# Supply and Demand Examples in the Stock Market

The stock market determines prices by constantly-shifting movements in the supply and demand for stocks. The price and quantity where supply are equal is called “Market Equilibrium”, and one major role of stock exchanges is to help facilitate this balance. We can use the stock market to give some great supply and demand examples with buyers and sellers who want different prices.

# Supply of Stock

“Supply” refers to the total number of stock holders who would be willing to sell their shares at any price. For example, lets say we have 10 shareholders, each of which would be willing to sell their share at a certain price:

All these sellers “value” their share differently. The shareholders on the left would be willing to take a much lower price for their shares than the sellers on the right. If we look at the whole market for shares, as the price goes up, the total number of shares “supplied” also goes up:

At a market price of $10, only 1 share will be supplied, but at a price of$25, 5 shares would be supplied.

# Demand For Stock

“Demand” refers to the total amount of stock potential buyers would be willing to buy at any price. We can use a similar example to the one above – imagine we have 10 people who want to buy 1 share each, but are only willing to pay a certain price:

Unlike supply, this means that as the price goes up, fewer people are willing to buy a share. For example, if the price per share was $30, only 4 people would be willing to buy (the 4 on the right side) who would be willing to pay$30 or more). If we look at the total demand as a graph, it slopes downwards:

# Market Equilibrium

“Market Equilibrium” is the point where the supply and demand meet – all the potential buyers and sellers trade until there is no-one left who agrees on price. In a graph, you can see the equilibrium point as where the supply and demand meet.

With our example of buyers and sellers, we can see the exact point where the market reaches equilibrium:

At a price of $27 (actually anywhere between$25.50 and $27.50) and a quantity of 5, the supply equals demand and the market is balanced. From a practical standpoint, these are the buyers and sellers who made a trade: The buyers who wanted the stock the most, and the sellers who were the most eager to get rid of it, made their trade. For the other buyers, no seller was willing to sell their stock low enough for them to want to buy. The next-lowest seller wants$28 for their stock, but the next-highest buyer will only pay $25, so no more trades will happen. # Efficient Equilibrium This example makes sense, but why didn’t we have 8 trades instead of 5? If all the highest and lowest buyers and sellers were linked directly, a lot more trades could take place. Unfortunately, there are some big problems with this. The biggest problem is information: the lowest seller, who sold for somewhere between$10 and $12, can now see that someone else just sold their share for over$35 – all the sellers would only try to sell to the highest buyers, and all the buyers would only try to buy from the lowest sellers.

## Producer, Consumer, and Total Surplus

If the potential buyer who is willing to pay $38 wants to make a good deal, they will first try to buy from the person who only wants$10. This way they start with an extra value of $28 – the difference between how much they were willing to pay and how much they actually had to pay. We call this bonus the “Consumer Surplus”: Consumer Surplus = Highest Price a buyer is willing to pay – Price they actually pay On the other side, the sellers want to make the most profit they can, so the seller who would take$10 at the minimum would much rather sell to the high buyer for $38, making themselves an extra$28. We call this bonus the “Producer Surplus”:

Producer Surplus = Price a seller actually sells an item for – Lowest price they would sell for

However, we can’t have it both ways. Since the buyer and seller both don’t want to lose out, there will be negotiations and the final sale price will fall somewhere in the middle. In a good system, we will get the maximum amount of these “bonuses” as possible – we want the biggest Total Surplus. We call the pricing and trading system that gives the most total surplus “Efficient”.

Total Surplus = Consumer Surplus + Producer Surplus

Lets compare the two trading systems – the one where the most number of trades happen (but every trade has a different price) with the one where supply and demand are equal at one price. We will assume that the buyers and sellers in the first system are paying the average of their two prices, and splitting the surplus evenly.

Total surplus when all trades have different prices

Now let’s compare this to the system where everyone is trading at the same price:

Total surplus where everyone pays the same price

## Supply And Demand Examples – Bid And Ask Prices

This instead makes a system of Bidders and Askers – when you get a quote on a trading platform, you’re seeing the most the highest buyer is willing to pay as the Bid Price, and the least a seller is willing to sell for as the Ask Price.

This is an example of a quote for Twitter (symbol: TWTR). There are three prices shown – the Bid Price, the Ask Price, and the Last Price, and this is the exact situation we have already seen with our buyers and sellers above!

The “Last Price” tells us what happened the last time a buyer and seller agreed on a price – they traded at $25.70. The “Ask Price” tells us how much the next-lowest seller wants for their share – he wants at least$28.00

The “Bid Price” tells us how much the next-highest buyer would be willing to pay for a share – he will pay up to $25.00. This also impacts you when trading – if you’re trying to buy stock with a “Market Order“, you will get the “Ask Price”, or how much the current sellers want for their stock. If you try to sell with a Market Order, you will get the “Bid Price”, or how much current buyers would be willing to pay for your shares. # Pop Quiz If reading this article was an Assignment, get all 5 of these questions right to get credit! Click "Next Question" to start the quiz! 1 of 5) Why does the quantity supplied of stock go up when prices go up? 2 of 5) In our example, what would be the Quantity demanded at a market price of$20?
3 of 5) "Market Equilibrium" is...
4 of 5) What is "Consumer Surplus"?
Why do we want to maximize the Total Surplus?