In a situation in which there are many sellers but a single monopoly supplier can adjust the supply and price of a good at will, the monopolist will adjust the price so that his profit is maximised given the amount that is demanded at that price. A similar analysis using supply and demand can be applied when a good has a single buyer, a monopsony, but many sellers.

Where there are both few buyers or few sellers, the theory of supply and demand cannot be applied because both decisions of the buyers and sellers are interdependent - changes in supply can affect demand and vice versa. Game theory can be used to analyse this kind of situation. See also oligopoly.

The supply curve does not have to be linear. However, if the supply is from a profit maximizing firm, it can be proven that supply curves are not downward sloping (i.e. if the price increases, the quantity supplied will not decrease). Supply curves from profit maximizing firms can be vertical or horizontal or upward sloping.

Standard microeconomic assumptions can not be used to prove that the demand curve is downward sloping. However, despite years of searching, no generally agreed upon example of a good that has an upward sloping demand curve has been found (also known as a Giffen good). Non-economists sometimes think that this would not be the case for certain goods. For example, some people will buy a luxury car because it is expensive. In this case the good demanded is actually prestige, and not a car, so when the price of the luxury car decreases, it is actually changing the amount of prestige so the demand is not decreasing since it is a different good.

9. Discrete Example

The above discussion of supply and demand can be thought of in terms of individual people interacting at a market. Suppose the following people exist:

Alice is willing to pay $10 for a sack of potatoes.

Bob is willing to pay $20 for a sack of potatoes.

Cathy is willing to pay $30 for a sack of potatoes.

Dan is willing to sell a sack of potatoes for $5.

Emily is willing to sell a sack of potatoes for $15.

Fred is willing to sell a sack of potatoes for $25.

There are many possible trades that would be mutually agreeable to both people, but not all of them will happen. For example, Cathy would be willing to trade with Fred for any price between $25 and $30. If the price is above $30, Cathy is not interested, since the price is too high. If the price is below $25, Fred is not interested since the price is too low. Of course, just because a trade is possible, doesn't mean it will happen. Each of the sellers will try and get as high of a price as possible, and each of the buyers will try and get as low of a price as possible.

Imagine that Cathy and Fred are bartering over the price. Fred offers $25 dollars for a sack of potatoes. Cathy is just about ready to agree when Emily offers to sell a sack of potatoes for $24 dollars. Fred is not willing to sell at $24 dollars, so he drops out. At this point, Dan can offer to sell for $12. Emily won't sell for that amount so it looks like the deal might go through. At this point however, Bob steps in and offers $14 dollars. At this point, we have two people who are willing to pay $14 dollars for a sack of potatoes (Cathy and Bob), but only one person (Dan) willing to sell for $14 dollars. So the price must go up because Cathy and Bob are both willing to pay more than $14 dollars. As soon as the price hits $15 dollars, Emily will be willing to sell so there are now two people willing to pay $15 dollars and two people willing to sell at $15 dollars so the trades can happen. But what about Fred and Alice? Well, Fred and Alice are not willing to trade with each other since Alice is only willing to pay $10 and Fred will not sell for any amount under $25. Alice can't outbid Cathy or Bob to try and purchase from Dan so Alice will not be able to get a trade with them. Fred can't underbid Dan or Emily so he will not be able to get a trade with Cathy. In otherwords, a stable equilibrium has been reached.

A supply and demand graph could also be drawn from this. The demand would be:

1 person is willing to pay $30 (Cathy).

2 people are willing to pay $20 (Cathy and Bob).

3 people are willing to pay $10 (Cathy, Bob, and Alice).

The supply would be:

1 person is willing to sell for $5 (Dan).

2 people are willing to sell for $15 (Dan and Emily).

3 people are willing to sell for $25 (Dan, Emily, and Fred).

And here is the graphs:

10. Application: Subsidy

A subsidy is a payment from the government to a firm or individual in the private sector, usually on the condition that the person or firm that receives the subsidy produce or do something, or to increase the income of a poor person.

For our example, we will think of a subsidy for the production of corn. (Some countries have paid subsidies for the production of grain in order to make food cheaper for poor people). Let us suppose the government pays corn farmers a dollar per bushel of corn, in addition to whatever price they get in the marketplace. Figure 11 shows the supply and demand for corn. A subsidy per unit of production works pretty much like an excise tax, except in reverse. In particular, we can look at the change from the point of view either of buyers or sellers. In this example, we will look at the subsidy from the point of view of the buyers. From their point of view, the subsidy is an increase in supply.

A Subsidy

Accordingly, the figure shows the subsidy shifting the supply curve to the right, from S1 to S2. The vertical distance is the amount of the subsidy: one dollar per bushel. Demand is D, as usual. With supply S1 -- before the subsidy is given -- the market equilibrium price is p1 and the equilibrium production is Q1. With supply S2 -- when the subsidy is given -- the market equilibrium price is p2 and the equilibrium production is Q2. We may conclude that a subsidy per unit of production reduces the market price (though not quite by the full amount of the subsidy) and increases the production of the item subsidized.

Conclusion

How are we to understand the market for a good such as beer, potatos, or cheese? Common sense can tell us that the supply, demand, price and quantity produced are interdependent, but how do they depend on one another? The most general and important answer to that question in modern economics is encapsulated in the "Supply and Demand" model.