Supply, demand and prices: how a market sets what things cost
Prices come from buyers and sellers, and the way they respond decides who gains when a market is shocked. This lesson explains demand, supply, equilibrium and price elasticity, with a calculator that removes part of a market's supply and shows how far the price, the quantity and total spending move. It then tests the ideas on two real cases: the 2022 egg price spike and Cal-Maine's results, and Tesla's 2023 price cuts and what they did to revenue and margin.
- Level
- Beginner
- Reading time
- About 24 minutes
- Know this first
- How securities markets work
By the end you will be able to:
- explain demand, supply and the equilibrium price, and tell a shift from a movement along a curve
- calculate and read the price elasticity of demand
- work out how a price change changes revenue, and the volume rise a price cut needs to break even
- explain why a supply shortage moves a price much more when buyers are not flexible
- separate price, volume and margin when reading a company's annual results
Prices are where buyers and sellers meet
Every price a business or an investor deals with was set by a market. A dozen eggs, a car, a share and a loan all cost what they cost because many buyers and sellers, each acting in their own interest, settled on a number. Economics is the study of how that settling happens, and finance rests on it: a company's revenue is a price times a quantity, and both are decided in a market.
Economists split the subject in two. Microeconomics looks at individual markets, firms and households, and asks why one price is what it is. Macroeconomics looks at the economy as a whole, and asks about total output, the general level of prices, jobs and interest rates. This module starts with the small scale, in this lesson, and then moves to the large scale: inflation, growth and interest rates are macro questions that the later lessons take up. The order book in how securities markets work is already a small market of this kind, where the price is set at the point where buy orders and sell orders meet.
Demand, supply and the price where they meet
Demand describes how much buyers want to buy at each possible price. At a higher price they usually want less, so the demand curve slopes down. Supply describes how much sellers will offer at each price. At a higher price they are usually willing to offer more, so the supply curve slopes up. The equilibrium price is where the two curves cross: at that price the quantity buyers want equals the quantity sellers offer, so nobody is left with an unwanted surplus or an unmet order.
Two kinds of change are easy to confuse. A change in the product's own price moves buyers and sellers along their curves. A change in anything else, such as income, tastes or the cost of inputs, shifts a whole curve, because it changes how much people want or offer at every price. The OpenStax economics textbook gives a drought as an example of a supply shift: a drought reduces the supply of farm products, so the supply curve moves left. When a curve shifts, the two curves cross at a new place, and the market finds a new price and a new quantity.
How far the price moves after a shift depends on how stubborn buyers and sellers are. That is what elasticity measures.
Elasticity: how far buyers move when price moves
The price elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in price. Because price and quantity move in opposite directions, the result is negative, so it is usually quoted as a positive number. If it is above 1, demand is elastic: buyers cut their purchases by more than the price rose. If it is below 1, demand is inelastic: buyers cut by less. At exactly 1 it is unit elastic. This is the definition the OpenStax textbook uses.
The last line is arithmetic, not a separate rule. If the price rises 10% and the quantity falls 5%, revenue is 1.10 × 0.95 = 1.045 times what it was, up 4.5%. If the price rises 10% and the quantity falls 20%, revenue is 1.10 × 0.80 = 0.88 times what it was, down 12%. That is why a business wants to know whether its customers are elastic or inelastic before it changes a price.
A shortage in a market where buyers do not budge
The calculator is a small market that starts at a normal price and a normal quantity. Set how much of the normal supply disappears, and how strongly buyers respond to price. The market then finds its new equilibrium. One thing is assumed throughout and cannot be moved: sellers can offer a little more when the price rises, with a supply elasticity of 0.2, because new capacity takes time to build. Both curves are smooth, constant-elasticity curves, which is a simplification chosen so the answer can be worked out exactly. It is a teaching model of one idea, not an estimate for any real market. At the starting settings, 20% of the normal supply disappears and the demand elasticity is 0.2.
If 20% of normal supply disappears and buyers respond with an elasticity of 0.2, the price rises 74.7% and buyers take 10.6% less. Total spending on the good rises 56.3%. Demand is inelastic, so the higher price outweighs the smaller quantity.
Four experiments. First, at the starting settings a 20% loss of supply lifts the price 74.7% while buyers take only 10.6% less, and total spending on the good rises 56.3%. Buyers cut back far less than the price rose. Second, look at the two seller lines. A seller whose own supply is untouched sells the same quantity at a price 74.7% higher, so its revenue rises by that much. A seller that lost 20% of its own output still ends 39.8% better off in revenue, because the higher price more than pays for the lost sales. That does not make a shortage good for everyone: buyers pay more, and the seller that lost output may still have costs to cover. Third, move the elasticity to 1.0. The price still rises 20.4%, but buyers cut back by 17.0%, and total spending does not change. Fourth, move it to 1.5. The price rises only 14.0%, buyers take 17.9% less, and total spending falls 6.4%. The last line of the right-hand side asks the reverse question: with the elasticity you chose, how much supply would have to disappear for the price to rise 150%, the size of the egg price rise described below. At 0.1 it is 24.0%; at 1.5 it is 78.9%. The more flexible the buyers, the larger the shock needed to explain a given price rise.
Eggs: a supply shock and what Cal-Maine reported
The US Bureau of Labor Statistics publishes the average price of a dozen Grade A large eggs in US cities. The table picks out some months from that series. Between January 2022 and January 2023 the price rose from $1.93 to $4.82, an increase of 150%. It then fell back by mid-2023.
| Month | Average price per dozen | Change from the row above |
|---|---|---|
| January 2021 | $1.47 | n/a |
| January 2022 | $1.93 | +31.6% |
| January 2023 | $4.82 | +150.0% |
| July 2023 | $2.09 | −56.6% |
| January 2024 | $2.52 | +20.4% |
| March 2025 | $6.23 | +146.9% |
| September 2026 | $2.27 | −63.5% |
Cal-Maine Foods is a US egg producer, and its annual results show the same episode from the seller's side. In its results for fiscal 2023, the company said they reflected the impact of the highly pathogenic avian influenza (HPAI) outbreak, which it said caused higher prices for shell eggs because of the reduced egg supply. That is a supply shift to the left, of the kind the calculator models.
| Cal-Maine Foods | Fiscal 2022 | Fiscal 2023 | Change |
|---|---|---|---|
| Weeks in the year | 52 | 53 | +1 week |
| Net average selling price per dozen | $1.579 | $2.622 | +66.1% |
| Dozens sold (thousand) | 1,083,789 | 1,147,373 | +5.9% |
| Net sales ($ thousand) | 1,777,159 | 3,146,217 | +77.0% |
| Net income ($ million) | 132.7 | 758.0 | +471.2% |
The net average selling price per dozen rose 66.1%, while the number of dozens sold rose only 5.9%. Net sales rose 77.0% and net income rose to about 5.7 times its previous level. Fiscal 2023 had 53 weeks and fiscal 2022 had 52, so some of the volume increase is the extra week: per week, the volume rose 3.9%. This is the pattern the calculator shows for a seller whose volume holds up when a shortage lifts prices: a large rise in price with little change in quantity. Two cautions apply. The company's own release lists higher grain and other input costs as well as the outbreak, so the profit rise is not all price, and one company's year cannot show how elastic the whole market is.
Cars: a price cut and what Tesla reported
The reverse case is a seller who lowers its own price. A price cut moves buyers along the demand curve, and revenue rises only if the extra units sold outweigh the lower price on each. With a cut of c, revenue stays the same only if units rise by 1 ÷ (1 − c) − 1. Anything above that raises revenue, which needs demand to be elastic over that range.
Tesla's year-end update for 2023 gives the figures for a company whose average selling price fell. The update's commentary on operating income cites "reduced vehicle ASP due to pricing and mix", where ASP is the average selling price and mix means which models were sold.
| Tesla | 2022 | 2023 | Change |
|---|---|---|---|
| Vehicles delivered | 1,313,851 | 1,808,581 | +37.7% |
| Total automotive revenues ($ million) | 71,462 | 82,419 | +15.3% |
| Automotive revenue per vehicle delivered, rough | $54,391 | $45,571 | −16.2% |
| Gross margin of the whole company (GAAP) | 25.6% | 18.2% | −7.4 points |
Deliveries rose 37.7% while automotive revenue rose only 15.3%. Dividing automotive revenue by deliveries gives a rough revenue per vehicle of $54,391 in 2022 and $45,571 in 2023, a fall of 16.2%. That is a rough figure, not a price: automotive revenue includes items such as leasing and regulatory credits, and a delivery is not the same as a sale recognised in the same period. To break even on revenue after a cut of that size, units would have to rise 19.4%. They rose 37.7%, far more, so revenue went up. Taken at face value, 37.7% ÷ 16.2% looks like an elasticity of 2.3. But that is not a measurement of Tesla's demand, because the price was not the only thing that changed: the mix of models changed, as the update itself says, and so did a great deal else in the year. What the table does show clearly is that more revenue was not more profit. The company's gross margin, which is its gross profit as a share of revenue, fell from 25.6% to 18.2%, and that is for the whole company, not only cars. Revenue rose while the profit earned on each dollar of it fell. Lower prices are one reason this can happen, and the lesson on contribution margin and break-even shows the mechanism: a lower price cuts the margin on every unit, so the volume needed to cover costs rises.
What this lesson leaves out
- One market at a time. The calculator holds everything else equal. Real prices also move with income, the prices of substitutes, expectations and policy, and several things change at once.
- Constant elasticity is a simplification. Real demand is more elastic at some prices than at others, and elasticity itself changes over time. Over a longer period, buyers and sellers can adjust more.
- The supply response is assumed. The value of 0.2 is chosen for teaching and is not an estimate for eggs or any other good.
- One year of one company is not a market. Cal-Maine and Tesla illustrate the ideas. Neither measures elasticity.
- Prices are not the whole story for a seller. Costs, competition and capacity decide profit, which this lesson does not model.
- The egg series is retail. The BLS series records what shoppers paid in the shop, which is not the price the producer received.
Common mistakes
Treating a price rise as always good for sellers
It raises revenue only when buyers are not too responsive. If demand is elastic, a price rise cuts revenue.
Confusing a shift with a movement
A change in the product's own price moves along the curve. A change in something else, such as the cost of inputs, shifts the whole curve.
Reading revenue as profit
Tesla's revenue rose while its margin fell. Revenue is a price times a quantity. Profit also depends on cost.
Calling one episode an elasticity
A ratio of two changes is an elasticity only if the price is the only thing that changed.
Forgetting that time changes the answer
In the short run, both buyers and sellers are slower to adjust than in the long run, so a shock can move prices more at first than later.
Try it yourself
1. A seller raises its price 10% and the quantity sold falls 8%. What is the elasticity of demand, and does revenue rise or fall?
Show the working
Elasticity = 8 ÷ 10 = 0.8, which is below 1, so demand is inelastic. Revenue is 1.10 × 0.92 = 1.012 times what it was, so it rises by 1.2%.
2. Cal-Maine's net average selling price per dozen rose from $1.579 to $2.622. What is the percentage increase?
Show the working
(2.622 − 1.579) ÷ 1.579 = 66.1%.
3. A company cuts its price by 10%. By what percentage must units sold rise for revenue to stay the same?
Show the working
1 ÷ (1 − 0.10) − 1 = 11.1%. Check: 0.90 × 1.111 = 1.00.
4. In the calculator, set the supply loss to 20% and the demand elasticity to 1.0. What happens to total spending, and why?
Show the working
The price rises 20.4% and the quantity falls 17.0%, so the two changes cancel and total spending is unchanged. The price is 1.204 times normal and the quantity is 0.830 times normal, and the product of the two is 1. At unit elasticity, quantity falls by exactly the proportion that makes price times quantity constant.
5. Why can a seller that lost part of its output to a shortage still see its revenue rise?
Show the working
If demand is inelastic, the price rises by more than the quantity falls. At the starting settings a seller that lost 20% of its output sees revenue change by 39.8%. It still has costs to pay, so its profit is a separate question.
Where this is used
- A company decides whether a discount will raise or lower its revenue, and by how much volume it needs to rise to pay for the cut.
- An analyst reading an annual report separates the effect of price from the effect of volume in a change in sales.
- A farm or commodity business works out what a poor harvest elsewhere does to the price it will receive.
- A central bank or ministry studies how a tax on a good would change its price and how much people buy.
Key terms
- Microeconomics
- The study of individual markets, firms and households.
- Macroeconomics
- The study of the economy as a whole: output, prices, jobs and interest rates.
- Demand
- How much buyers want to buy at each possible price.
- Supply
- How much sellers will offer at each possible price.
- Equilibrium price
- The price at which the quantity demanded equals the quantity supplied.
- Shift
- A move of a whole demand or supply curve, caused by something other than the product's own price.
- Price elasticity of demand
- The percentage change in quantity demanded divided by the percentage change in price.
- Inelastic and elastic
- Elasticity below 1 and above 1. Inelastic buyers change quantity by less than the price changed.
- Gross margin
- Gross profit as a share of revenue.
Questions people ask
Is the calculator a forecast of egg prices?
No. It is a teaching model of how a supply shock moves a price when buyers are more or less responsive. The supply response and the curve shapes are assumptions.
Does a price rise always raise revenue?
No. It does only when demand is inelastic over that range. If demand is elastic, revenue falls.
Why does a small shortage cause a big price change?
When buyers respond little to price, the price has to rise a lot to persuade them to buy less. Set the elasticity to 0.1 in the calculator and watch the first line.
Which matters more for finance, micro or macro?
Both. Micro explains a firm's revenue and costs. Macro explains the interest rates, inflation and growth that surround every firm. The next lessons cover the macro side.
Sources and review
- OpenStax, Shifts in demand and supply for goods and services, Principles of Economics 3e (14 December 2022), for the difference between a movement along a curve and a shift of the curve, and the drought and input-cost examples of supply shifts.
- OpenStax, Price elasticity of demand and price elasticity of supply, Principles of Economics 3e (14 December 2022), for the definition of price elasticity of demand and the elastic, inelastic and unit-elastic cut-offs.
- US Bureau of Labor Statistics, Average price: eggs, Grade A, large (cost per dozen), US city average (series APU0000708111, as published by the Federal Reserve Bank of St. Louis and last updated 14 October 2026), for the monthly prices in the egg table.
- Cal-Maine Foods, Inc., Fiscal 2023 results release (Form 8-K, Exhibit 99.1), for net sales, net income, the net average selling price per dozen, dozens sold, the 53-week and 52-week years, and the company's explanation of the results.
- Tesla, Inc., Fourth quarter and full year 2023 update (Form 8-K, Exhibit 99.1), for total automotive revenues, vehicles delivered, the company's gross margin for 2023 and 2022, and the wording on average selling price and mix.
How the numbers were checked: the calculator's results were recomputed in plain code and compared with the calculator for every combination of settings it allows. The percentage changes in the egg, Cal-Maine and Tesla tables were recomputed from the figures in the sources cited above. The egg prices are those in the series as it stood when last updated on 14 October 2026, and the series can be revised. The supply elasticity of 0.2 and the starting market are assumptions for teaching.