Supply, Demand, and Allocation

As we have seen, one of the key words in economics is "allocation." To allocate resources is to determine who gets the use of what resources.

An obvious case of allocation of resources is when the government decides who will get the use of the resources. But market processes of bidding, buying and selling can also determine who gets the use of what resources. That is, in effect, markets can allocate resources.

Accordingly, economics is centrally concerned with the workings of markets, and with the question, how do markets allocate resources? One answer to that question is expressed in the familiar phrase, "Supply and Demand."

Here, again, we encounter "models." The allocation of resources through markets is a complex process. The economist's approach to understanding this complex process is to

conceive a model based on some of the key aspects of the market system,
abstract from other aspects, and
to investigate the workings of the model,

with the idea that the answers will then be applicable (at least as hypotheses to be checked) to the actual market system.

While there are several models of resource allocation through markets, the model of "Supply and Demand" is the best known and most widely used model. It is the starting point for the others (though most of the other models begin by contradicting some aspect of the Supply and Demand model).

The main objective of this chapter will be to introduce the Supply and Demand model, together with very brief sketches of some alternative models.

We are concerned with efficiency in the allocation of resources, so a natural question to ask is whether the market allocation of resources is efficient. This is a large and complex question. Over the next few chapters, we will explore some of the dimensions of the question and its answer.

Economic Analysis