Prices and quantities are set by the interaction of willingness to buy and willingness to sell. Shifts in either curve change the equilibrium; elasticities determine how much price vs volume moves.
Classical and neoclassical economics (Smith, Marshall, Walras)
The basic market model: a downward-sloping demand curve and upward-sloping supply curve intersect at equilibrium price and quantity. Policy, technology, preferences, and constraints shift curves; elasticities govern sensitivity.
Demand – quantities buyers will purchase at each price. Shifters: income, preferences, substitutes/complements, expectations, population.
Elasticity (price): %ΔQ / %ΔP. High elasticity → volume moves more than price.
Cross-elasticity: response to other goods’ prices (subs/complements).
Supply – quantities sellers will offer at each price. Shifters: input costs, technology, capacity, regulation/taxes, expectations.
Elasticity: short run often inelastic (capacity fixed), long run more elastic (investment possible).
Equilibrium – intersection (P*, Q*). Surplus if P > P*, shortage if P < P*.
Incidence: who bears taxes/subsidies depends on relative elasticities.
Price controls: floors (surplus), ceilings (shortage) when binding.
Pricing and revenue – estimate own- and cross-elasticities; choose price moves vs volume goals.
Capacity & capex – gauge supply elasticity and lead times before committing investment.
Commercial diligence – test demand shifters, pass-through, and competitor supply responses.
Product & GTM – identify substitutes/complements; design bundles and versioning.
Policy & contracts – model tax, tariff, or rebate incidence; set escalation clauses.
Marketplace/platforms – balance two-sided supply and demand; manage surge/constraints.
Define the market – product, segment, geography, time frame (short vs long run).
Measure – gather price–quantity data; identify substitutes/complements; note capacity limits.
Estimate elasticities – own-price, cross-price, and income where relevant.
Identify shifters – tech, input costs, regulation, seasonality; separate shifts from movements along curves.
Simulate scenarios – apply shocks (±% to shifters); compute new equilibrium and split between P vs Q.
Decide levers – price change, promo, mix, capacity, contracts (indexation, floors/ceilings).
Confusing shifts with movements – a price change moves along a curve; shifters move the curve.
Ignoring heterogeneity – elasticity differs by segment, channel, and time horizon.
Capacity & frictions – short-run supply is often kinked by bottlenecks and lead times.
Averages vs marginals – decisions ride on marginal effects, not historical averages.
Externalities & controls – taxes, quotas, or price caps change outcomes and incidence.
Linear comfort – relationships are often non-linear; watch for thresholds/tipping points.
Click below to learn other mental models
Richard Koch’s rule to back category leaders in high‑growth niches; leadership + growth compounding.
A KPMG framework that links what to aim for (financial ambition), where to play (business model), and how to win (operating model) across nine levers.
Build the smallest thing that tests the riskiest assumption with real users, measure what matters, and decide to pivot, persist, or kill.