Let's start by defining the terms, which are so intertwined that Wikipedia.com actually combines them in a single entry on the topic. In this entry, authors on the site define the terms by saying that 'Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity.' Investopedia.com, whose authors call the supply and demand concept 'the backbone of a market economy,' explain the concept in slightly different terms,
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship.
So, what does this mean in its simplest terms? Supply is the amount of a thing in an economy, whether that thing be a commodity like oil or a commodity like labor. Demand is the requirement that economy has for the thing, driven by factors like production and growth. Price is a function of how these two factors play off of each other. So, when supply remains the same, and demand rises, price rises. Likewise, when demand remains constant and supply rises, prices fall. The relationships work in reverse as well. A few simple examples might help to illustrate the point.
Say a baseball card collector is a fan of the Boston Red Sox and is missing only a Ted Williams card to complete his otherwise impeccable collection of Sox players in the Hall of Fame. Because there are relatively few Ted Williams cards on the market (low supply), and because it is a highly sought after item (high demand), the price will be much higher than one might expect for what is otherwise a smallish piece of thin card stock. Fans of programs such as Antiques Roadshow are similarly able to observe these forces at play on a daily basis when people dig out the rare and highly sought tea set that they thought was ugly trash in the attic. On the flip side, and back to the baseball card example, a card currently in mass production and easy to obtain (high supply) representing a shall we say less-than-perennial-All Star-caliber-player (low demand) might only be worth a few pennies.
To summarize, both the supply of, and demand for, a good are important factors in the pricing equation. They play off of each other and are constantly changing for any given good. If supply and demand and how they impact pricing are clear, the next important factor to discuss in the supply/demand relationship is elasticity.
Elasticity is very simply the extent that the aforementioned changes in pricing impact consumer behavior. The demand for elastic goods can vary widely at different price levels. The demand for inelastic goods changes less as price does. Let's take another example to illustrate. One that is griped about quite often in a situation that the government is able to effectively exploit for tax revenues is cigarettes. Cigarettes qualify as a classic inelastic good because even when the price goes up, people who are addicted still buy them. Gasoline, medicine and butter are all similarly good examples. Of course there is always a breaking point. Indeed, in some cases, consumers will seek out alternatives, or substitutes, even for inelastic goods when things become severe enough. One example is the increase in smaller and/or electric vehicles when gas prices increased in the US over a protracted time period. However, in general terms when price increases occur, demand will remain fairly static for such goods.
As one might imagine, the opposite of inelastic goods are elastic goods, or those which, when price shifts occur, behaviors rapidly adjust accordingly. These items are not typically 'necessaries' and often have substitutes more readily available than inelastic goods as well, further facilitating behavioral adjustments. Some examples would include expensive hotel rooms during a recession (one could substitute a cheaper room, or even a day trip, rather than a resort vacation). Another example could be generic rather than brand name goods, or used cars rather than brand new models.
So supply and demand shifts and interplay impact the pricing of goods, and elasticities reflect how consumer react to those price changes. Let's take a look at how all of this comes together in an example that has relevance to a lot of my fellow law students; the current job market.
In a boom economy, things are easy. There is a lot of corporate activity (the good kind, not bankruptcies), and firms hire both more summer associates and lateral employees. There is plenty of work and profits, so job seekers might receive a number of bids. In other words, their labor (supply) is in high demand, so the price (wages) goes up. This is all fairly intuitive and easy to follow. The cliche 'a rising tide lifts all ships' is certainly appropriate in these situations.
However, economies around the globe are currently in a bust cycle. Not only is this worse for job seekers for supply and demand reasons, it is even a bit more complicated due to factors such as minimum wages, seniority, etc. If in a boom, the rising tide lifts the ships, in a bust a falling tide creates muddy puddles and confusion. Though one could intuit that bad economies lead to lower wages and that young lawyers would benefit due to a willingness to work for less, they would not be correct in reality. Indeed, it is the restriction of supply and demand forces that is leaving many young lawyers jobless currently.
For example, if the price of labor were allowed to fluctuate naturally, employers would simply depress wages and those who were willing to work would accept them. This might actually be good for young lawyers as those who were nearing retirement might be stimulated to do so a bit earlier, or maybe as senior associates decided to embark on alternate career paths. However, cultural norms dictate that wages aren't allowed to fluctuate on the downside to the extent that they otherwise might, keeping many currently employed lawyers right where they are and saddling newly minted ones with loans and a lack of prospects. In other words, demand is artificially restricted to keep prices high, and therefore there is an excess supply of labor, or unemployment (another topic for another day perhaps) which is all quite depressing.
On second thought, maybe it isn't so helpful to understand supply and demand after all...