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Explaining Supply and Demand

Dan Lehavi is a student, activist, economic enthusiast, and debater. He most frequently writes about economics.


Understanding Basic Transactions

The concept of supply and demand relies on two sides, the buyer side and the seller side. Both sides can have large chains with multiple people however they all boil down to a single transaction where one person or company buys a good or service from another person or company. Both sides have a clear obligation in this transaction. Sellers must supply the good or service and buyers must buy the good or service with money. Each transaction may also have other transactions within it. For example, if person A buys a product off of amazon, amazon probably doesn't produce that product. So amazon goes and buys said product then stores it and later, when person A puts in an order for it, amazon sells said product to person A. In this scenario, one transaction is really linked to two. Real life examples can involve many more transactions. Each individual transaction occurs within the scope of microeconomics or personal finance however, economies are built off of millions of these transactions and these economies operate within the scope of macroeconomics or the economics of entire countries.

Transaction- (noun) an instance of buying or selling something; a business deal.

What is Supply?

As previously mentioned, each side in a transaction has a certain obligation. This is where demand and supply come into play. The seller's obligation is to control the supply of a product. Simply put, supply is how much of a product you have. If you have ten bicycles you have low supply, whereas if you have ten-thousand bicycles you have high supply. When supply for a good is high, the price goes down. This is because the company knows that if they sell at too high a price, no one will buy their product. Therefore, they must lower the price in order to sell their product. The inverse is also true. Imagine you are at an auction with ten markers vs an auction with only one marker. With the ten marker auction, people won't bid as high because if they lose out on one marker, they can still buy the other nine. There will always be a marker for them therefore they won't buy until the marker is appropriately priced. However, if everyone is fighting over one marker, the price gets higher because everyone is rushing to outbid each other. This small scale example of an auction can be applied to much larger quantities in order to fully understand the scope of a supply curve.


What is Demand?

Demand is the other side of the transaction. Demand is much more simple to grasp. If more people want a product, demand for that product increase. The inverse is also true, if less people want a product, demand for that product decreases. Returning to the example of a marker auction. Assuming that supply is at some normal, constant value, say 5 markers, demand will control the price. The cost to create each marker is 50 cents so the bidding would start at one dollar. Assuming that demand is low, say 5 people, the price will never go above one dollar as each person is always guaranteed a marker so no one will pay more than they need to. However, once demand increases, say 20 people, no one is guaranteed a marker, so people are willing to pay more in order to ensure they get the marker. This means that demand is the direct inverse of supply in its relationship with price. When demand is high, prices are high, and vice versa.

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Understanding Supply and Demand Graphs

Now is the part where most people find it most difficult to understand. Pictured above is a supply and demand graph and the point in which the two lines intersect will be the price of the good. The graph clearly displays all of the information from the past two sections about the relationship between price and supply or demand. Here's the difficult part, how does the graph change when supply changes? Whenever supply or demand changes, the graph just shifts. If demand increases, you shift the demand line to the left. If the demand line is shifted to the left then the intersection point gets higher, in other words, a higher price. The same is true with supply. If you shift supply to the left, the price decreases proportionally. This graph will hold true for all products with certain exceptions.


Veblen Goods: The Exception

There is one notable exception to the supply and demand curve, Veblen goods. These are goods which, when priced higher, increase demand because of a perceived increase in quality. An example of this is wine. Typically, if you lower the price of a good, it gets cheaper. However, with wine, the opposite is true. Because consumers perceive cheap wine to be of lower quality, demand decreases. Therefore, by increasing pricing, a company can increase demand. There are many other goods like this such as phones and watches which behave in complete contrast to other goods however, the economy has little effects on these goods as they are mostly luxury items for which demand barley decreases during a recession.

© 2020 Dan Lehavi

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