Supply and demand
Family XII · Other terms
Not to be confused with support and resistance, order flow, market structure.
Supply and demand describes the two sides of a market and the way their interaction sets price and quantity. Supply is the schedule of quantities sellers will offer across a range of prices; demand is the schedule of quantities buyers will take. Where the two schedules meet, the market clears at an equilibrium price and quantity.
The two schedules
A supply schedule lists the quantity sellers will offer at each price, other things equal. It normally slopes upward: higher prices attract more production or more willing sellers. A demand schedule lists the quantity buyers will take at each price. It normally slopes downward: higher prices push buyers toward substitutes or out of the market.
In financial markets the same logic appears as an order book. Resting sell orders form the supply side; resting buy orders form the demand side. The best ask is the lowest price at which someone will sell, and the best bid is the highest price at which someone will buy.
Equilibrium and shifts
Equilibrium is the price at which quantity supplied equals quantity demanded. A movement along a schedule is caused by a change in price. A shift of a schedule is caused by something else: for demand, changes in income, preferences, or the availability of substitutes; for supply, changes in input costs, technology, or the number of sellers.
Shifts change the equilibrium. A rightward shift in demand raises both price and quantity. A rightward shift in supply lowers price and raises quantity. When both shift at once, the direction of one variable may be ambiguous.
Worked example
In trading
Traders read supply and demand through price and volume. Heavy volume near a price level suggests many participants are willing to transact there; thin volume suggests few. Support is often described as a zone where demand has previously absorbed supply, and resistance as a zone where supply has previously absorbed demand.
These levels are tendencies, not guarantees. Order flow, news, and liquidity can overwhelm either side of the book, and the resulting price move is the market resolving an imbalance between supply and demand.
Often confused with
- support and resistance
- Support and resistance are price levels on a chart where buying or selling pressure has previously halted or reversed a market move, forming horizontal zones that traders watch as potential turning points.
- order flow
- Order flow is the sequence of buy and sell orders reaching a market, including their size, price and timing, as distinct from the resulting trades printed on a chart.
- market structure
- Market structure is the observable sequence of swing highs and swing lows on a price chart, classified as trending or ranging according to whether those swings extend in one direction or overlap.