Economics, 3rd Edition

law of supply 

and demand

: the price of any good adjusts to bring the quantity supplied and quantity demanded for that 

good into balance.

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CHAPTER 3  THE MARKET FORCES OF SUPPLY AND DEMAND  59

made in terms of the value of the benefits gained from alternatives is greater and so we may be less 

willing to do so as a result. If the price of a ticket for the movie was 

€15 then it might have to be a very 

good movie to persuade me that giving up what else 

€15 could buy me is worth it. Price also acts as a 

signal at the margin. Most consumers will recognize the agony they have experienced over making a 

purchasing decision. Those ‘to die for’ pair of shoes may be absolutely perfect but at 

€120 they might 

make the buyer think twice. If they were 

€100 then it might be considered a ‘no brainer’. That extra 

€20 might make all the difference to the decision of whether to buy or not.

Economists and those in other disciplines such as psychology are increasingly investigating the com-

plex nature of purchasing decisions that humans make. The development of magnetic resonance imaging 

(MRI) techniques, for example, has allowed researchers to investigate how the brain responds to different 

stimuli when making purchasing decisions. This increased understanding is being used by firms to per-

suade buyers to choose their products over rivals.

For sellers price acts as a signal in relation to the profitability of production. For most sellers, increasing 

the amount of a good produced will incur some additional input costs. A higher price is required in order 

to compensate for the additional cost and to also enable the producer to gain some reward from the risk 

they are taking in production. That reward is termed profit.

If prices are rising in a free market then this acts as a different but related signal to buyers and sellers. 

Rising prices to a seller means that there is a shortage and thus acts as a signal to expand production 

because the seller knows that s/he will be able to sell what they produce. For buyers, a rising price 

changes the nature of the trade-off they have to face. Rising prices act as a signal that more will have to be 

given up in order to acquire the good and they will have to decide whether the value of the benefits they 

will gain from acquiring the good is worth the extra price they have to pay and the sacrifice of the value of 

the benefits of the next best alternative.

For example, say the price of going to the movies increases from 

€10 per ticket to €15 per ticket. Some 

movie goers will happily pay the extra because they really enjoy a night out at the cinema but some people 

might start to think that 

€15 is a bit expensive. They might think that they could have a night out at a res-

taurant with friends and have a meal and a few drinks for 

€15 and that would represent more value to them 

than going to the cinema. Some of these people would, therefore, stop going to the cinema and go to a 

restaurant instead – the price signal to these people has changed.

What we do know is that for both buyers and sellers, there are many complex processes that occur 

in decision making. Whilst we do not fully understand all these processes yet, economists are con-

stantly searching for new insights that might help them understand the workings of markets more fully. 

All of us go through these complex processes every time we make a purchasing decision – we may 

not realize it but we do! Having some appreciation of these processes is fundamental to thinking like 

an economist.