The Foundation Of Economics
In Economics, there really is no more basic principle than the law of Supply & Demand; in fact, it could be argued that that's all economics really is, the study of the relationship between what we have versus what there is.
In this edition of Economics for Beginners, we're going to take a look at how the law of Supply & Demand drives our economy.
We'll look at how it affects our everyday lives, and how learning to analyze its influence in a particular area can save you a ton of money (and maybe even help you make a buck or two).
The Law Of Supply & Demand
Stays The Same
Stays The Same
Stays The Same
Stays The Same
Demand An Explanation
Demand is the measure of how much of a certain item is wanted. There are lots of things that can cause demand to increase or decrease, for instance: lots of people want heavy jackets when it's cold, this is an example of an increase in demand. Here are a few more examples of how demand can fluctuate:
- The demand for Ice Cream goes down in cold weather.
- When it's raining the demand for umbrellas goes up
- The demand for a specific toy can get very high at Christmas time
- School Supplies are in high demand in the fall.
- Because of Valentine's Day there is a high demand for Roses in February
Trying to determine the demand for a product is one of the things a business has to do when setting the price of that product. Sometimes, businesses will use price to try to increase demand, for example: putting an item on sale for 50% off can increase the demand for that item.
To understand how these changes in demand can affect the supply and price of an item, let's look at the "$2 Pizza" example:
Let's say that you have a favorite pizza place, and that they make a pizza that you love more than any other food in this world, and that pizza costs $20.
Now, imagine that your favorite pizza place had a new deal: they would deliver you your favorite pizza every hour on the hour, and that each pizza is only going to cost $2, no matter how many you buy. The catch is, you can't share, you're the only one that can eat them.
In the beginning, this would be a great deal; you love the pizzas and they're insanely cheap, only $2. After a while, you would get to a point where you were tired of pizza but you would keep buying them because of the cheap price. Eventually, you would be so sick of pizza that you wouldn't buy anymore, no matter how much they cost.
In this example, your demand for pizza decreased over time to a point where, finally, the pizza had no value to you at all. So how does this effect supply? Well, when you were buying lots of pizzas every hour, the restaurant had to make a bunch of them (increase supply) in order to keep up with your demand. Now that you don't want any more of the pizzas, they have a surplus.
A surplus is when you have more of an item than is needed. Most of the time when you hear people talk about a surplus, they're talking about a budget, but it applies to pretty much anything.
A Warehouse Full Of Goods
Grab Your Supplies
Supply is the measure of how much of an item there is available.
Generally speaking, supply is determined by demand. When demand increases, supply decreases. When demand decreases, supply increases.
Using the examples from the demand section, let's look at how fluctuations in demand can effect supply:
- Decreased demand for Ice Cream in winter will cause the supply to increase
- The supply of Umbrellas will decrease in rainy weather
- High demand for a specific toy can result in a limited supply
- School Supplies can be in short supply in the fall
- The supply of Roses will decrease in February as the demand increases
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Like with demand, businesses have to manage their supply effectively; for the most part, it's easier to manage supply than it is to anticipate demand, but there are times when sudden fluctuations in demand can be hard for companies to handle. These sudden changes can wreak havoc on supplies of goods, causing large surpluses, or causing a Shortage.
A Shortage is when there isn't enough supply of a certain item to fill the demand. If you were baking a cake, and the recipe called for three eggs and you only had two, then you would have an egg shortage, since the available supply (two eggs) wouldn't be enough to satisfy the demand (three eggs).
Sometimes, companies will use a surplus or shortage to try and influence demand (and thereby price) on certain items. For example: a car company may limit the production of a certain model to increase its demand. Some companies might also increase the supply of an item in an attempt to decrease the demand for a product.
The Price Is Right?
In economics, Price is where Supply and Demand intersect. Like we talked about above, price is determined by the relationship between how much of an item people want, and how much is available. When the demand goes up, so does the price. When demand goes down, prices come down.
To be honest, pricing is pretty complicated, mostly because there are multiple formulas for determining price. The key thing to remember is: no matter what method a company uses to set the price for its products, the basis for all of it is the intersection of supply and demand.
If we use the same examples we did for Supply and Demand, we can see how price is affected by those fluctuations:
- In winter, when the weather is cold, the demand for Ice Cream goes down, so Ice Cream is cheaper.
- In rainy weather, the demand for umbrellas goes up, so the price of umbrellas goes up.
- A limited supply of a certain toy at Christmas time can lead to increased demand, and prices can skyrocket.
- As the demand for School Supplies increases, the supply decreases, leading to higher prices.
- The high demand for Roses in February leads to short supplies, and higher prices.
Like with Supply and Demand, companies can use price to manipulate the other two. If a company has a surplus that it wants to get rid of, it can lower the price to increase demand. Similarly, if a certain product is less desirable, a company can raise the price to decrease demand.
How Studying Supply And Demand Can Save/Make You Money
Learning how to monitor and analyze supply & demand is a difficult task for anyone; there are economists who spend all of their time looking at market trends to try and figure out exactly what it is people want and how much of it.
There are some simple things you can do however, to maximize these trends, and even save yourself some money in the process:
Buying "Opposite Season": If you buy your clothes in the opposite season (summer clothes in winter, winter clothes in summer), you can take advantage of the decreased demand.
Geographical Demand: I live in Florida, since we only have about three days of winter each year, warm clothes are in short supply, and therefore expensive. On the flip side, summer clothes are cheap since the supply is so large. By shopping online and taking advantage of geographical demand, you can save tons of money.
Stockpiling: If you have the space to do so, buying large quantities of items when prices are low is a great way to save money on things you'll buy later anyway.
Along with saving money, you can also use these tricks to make money. By taking advantage of the differences in price between markets, you can use sites like eBay to make pretty good money.
Mel Carriere from Snowbound and down in Northern Colorado on August 07, 2016:
Ice Cream is in high demand in our house year round. In contrast, here in Southern California we never use umbrellas. Don't own one. Nonetheless, I think most of these principles explained here are valid most of the time. Great primer.
Cody Atkinson from Canada on March 11, 2016:
Every person living in a capitalist market needs to understand these principles.
Shawn McIntyre (author) from Orlando, FL. on August 06, 2013:
@heidithorne Thanks for taking the time to read the article, I'm glad you enjoyed it. =)
Economics is one of those subjects where a little knowledge can go a long way. I'm glad someone found some value in it.
Heidi Thorne from Chicago Area on August 06, 2013:
What a great hub with practical applications for what is sometimes quite an academic subject! Love the supply and demand grid. Voted up and sharing!
Shawn McIntyre (author) from Orlando, FL. on August 05, 2013:
@jainismus Thanks for stopping by, I'm glad you liked the article. =)
Mahaveer Sanglikar from Pune, India on August 05, 2013:
Great analysis of Supply, Demand and Prices. Thank you for sharing this useful information for beginners.