Economics for Business: Supply, Demand & Costs

You’ll be able to

Explain the laws of supply and demand and how they set market price
Distinguish fixed costs from variable costs
Analyze how opportunity cost informs business decisions

Supply, demand, and market price

Markets set prices through the interaction of supply and demand. The law of demand says that, all else equal, as price rises, the quantity consumers want to buy falls. The law of supply says that as price rises, the quantity producers want to sell rises. Where the two curves meet is the equilibrium price, at which the quantity supplied equals the quantity demanded. Shifts in either — a new trend raising demand, a shortage cutting supply — move the equilibrium and change the price.

Fixed costs versus variable costs

Every business faces two kinds of costs. Fixed costs do not change with output in the short run — rent, insurance, salaried staff — you pay them whether you sell one unit or a thousand. Variable costs rise and fall with production — materials, hourly labor, packaging — each additional unit adds more. Total cost is the sum of the two. Knowing which costs are fixed and which are variable is essential for pricing, break-even analysis, and deciding whether to expand.

Opportunity cost

Opportunity cost is the value of the next-best alternative given up when a choice is made. Every decision to use money, time, or resources one way forecloses using them another way. An entrepreneur who invests $50,000 in a shop gives up the interest that money could have earned, and the salary she could have drawn elsewhere. Good business decisions weigh not just the accounting cost but this hidden cost of the road not taken.

Total cost

Total Cost = Fixed Costs + (Variable Cost per Unit × Quantity)

Fixed costs stay constant while variable costs grow with output. This relationship underlies pricing and break-even decisions covered in later units.

Worked example

A t-shirt company pays $2,000 per month in rent and equipment (fixed) and $7 in materials and labor for each shirt (variable). What is its total cost in a month when it produces 500 shirts, and what is the cost per shirt?

1.Identify fixed costs: $2,000 per month, regardless of how many shirts are made.
2.Compute variable costs: $7 per shirt × 500 shirts = $3,500.
3.Apply the total cost formula: Total Cost = $2,000 + $3,500 = $5,500.
4.Find cost per shirt: $5,500 ÷ 500 shirts = $11 per shirt.

Answer: Total cost is $5,500 for the month, or $11 per shirt. Note that spreading the fixed $2,000 over more shirts would lower the cost per shirt — the benefit of scale.

Checkpoint

Which of the following is a fixed cost for a manufacturing business?

Watch out

Do not confuse a fixed cost with one that never changes at all. Rent can rise next year, but it is "fixed" because it does not change with output in the short run. The test is always: does this cost move when I produce more units?

Checkpoint

The equilibrium price in a competitive market is the price at which:

On the exam

For cost questions, first classify each cost as fixed or variable, then apply Total Cost = Fixed + Variable × Quantity. Getting the classification right is usually where points are won or lost.

Answer the 2 checkpoints as you read.