Shifting supply and demand in the classic model
- Learn more about the assumptions embedded in the classic supply and demand model
3. Assumptions in the Classic Model
In describing the classic supply and demand model, we also mentioned several of its assumptions. For clarity, we reiterate those assumptions, as well as some additional ones, here:
- buyers and sellers are both price-takers in the market, such that neither buyers nor sellers can do anything to affect the price at which the good is exhcanged;
- the market must clear, which means that the amount of the good produced by sellers must match the amount of the good demanded by buyers;
- there is a single price in the market, which is the price at which the market clears; and
- buyers and sellers have perfect information, which means that they have access to all facts that might influence their decision-making, including characteristics of the good being exchanged and their own reservation prices and marginal costs.
Under these assumptions, the shape of the supply and demand curves determines the equilibrium price and quantity. As described previously, there is nothing in the model that specifies how equilibrium is reached and, if underlying factors change (such as the shape of the supply and/or demand curves), how a transition may occur from one equilibrium to another. The model instead treats each combination of factors as its own snapshot: when the factors are one way, the equilibrium is a certain way; when the factors are another way, the equilibrium looks a different way.
In the Interactivity section of the Imagine Economics introductory module, we describe how we can think about economic modeling assumptions in layers.
The assumptions above are part of the outer layer for the classic supply and demand model; these are assumptions we make so that the model is well defined and can be solved.
There are even deeper assumptions, however. For example, one is that buyers and sellers are different people (rather than, for instance, recognizing that people may buy the product that the business they work for produces). Another is the assumption that individual buyers and sellers are the entities that have decision-making power (rather than, for example, organizations or institutions). Another is that buyers and sellers make their decisions independently and without regard for non-market factors, such as social norms or influences.
Although it is beyond the scope of this module to explore these assumptions in detail, we want to highlight that they are fundamental to the setup of the classic model. Given their importance, it is worthwhile to think about other model formulations that could more explicitly consider such factors and their implications.
However, it is likely that one or more of these assumptions does not hold when considering a real-life market. For instance, we can think of many markets where sellers are able to set their individual sales prices such that they are not price-takers.