Supply and Demand - The Basics

I have a lot of things to post about, but it would be pointless without first covering some of the basics. Economics without an understanding of supply and demand is like Barak Obama without a teleprompter, incoherent and nonsensical. Economics is simply the study of how limited resources are allocated in a world of unlimited wants. Supply and demand are the measuring sticks that we use to see how this process occurs. The easiest way to illustrate their interaction is with a graph. Be forewarned however, economists use graphs as often as Angelina Jolie adopts children, so if you don't like graphs, well, you must hate orphans...shame on you!



The basic supply and demand graph is pretty simple. On the x axis we have the quantity of a good or service and on the y axis we have the corresponding price of the good or service. Demand is plotted as a curve moving from high to low as we move to the right. This illustrates how demand works. As the price of a good or service falls, the quantity demanded of it increases. You have probably experienced this when you go to the dollar store and see that a pack of 32 ping pong balls only costs a buck, whereas Walmart sells them for $2. So you buy 13 packs of them. I mean, what a bargain! I would have only bought 5 packs at that ridiculous Walmart price. Now, I know I am not the only one that has bought 416 ping pong balls on an impulse. ...Hey, stop judging me!

The supply curve works the opposite way. It goes up as we move to the right because as the price rises, more of the good or service becomes available. As the price that people are willing to pay for ping pong balls goes up, the more ping pong ball suppliers are willing to make because there is a lot of money in ping pong balls (like, no duh!). Its where these two curves meet, that producers sell the most ping pong balls that the consumer is willing to pay that price for and the consumer gets the lowest price the supplier is willing to sell that number of ping pong balls at. This point is called the equilibrium. At this point, everyone is happy (except your wife).

Lets say, hypothetically, that you really like ping pong balls but your wife says, hypothetically, that you are a lunatic for buying 32 packs of them. So now you need to sell them. You put them on Ebay and set the Buy It Now price at $3 per pack, already figuring up how much bubble wrap your profits will buy. By the end of the auction, you start to think that people don't appreciate the implements of table tennis like you do. The winning bidder STEALS them from you for a measly 25 cents per pack (probably those evil Walmart people, taking advantage of the less fortunate). My, errr... I mean your original price was clearly too high since it did not attract any buyers. When the price is too high, there are less buyers than sellers which leaves a lot of balls on the market. This is called a surplus of balls. When the price is too low, there are more buyers than sellers and there are not enough balls for everyone (probably Bush's fault, but I digress...). This results in a shortage of balls. Both surplus and shortage represent inefficient use of ball capital. In a perfect world, we would always be at equilibrium, everyone would get exactly the number of ping pong balls they want. And what a world that would be... But in most cases, the market is in a constant flux, moving from surplus to shortage as all of the participants try to get the best deal or make the most profit. When left alone, the market will come pretty close to equilibrium most of the time. Its when we try to force it one way or the other that the problems begin.

Now, whenever you hear something on the news about the economy, you can refer back to the graph to see if that makes sense or not. We will use that graph a lot as we look at various issues in future posts. Remember, the laws of economics work whether or not we want to believe they do. Just like hypothetical wives consider closets full of ping pong balls to be "stupid" whether we believe it or not...I'm sure she will feel differently about the bubble wrap.