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Supply and demand are the two most important terms in economics. A thorough and solid understanding of these terms is crucial for understanding the markets, economics, and some government policies.
So, let’s go.
Demand: Demand are the buyers. Or, more specifically, demand is the desire and capability of people to purchase things.
Supply: Supply are the sellers. Or, more specifically, supply is desire and capability of sellers to make things available for purchase.
Once supply increases, when there’s more things for sale, prices will decline until it is low enough to attract more buyers to offset the increase in supply.
When demand increases, prices will begin to rise, until they’ve risen high enough to attract more sellers to offset the increase in demand.
The Law of Demand: The Law of Demand states that, as the price of an item goes up, and everything else stays the same, the quantity demanded by buyers will go down.
As the price of an item goes down in price, and everything else stays the same, the quantity demanded by buyers will go up.
In other words, people will buy more of something if the price is lower than they will buy if the price is higher.
The Law of Supply: The Law of Supply states that as the price of an item goes up, and everything else stays the same, the amount people are willing to sell will go up.
It also states that, as prices of an item go down, the amount people are willing to sell will go down.
It’s just common sense that people will sell more of something if prices are higher and they’re going to be getting more for it than they will sell if the prices are lower and they are getting less for it.
As prices rise, more and more sellers will begin to sell and more and more buyers will stop buying until a balance is reached.
As prices drop, more and more buyers will begin to buy, and more and more sellers will stop selling until a balance is reached.
That balance, the price at which the quantity demanded is exactly equal to the quantity supplied, is known as the equilibrium price.
So, let’s look at an example involving wheat being sold by the bushel.
Looking at the supply side, at $5 a bushel, farmers are only willing to supply 100,000 bushels of wheat. However, if the price were $6, farmers are willing to supply 200,000 bushels of wheat.
At $7, they’re willing to supply 300,000, all the way up to $9, where they’re willing to supply half a million bushels of wheat.
And that just is common sense, that people would sell more of something if they’re getting more money for it.
Over on the demand side, if the price per bushel is $5 per bushel of wheat, buyers will buy 500,000 bushels’ worth.
However, if the price is $7 per bushel, buyers will only buy 300,000 bushels.
All the way to where if the price is $9 a bushel, buyers will only buy 100,000 bushels of wheat.
Which just makes sense, that people will buy more of something when it’s cheaper and on sale than they will when it’s really expensive.
Putting the two sides together, we can see that the equilibrium price for wheat, at this particular time, is $7 per bushel.
If the price were to rise above or below $7 per bushel, there would either be a shortage of buyers or a shortage of sellers.
As the price rises above $7, more people start selling their wheat. There is more wheat for sale, yet the higher prices also mean that less people are willing to buy it.
This means that sellers must reduce prices back down to either attract new buyers or to get existing buyers to purchase more.
As the price drops below $7 per bushel, less people are now willing to sell their wheat. Yet the cheaper prices mean that more people now want to buy it.
This means that buyers are now competing with each other for the available supply, which causes prices to rise back up.
Price will move until supply and demand are balanced.
If the price is above $7 for wheat, a surplus will exist. There will be more wheat for sale than people want to buy.
For instance, at the price of $8 per bushel, sellers will want to sell 400,000 bushels of wheat. However, buyers will only be willing to buy 200,000 bushels of wheat at that price.
If no other buyer is wiling to increase the amount of money he was willing to pay, and the sellers still want to sell the wheat, they will be forced to lower their prices down to the next price any buyer is willing to pay; at this particular instance, it’s $7.
If the price is below $7 a bushel, there will be less wheat for sale than people want to buy. For instance, at $6 a bushel, buyers will want to buy 400 bushels of wheat; however, a seller will only be willing to sell 200 bushels of wheat.
If no other seller is willing to lower his price from the next available price at $7, if buyers wish to buy the other remaining 200 bushels of wheat, they must increase the price they are willing to pay from $6 to $7.
Now, let’s look at oranges. If the weather is particularly nice this year, there will be a rather large supply of oranges during harvest season.
If the farmers want to sell all these oranges, they must lower their prices so the stores can lower their prices so it will attract enough buyers to buy all the oranges and there will not be any left over.
If the weather is particularly poor this year, there will be a much smaller supply of oranges at harvest season. So, therefore farmers must raise their prices to offset their costs, since they have less oranges for sale.
Therefore, stores must raise their prices to offset their costs, which lowers demand as customers now buy less oranges because they are more expensive.
Once supply and demand find an equilibrium price, the price will hold steady until there’s either a change in supply or a change in demand.
If either supply or demand change, so will the equilibrium price.
The Elasticity of Demand: How much demand will change as prices change. Will a small change in price affect how much people are willing to buy? What about a big change in price?
The Elasticity of Supply: How much supply will change as prices change. Will a small change in price affect how much people are willing to sell? How about a big change in price?
A free market will determine market prices, and should eliminate both surpluses and shortages.
However, sometimes the government steps in and forces prices above or below the equilibrium price.
They do this by setting price ceilings, also known as caps, and price floors.
Price ceilings are regulations put in place by government that prevent prices from rising above a certain level.
This is sometimes done when shortages in commodities force prices to extremely high levels.
Price floors are regulations put in place by government that prevent prices from falling below a certain level.
This is sometimes done in agricultural products to protect farmers.
So, that sums it up for supply and demand. Hopefully everybody understands my presentation that I put forth for you. And we are ready to head into the next section on economics: The Gross Domestic Product.
I’ll see you in the next video. In the meantime, happy trading.
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Kevin MacLeod @ incompetech.com
