance is $14, with 8,000 bags sold. Buyers pay more and get less. How much more depends on how strongly they react to the price, which is the next idea.

Elasticity

Some buyers drop a product the moment it gets dearer. Others keep buying almost regardless. Price elasticity of demand measures the difference.

Price elasticity = Percentage change in quantity bought ÷ Percentage change in price

• Inelastic demand, with an elasticity between 0 and −1, belongs to things people need and can't easily replace in the short run: basic foods, fuel for the commute, medicines.
• Elastic demand, beyond −1, belongs to things with close substitutes or that can be put off: one brand among many, restaurant meals, holidays.

Product	Change in quantity bought	Elasticity	Change in revenue
A staple with no close substitute	−5%	−0.25	1.20 × 0.95 − 1 = +14%
One brand among many similar ones	−30%	−1.5	1.20 × 0.70 − 1 = −16%

Raising the price of the staple brings in more money. Raising the price of the brand drives away enough customers to bring in less.

Elasticity also decides how violently a price reacts to a shock. When demand is inelastic, buyers won't cut back much, so a cut in supply has to be met almost entirely by a higher price before the market balances again. A small shortage in something people can't do without produces a large price spike.

A real supply shock: eggs

US egg prices show every part of the model. The average retail price of a dozen large Grade A eggs was $1.47 in January 2021. It reached $4.82 in January 2023 and a peak of $6.23 in March 2025, more than four times its 2021 level.¹

The cause was on the supply side. A wave of highly pathogenic avian influenza from mid-October 2024 to early March 2025 led to the culling of 50.7 million egg-laying hens. The losses came as the winter holidays approached, when demand for eggs is traditionally strong. Strong demand and tight supplies pushed both wholesale and retail egg prices to all-time highs by February 2025.²

Then the shock passed. Demand eased after the holidays and new outbreaks paused, and the average wholesale price fell from $8.20 a dozen in February 2025 to $3.74 in April.² By June 2026 the average retail price was $2.14, about a third of its peak.¹

Month	Price	What was happening
January 2021	$1.47	Before the outbreaks
January 2023	$4.82	Already more than three times the 2021 level
March 2025	$6.23	Peak, after 50.7 million hens were lost
June 2026	$2.14	Supply rebuilt

Bureau of Labor Statistics average prices.¹

Three lessons are in that table. Eggs are a staple with no easy substitute, so a loss of supply showed up mostly as price. Wholesale prices, set day to day by trading, moved first and furthest, and retail prices followed with a lag: the Economic Research Service notes that retail prices are slower to fall as wholesale prices retreat.² And the spike corrected itself as flocks were rebuilt, because high prices are a strong signal to produce more.

What this means for companies

For a company, the two markets it sits between decide its margins.

• Producers of commodities take whatever price the market sets. Their revenue can double or halve with no change in what they do, which is why their profits swing so widely, as Energy and Commodity Producers described. An egg producer that kept its flock through 2025 sold at record prices. One that lost its flock had nothing to sell.
• Buyers of commodities, such as food manufacturers or airlines, face the same swings as costs. Whether they can pass a higher cost on to their own customers depends on the elasticity of demand for what they sell, which is the subject of Pricing Power.
• High prices attract supply. Record profits in a commodity encourage producers to expand and newcomers to enter. The new supply arrives later, sometimes years later for mines or factories, and often in time to meet a fall in demand. That lag is behind the boom-and-bust pattern of many capital-intensive industries.

The practical point: a company's peak profits in a supply shock aren't a guide to its normal earnings. Valuing it on the best year means paying for a shortage that the market is already working to end.

Key takeaways

• Buyers want less at higher prices and sellers offer more. The price settles where the two quantities match.
• A change in price moves along the schedules. A change in incomes, costs, tastes, or a shock shifts them.
• Elasticity measures how strongly buyers respond to price. When demand is inelastic, a price rise increases revenue.
• With inelastic demand, a small loss of supply causes a large rise in price.
• US egg prices reached more than four times their 2021 level as avian flu cut the laying flock, then fell by about two thirds as supply recovered.
• Peak earnings from a shortage aren't normal earnings. High prices bring more supply.

Check your understanding

A company raises the price of its product by 10%, and the quantity it sells falls by 4%. What's the elasticity of demand, and what happens to revenue?

1. About −0.4, inelastic: revenue rises by about 5.6%.
2. About −2.5, elastic: revenue falls because fewer units sell.
3. About −0.4, inelastic: revenue falls by the 4% drop in sales.

A disease cuts the supply of a basic food by 15%, and its price triples. What does this suggest about demand for it?

1. That demand rose sharply at the same time as supply fell.
2. That demand is elastic, since buyers reacted strongly to the price.
3. That demand is inelastic, so only a large price rise rations the supply.

What's next

Elasticity decides how hard a price change hits sales and who ends up paying for a cost shock. Elasticity in Depth looks at it closely: in the short and long run, across incomes, in who really pays a tax, and in how high a company's margins can go.