No two terms employed in the language of economics are better known and oftener misused than demand and supply. One of the most severe critics of our subject once said that a parrot could be made an economist by merely teaching him to answer "demand and supply ' to every question put to him. This statement was extreme and meant to ridicule. Yet it has a sound foundation, for relatively few people have ever seriously attempted to analyze the nature of these terms. We have already seen that demand is effective desire; also that an individual has a demand only when he is willing and able to satisfy it by foregoing the use of other goods - that is, to pay the current price. Desires, therefore, are constantly becoming demands. In the light of this knowledge we can, by recasting slightly the meaning of the word demand, say that there are active demands (demands in the strict sense of the word) and potential demands (desires or wants).
Likewise, supply may mean one of three things. First, it may mean the supply of goods offered at the current price - that is, the supply which owners are willing to furnish on the instant at the market price. Second, supply may mean, in addition to the amount supplied, goods that would be offered at higher prices. Third, it may mean goods not yet produced, owing either to a lack of time or to an unsatisfactory market price. When we speak, therefore, of demand and supply we ought to have clearly in mind the exact nature of each. Otherwise, we are almost sure to create confusion, and to acquire habits of loose thinking.
It is apparent no doubt that neither demand nor supply works independently of the other; that there is a close mutual relationship. Any increase in demand, other things remaining equal, produces a change in supply; and conversely, any change in supply produces a change in demand. Professor Marshall has likened them to the two blades of a pair of shears, both of which are necessary if any cutting is to be done. It is also apparent from this analogy that supply and demand naturally tend to approach each other. Increase in demand tends to raise price, and, consequently, causes an increase in supply. An increase in supply, on the other hand, tends to lower price, thus increasing the demand.