Supply, Demand, and Shortages.

What is a shortage as economists understand the term? To answer this carefully, we must employ economists' favorite tool: supply-and-demand graphs.

Figure 1 depicts a competitive market for a given good or service, with prices on the vertical axis and quantities on the horizontal axis (the way it is traditionally done in economics).

The demand curve DD has the usual property of a negative slope: reading along the curve, the higher the price, the lower the quantity demanded, and mutatis mutandis in the other direction. The curve is drawn as a straight line only for convenience; it can have any shape or any position, depending on consumer preferences, the number of consumers, their incomes, etc., provided its slope is everywhere negative. The demanders are consumers if we consider the market for a consumer good (or service); they are intermediate users if the market is for an input (say, labor services or material). For ease of exposition, we will consider the market of a consumer good.

The supply curve SS shows a positive slope: the higher the price, the higher the quantity supplied. Provided this condition is satisfied, the curve can have any shape or position depending on production (including distribution) costs. The slope of the supply curve is positive because of the law of diminishing marginal productivity: if all workers are given the same amount of other inputs, the worker is less productive than the previous one if only because the previous worker was assigned the most urgent tasks. Thus, every successive unit produced by the firm has a higher marginal cost, especially in the short run where, by definition, the size of a factory or office is fixed.

On one side of the market, consumers who prefer to have some (or more) of the good at a higher price will bid up its price. On the other side of the market, the competition by suppliers who are eager to produce (or sell) a unit as long as its price is above marginal cost will push down the price. These two factors lead to the market-clearing or equilibrium price P,, where quantity demanded is equal to quantity supplied at [Q.sub.1] units. [E.sub.1] is the market equilibrium.

Staying on Figure 1, suppose that supply decreases--that is, the supply curve shifts inward to S'S'. Because of cost increases, producers reduce their quantity supplied at any given price. At the old price [P.sub.1], quantity supplied is now [Q.sub.3] and faces quantity demanded [Q.sub.1]. (Important note: Quantity...