supply and demand

At its root, what supply and demand says is "if I have a lot of x, and you have a lot of y, we can trade x and y in a ratio we work out according to our respective needs of x and y and everyone will be better off -- we will have aquired a good which we value more in return for a good which we value less." Instead of trading goods, we can exchange money for goods, or services for goods, etcetera, etcetera. The law works whenever there is a scarcity of something which is in demand.

For instance, let's say I sell pet chickens in a small town. I do a poll door-to-door, and find what people would be willing to pay for a chicken (thus finding the level of demand at certain prices), and create a table with that data; additionally, I figure out how many chickens I can afford to produce at certain prices (since I'd have to build more coops, hire more trucks to send chickens out, hire more chicken trainers to make sure the chickens are housebroken, etc). Here's that table:

flamingweasel's chicken monopoly:

|price | # demanded | # supplied |
|------+------------+------------|
| $1   |     100    |     10     | <-- (point 1)
| $5   |      80    |     20     |
| $9   |      60    |     30     |
| $13  |      40    |     40     | <-- (point 2)
| $17  |      20    |     50     |
| $21  |      10    |     60     |
| $25  |       1    |     70     | <-- (point 3)

• Point 1: Supply < Demand - Well, I'd definitely sell all my chickens, but I'd only make $10. In a market with lots of competition, this may be all I can do (more on that later)
  
  
• Point 2: Supply == Demand, or Equilibrium - Here is the ideal spot, the most efficient use of everyone's energy. I make $520, and the most people get the most goods at the best price for both of us. Once you move off this spot, the transaction is no longer perfectly efficient -- one party is giving up more than the other party is giving up.
  
  
• Point 3: Supply > Demand - Bad place for a seller to be. I've invested a lot of money into producing a whole bunch of chickens, and must raise prices accordingly, but I can only sell 1 at this price. And since chickens aren't very easy to warehouse, this is a disasterous place for me to be.

flamingweasel's chicken farm versus ChickenMart:

|price | # demanded | supplied by | supplied by |  total |
|      |            |   weasel    | ChickenMart | supply |
|------+------------+-------------+-------------+--------|
| $1   |     100    |     10      |      20     |   30   |
| $5   |      80    |     20      |      40     |   60   |
| $7   |      70    |     25      |      50     |   75   | <-- (near equilbrium)
| $9   |      60    |     30      |      60     |   90   |
| $13  |      40    |     40      |      80     |  120   |
| $17  |      20    |     50      |     100     |  150   |
| $21  |      10    |     60      |     120     |  180   |
| $25  |       1    |     70      |     140     |  210   |

Weep for the future.

Weep for us all.

The relationship between supply and demand is often expressed graphically.

The y axis (vertical) represents the PRICE of the product/service.
The x axis (horizontal) represents the QUANTITY of the product or service.

The DEMAND CURVE slopes downward (high on the left, low on the right.
The SUPPLY CURVE slopes upward (low on the left, high on the right.

The point where the supply curve and the demand curve meet is called the EQUILIBRIUM point. Using flamingweasel's chicken monopoly from above as an example, point 2, where the price is 13$ and the quantity supplied is 40 chickens, is the equilibrium point for that market.

The point where the demand curve meets the vertical axis (price) is the point at which the price is too high for any of the product to be sold. Back to flamingweasel's chicken monopoly, if he tried to sell his chickens for $28 a piece, the demand for his chickens would go to 0 because no one would buy a chicken from him for that much.

The point where the demand curve meets the horizontal axis (quantity) is the amount of the product that people would want if it was free. If flamingweasel was giving away his chickens, the town still wouldn't want more than 150 of them.

Factors in the economy can make the supply and demand curves shift. The supply curve shifts left and right along the horizonal quantity axis. The demand curve shifts up and down along the vertical price axis.

Demand curve shifts:

• Changes in Income: If everyone in the town gets a pay raise, and now all have 100 extra dollars to spend, they might be more willing to pay a higher price for chickens, causing the demand curve to shift upward. The inverse is true as well.
• Availability of Substitutes: at this point, flamingweasel is the only person in town selling chickens. But if his neighboor starts selling turkeys for half of what flamingweasel is selling his chickens for, the people might decided that turkey is just as good as chicken, and buy the turkeys instead. This would cause the demand curve for chickens to shift downward.
• Changing Tastes and Preferences: If the most respected doctor in the town is quoted in the news as saying "We have proven that eating chicken will make you bald and fat, but turkey is really great for you." peoples tastes are going to shift from chicken to turkey, causing the demand curve for chicken to shift down.
• Expectations: If flamingweasel announces that he will only have chickens for one more week and then he won't have any for the rest of the year, people will expect to not be able to buy chickens for a while, so they will buy more while they are available, causing the demand curve to shift upward. (the demand for gasoline is highly effected by expectations)

Supply curve shifts:

• Number of Sellers: if someone else starts selling chickens, then there is a larger supply of chickens and the supply curve shifts to the right.
• Technology: if flamingweasel gets ahold of some way to make chicken eggs hatch faster, he can produce more chickens, causeing the supply curve to shift right.
• Expectations: if flamingweasel expects that people will be willing to pay more for chickens next month, he may withold some of the chickens he currently has so he can sell them for the higher price later. This would cause the supply curve to shift to the left.
• Price of Other Goods: if flamingweasel also raises pigs, and the price of pigs goes up, he will allocate more of his resources to raising pigs instead of chickens, causing the supply curve for chickens to shift to the left.