The supply and demand model illustrates how price and quantity sold are determined in a free market.

Assumptions:
1. Perfect Competition - An industry comprised of many small firms, each producing an identical product.
2. Static Model - Time is fixed.

Part 1: The Demand Schedule

The demand schedule is used to represent the behavior of consumers. It is a table that shows the quantity of a good that consumers are willing and able to purchase at various prices, ceteris paribus. The ceteris paribus assumption means that everything else that might affect quantity demanded, other than price, is held constant Common sense tells us that there is an inverse relationship between quantity demanded and price. In other words as price goes up the amount we are willing to buy goes down. This is known as the law of demand.

The quantity demanded is the dependent variable and it is a function of several independent, or explanatory, variables. We can use mathematical notation to represent this relationship

Qd = f (price, income, taste, the price of substitutes, the price of complements)

where

Qd = dependent variable or endogenous variable
Qd = dependent variable or endogenous variable

Note:

• Price is the independent variable or exogenous variable
• Taste, income, price of substitutes and the price of complements are parameters
• Complements - Commodities that must be used together. For example, a car and gasoline or a CD and a CD player.

The demand curve, or the relationship between price and quantity, can be represented graphically as follows:

Note: When graphing any relationship where price is one of the variables, it is always placed on the vertical axis.