Supply and demand are fundamental concepts in economics. You already know the law of supply and demand, right? Higher demand means higher prices, and higher supply means lower prices, or something like that. Let’s try to iron that out and expand it a little bit.
Supply is the amount of a good or service that is produced. A supply curve shows how much of a good suppliers are willing to produce at different prices. Every good and service has a different supply curve, but they follow the same general structure.
If the price of crops goes up, then a farmer will make more profit, so there’s an incentive to produce more crops. If the price goes down, it isn’t worth the farmer’s time to produce as much crops anymore.
GMO strawberries may be the cheapest to produce, while organic, grass-fed strawberries may cost a lot more to make. When prices are low, only farmers who have cheap production costs can afford to grow them.
But as the price gets higher, even the most expensive farming techniques become profitable. At a high enough price it would be profitable to make organic, grass-fed, Himalayan air purified, Saharan sun infused strawberries.
A supply curve is a summary of the way that producers respond to changes in price.
Demand is the amount of a good or service that people want. A demand curve shows how much of a good customers are willing to buy at different prices. Every good and service has a different demand curve, but they follow the same general structure.
If the price of strawberries goes down, it’s a better deal for consumers, so there’s an incentive to buy more strawberries. If the price of strawberries gets really high, like $50 per strawberry, then people will just go buy pineapples instead.
Now strawberries have a lot of potential uses. Some of those uses are high value like using them as models in expensive oil paintings. And some of those uses are low value like throwing them at bad comedians on stage.
When the prices of strawberries are low, the strawberries being demanded are used for high and low value uses. As the strawberry price goes up, people won’t be willing to buy strawberries for low value uses anymore.
At higher prices, the only buyers are those who use strawberries for high value purposes.
The demand curve is a summary of the way that buyers respond to changes in price.
The equilibrium price is the price at which the quantity that buyers want to buy is equal to the quantity that sellers want to sell. Supply and demand are equal, and we get to some equilibrium price and quantity.
If the price is above the equilibrium, then customers won’t want to buy it, while suppliers will want to produce more. This creates a surplus.
Since the sellers can’t sell their strawberries anymore, they’re incentivized to lower the price to outcompete other sellers. As the prices fall, demand increases and supply decreases, until demand and supply are equal again at the equilibrium price.
If the price is below the equilibrium, then suppliers won’t want to produce anymore, while customers will be eager to buy. This creates a shortage.
Since buyers can’t get the goods at the current price, they’re incentivized to buy at higher prices to outbid the other buyers. As the prices rise, supply increases and demand decreases, until supply and demand are equal again at the equilibrium price.
In a free market, buyers and sellers acting in their own self interest land on a price that allocates products to the highest value buyers, produced by sellers with the lowest production costs, in a way that maximizes gains from trade.
People act almost as if they were led by some kind of...invisible hand.