Supply and Demand Is Not What Most People Think
Shon Czinner
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Supply and Demand Is Not What Most People Think<br>The Supply and Demand model does not predict the impact of price on quantity.
Shon Czinner<br>Aug 01, 2026
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Here’s a quiz:<br>(1) Developers increased the quantity of housing in my city by 10,000 last year. What is the impact on housing prices per the ECON 101 supply and demand model?<br>(2) Housing prices fell last year by 20% in my city. What is the impact on new housing quantity this year per the ECON 101 supply and demand model?<br>To (1), most people answer "Prices will fall."<br>To (2), most people answer: “Quantity will fall.”<br>Yet both answers are incomplete. They could be right or wrong, depending on why housing quantity increased and why prices fell.<br>For the increase in quantity, if homes were built because the demand curve shifted right (e.g. your city experiences a gold-rush), prices may rise. If they were built because the supply curve shifted right (e.g. your city relaxed binding zoning laws or binding height restrictions), prices will indeed fall. The quantity change alone tells you nothing.<br>For the decrease in price, if it is because the demand curve shifted left, new building will decrease. If it is because the supply curve shifted right, quantity will increase. The price change alone tells you nothing about quantity.<br>Here’s Substack author Mike Fellman making this mistake:<br>They [The supply and demand curves] predict that if home prices are high and rising, more homes should be produced than if homes are cheap or prices are falling.
However that is not a prediction of the Supply and Demand model. That’s the relationship in the supply curve.<br>Here’s economist Noah Smith getting it wrong as well in a podcast with fellow economist Russ Roberts1:<br>[People say] ‘We just built 10,000 houses and price went up. Supply and demand is fake, man.’<br>What happened was we had a small supply increase and a very large demand increase. And obviously the demand increase outweighed the supply increase, so you’re going to get prices going up.
Roberts quickly corrected Smith:<br>Well, I would say it a little differently. I would say we moved along the supply curve. We didn't shift the supply curve. And, that increase in the quantity supplied doesn't bring prices down. It's a response to the increase in demand that started things moving.
Roberts is correct because the Supply and Demand model predicts what happens in response to shifts in supply or demand curves. In Smith’s scenario, the demand curve shifted right increasing price and quantity supplied.<br>Here’s how the Supply and Demand model works:<br>(1) If an area’s desirability increases (shifting the demand curve), price and quantity increase.<br>(2) If an area makes it more expensive to build (shifting the supply curve), price increases and quantity decreases.<br>On their own, supply and demand curves describe relationships between prices and quantity. The two curves have opposing relationships.<br>The demand curve says people demand a lower quantity when prices are higher. The supply curve says builders supply a greater quantity when prices are higher. The Supply and Demand model does not predict the impact of market price on market quantity or vice versa. The Supply and Demand model predicts what happens to market price and market quantity in response to shifts in supply or demand curves.<br>The connection between prices and quantity is opposite for producers and consumers. The Supply and Demand model is about predicting the equilibrium.
Using Fellman’s logic one could equivalently say, “The supply and demand curves predict that if home prices are high and rising, fewer homes should be consumed than if homes are cheap or prices are falling”.<br>Again, however, that’s not a prediction of the Supply and Demand model. That’s the relationship in the demand curve.<br>When Smith says “the demand increase outweighed the supply increase” he is presenting the common, but incorrect understanding of Supply and Demand. An increase in quantity does not require a shift in the supply curve.
LLMs get it wrong too. This was ChatGPT’s response to both:<br>Per the ECON 101 supply-and-demand model, an increase in the supply of housing shifts the supply curve right, causing equilibrium housing prices to fall (and equilibrium quantity to rise).
Per the ECON 101 supply-and-demand model, a fall in housing prices causes a movement along the supply curve, leading developers to supply a smaller quantity of new housing.
Economist Scott Sumner posted about how LLMs fail on Supply and Demand questions in February 20232. Despite researchers in 2023 naming a paper “ChatGPT has Aced the Test of Understanding in College Economics” they found that ChatGPT answered only 19 of 30 microeconomics questions correctly and had 33% accuracy on supply and demand problems3.<br>The Supply and Demand model might just be widely...