Basic Economics: Supply and Demand

Part 2: Comparisons on Price

So we have supply, which is how much of something you have, and demand, which is how much of something people want. Put the two together, and you have supply and demand.

Now, how do you show the relationship between the two? One way is to use the price of something. Generally speaking, the price of something will go up if the demand goes up. Why? Because the seller thinks he or she can get more money for whatever he or she is selling.

If more people want something, they will be willing to pay more for it. A good example is the newest basketball shoes. Everybody wants them, and they will be willing to pay more than they normally would to get them. The demand goes up. Why? Because more people want them. The price also goes up. Why? Because the seller knows he or she can get more money for the product because it is in demand.

In the same way, the price will go down when the demand goes down. When the new style of basketball shoes comes out, everyone wants the new shoes. The old shoes don't seem so new anymore. The seller still wants to sell those older shoes, since he or she has a lot still in stock. So, the price goes down. Why? The seller hopes that people will be willing to buy the older shoes at a lower price. After all, the older shoes aren't that much older or worse than the brand new shoes.

What does all this mean? It means that you can track supply and demand by also tracking price. If something has a high price, you can usually conclude that the demand for that item is low. (This is not always the case; it is usually the case.) In the same way, if something has a low price, you can usually conclude that the demand for that item is high.

Why? First of all, a seller has already paid money for what he is trying to sell. A bookseller has paid \$4 for each paperback book he has on his shelves. He has bought 1,000 books and paid \$4,000. He is selling those same books for \$5 each. He hopes to sell all of them at \$5 each and get a total of \$5,000.

But what if the demand is low and no one wants to buy them? The seller wants to make some of his money back, so he might lower the price. He is already out the \$4,000. He can't change that. But he can change how money he is bringing in. If he lowers the price of the books to \$4 each, he breaks even on each book but still takes in some of the money he had spent to buy the books in the first place. And this bookseller would have had to lower the price of the books because the demand was low.

The reverse can also be true. If the bookseller decides that he wants to get as much money as he can back, then he might raise the price of the books to \$6 each, figuring that he will sell fewer books overall but will get more money for each book he sells.

Why would the bookseller do all of this? He would have paid money for those books in the first place, and he wants to decrease his supply of those books for two reasons: so he can get his money back and so he can stock more books. In the same way, the bookseller could try to decrease his supply of a certain book by lowering the price, thereby creating more demand.

What does it all mean? Supply and Demand are two very strong market concepts. Studying the two of them can give you a good idea of what people like to buy and sell. And you can track both supply and demand by comparing the price of an item over time.

To study Supply and Demand is to understand economics at its most basic.

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