Supply and Demand

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You’ll often hear people talk about the “supply curve” and the “demand curve” and “supply must meet demand”. This is a critical component of fundamental economics that every voting American should understand. Certainly, every businessman understands this, and exploits it to make a profit.

The price of a good or service determines a lot. It determines who, if anybody, will buy that product. It also determines who, if anybody, will sell that product. In short, the price is where buyers and sellers come together to make a deal.

Obviously, if the price is too high, then no one or very few people will buy the product. As the price decreases, demand increases. If the price is very low, then everyone can and will buy the product. They may even use it for something it wasn’t intended to be used for. This is called the “demand curve”. While no one knows what the demand curve actually is for any product, we do know the following facts:

  • As price increases, demand for the product falls.
  • As price decreases, demand for the produce increases.

The “supply curve” explains how sellers react to changing prices. At a low price, no one can sell the product and stay in business, so the product doesn’t get sold. At high prices, everyone wants to get in on the act and supply increases. Again, no one knows what they curve actually is for any product, but we do know the following facts:

  • As price increases, supply of the product increases.
  • As price decreases, supply for the product decreases.

These two curves end up looking like two paths that are each running in opposite directions. Somewhere in the middle, the paths cross. This is the magical point where “supply meets demand”. This point is what the price of the product should be.

Now, as I said, no one can say with much certainty what the demand or supply curves actually are. All we know is how they react to changing conditions. We’ve just described what happens when the price changes. This is observed throughout the world. But other conditions can change the supply and demand curves as well.

  • The value of certain goods and services may change. As something becomes more valuable, its demand increases, raising the price. If something loses value, its demand decreases, lowering its price.
  • Innovations that reduce the cost of delivering a good or service tends to increase the supply curve. At the same price, more of the same product can be provided. This drives prices down.
  • Taxes reduce the supply curve. At the same price, less product is delivered because the cost of making a sale has gone up. This drives prices higher.
  • Regulations also reduce the supply curve, making it more difficult to deliver the same product. The price goes up with more regulation.
  • An increase in the money supply moves the demand curve up. As people have more money, they can spend more on the same stuff. All things being equal, this is called “inflation”.
  • A decrease in the money supply has the opposite effect. With less money available, people can’t spend as much as they used to, so demand falls. This drives prices down. We call this “deflation”.
  • People’s expectations of current or future conditions also affect the supply and demand curve. Depending on what they foresee, they will either delay purchases or sales today, or try to obtain or liquidate what they have.

With a basic understanding of the supply and demand curves, it becomes elementary to predict how government policy will affect our economy. It becomes obvious that taxes, regulations, government borrowing and spending will increase the price of goods, while limited government policies such as low taxes, limited regulation, and limited spending will decrease the price of goods.

It also becomes apparent that the road to economic success is innovation. By finding ways to lower the cost of goods and services, the supply curves shift to provide much more of the same product at the same price, or the same amount of the product at a much lower price. We should hold innovators with the greatest regards, whether that innovation is in the sciences or in how a business is administered.

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