Question

Explain in at least one well-written paragraph how the law of supply and demand controls prices. Your response will include a description of demand, supply, and the relationship between the two. Your response/explanation should use a product or commodity as an example.

Answer 1

I can help you get started with a little info to give you a nudge in the right direction. One way to understand supply and demand that if something is in short supply, and a lot of people want it, it's going to valuable. For example, diamonds are valuable because they're rare. The same with rare metals like gold and platinum. But if they were as common as sand, they wouldn't be worth much at all because then everyone would be driving around in bling plated cars.

The same can also be for food. Food prices can go up if there's a problem, making it so that there's less of it out there. For example, if corn suddenly had a terrible harvest season, the price of corn would go up because there's not a lot of it to go around. There are also a lot of other reasons why prices would be more for certain things than others, but it's basically how it works.

You can find a lot more examples out there. Take a look around, check out a few prices for your favorite things, and ask yourself why they might be so expensive - and you'll start seeing a pattern of supply and demand and how it influences the economy.

Answer 2

Both supply and demand are terms that convey the fact that the resources and labor required to produce a good or service vary in quality and quantity.

For example, how much land, water and human labor is required to produce a bushel of corn? That question doesn't have just one answer, because the quality of land and weather, and of human labor in farming, varies in time and place. If you grow corn in Illinois, the land is fertile and the rainfall (usually) copious, so it's pretty easy. But if all the land in Illinois is already planted in corn, you might have to try to grow it in Kansas, where the land is not as fertile and the rain less predictable -- so you'll get less per acre and have to irrigate. Similarly, some corn can be produced by nearly anyone who has the wit to through seeds on the ground, while in other cases it can only be produced by someone who is deeply expert in doing it -- who has been raising corn for decades, and knows exactly how to avoid pests, bad weather, et cetera. The first person can be hired for a lot lower wages than the second.

Since people are rational, they will use the best resources and cheapest, most easily-available labor to produce a good or service first, and then, when those resources and labor are busy, turn to lower quality resources and more expensive labor as more of the good or service is required. The first barrel of oil will be simply collected from the ground where it seeps out by energetic yokels with nothing but physical strength and common sense to guide them. The last will be drilled from deep in the Gulf of Mexico, using hugely expensive diamond-tipped drills manned by people who have studied 10 years and have PhDs in geology.

What this means is that the amount of a good or service that is available rises with the price offered for it. Because to amount of resources and labor that go into the last bit of the good or service you want rises steadily. This uprising curve is called the demand curve. It always go up with price, but it may not do so steadily, and it will rise more or less steeply depending on the nature of the good or service. It will also shift over time -- technological progress tends to shift it to the right, as it makes production of the good or service cheaper at any level of supply.

Demand is similar, but the curve goes the other way. Presumably the first person in line for a barrel of oil -- or a haircut, new generation iPod, new song from a band -- is someone for whom the personal value of the good or service is very high. He derives HUGE amounts of pleasure from it, and will sacrifice a great deal of his own labor to get it. That is, he'll pay a lot, a high price.

The next person in line isn't so eager, and won't pay as high a price. And so on, until you get to someone who's reaction is "meh" and won't pay very much at all. So the demand for a good or service is the amount of good or service that can be absorbed by consumers at a given price. As the price falls, more people are happy about getting the good or service for the price, and as the price rises, fewer people are willing to pay it. (Notice, by the way, that because the price generally cannot be set according to how eager you are, although suppliers are always looking for ways to do that, the price is set by the least-eager person, and the most-eager consumers generally get the good for a lot less than they would be willing to pay. This is called the "consumer surplus.")

Equilibrium is reached when demand equals supply, and this happens at a particular price, where the supply and demand curves cross. This is the first aspect of "the law of supply and demand."

The other important aspect is that if something happens to shift either curve, then the price will adjust to bring the situation back into equilibrium.

For example, if government puts in place a mandate saying a certain amount of corn must be turned into ethanol, to save the planet, then the amount of corn available to make food at a given price is reduced -- the supply curve shifts left. That means the new crossing with the demand curve for food is at a higher price. So an ethanol mandate increases the price of food -- and this is simply the result of forces as natural and inevitable as the law of gravity. It will do zero good for the government to demand that the price of food not go up -- that makes no more sense than the government demanding that the tide not go out, or water flow uphill.

Similarly, if the government subsidizes college education, by using tax money to give out grants and loans, then the supply curve of college degrees shifts to the right -- there are more college degrees available at a given final price to the consumer. The supply curve has shifted to the right. The new crossing with the demand curve will occur at a higher demand, that is, consumers will acquire more college degrees. (Which, incidentally, means college degrees themselves acquire less value in the workplace, for the same reason: there is a greater supply at the same price employers are willing to offer.)

Things can change on the demand side as well, of course. When the weather gets hot, the demand curve for air-conditioning shifts left, and the price can be expected to rise, and when unemployment rises the demand curve for gasoline shifts right, and other things being equal the price of gas should fall (or not rise as much).

Part of the difficultly economists have talking about supply and demand is that people often mix together the results of short-term and long-term changes to supply and demand. For example, increasing the demand for smartphones means their price rises in the short-term: Apple can charge $500 for an IPhone because the demand is, initially, very high. But a high price also drives innovation and technology growth, and that tends to shift the demand back again. Because Apple makes so much money in smartphones, Samsung gets into the business and undercuts Apple, and the price falls as the supply increases...

So, does a strong market for smartphones mean the price will go up or down? Up in the short run, down in the long run is the correct answer. But unless you are thinking clearly it's easy to confuse the short- and long-run, and this is a general problem economists have talking about these things to people who haven't clearly thought out the processes involved.