Supply and Demand:
the driving force of capitalism
What is a market?
When I refer to a market, I don't mean a physical place where people go to buy stuff. Rather, I mean the larger structure that develops when a whole lot of different people or companies are supplying and demanding a particular product.
Supply is...?
Supply is when one or more companies offer to sell a product. In most markets, most of the supply comes pretty directly from production. (In some markets, such as precious metals, the product may be stored for long periods of time, or traded around quite a number of times.) If a lot of competing parties are trying to sell the product, then in the long run the price will tend to go to about the amount it costs to produce it.
Yeah, well what about demand, Mr. Smarty Pants?
The demand is kind of the opposite of the supply. Demand is what happens when one or more parties wants to buy a product. If a lot of competing parties want to buy a product, then in the long run the demand will tend to make the price of the product equal to the utility of it (how much good it is).
That's nice. What's so special about supply and demand then?
It all gets complicated when one realizes that neither the price, nor the supply nor the demand are constants. There is a (often simple) relationship between them.
As price goes up, supply goes up. If I can make one dollar per bushel of potatoes, I'll grow a certain number of potatoes. If, the next year, I can make two dollars per bushel, I might well skip planting other stuff so that I can plant more potatoes. If price is low, I'll try to make money some other way.
As price goes up, demand goes down. If the price of potatoes at the supermarket remains the same, I'll probably buy about as many as I ever did. If the price goes up, then I might eat more carrots and fewer potatoes, or I might even just not eat as many vegetables at all. On the other hand, if the price is very low, I might try to substitute potatoes for some more expensive food.
As you might guess, there tends to be a point where these things all work out. In a healthy market (where there are lots of buyers and sellers competing) then all other things being equal, in the long run the price buyers are willing to pay for a product will be right about the same as the price it costs to produce (often just a little bit more, allowing profit, but not much of it). This is the equilibrium point on a supply-demand graph (insert graph here).
This graph is just a generalization. In real life, while the lines maintain their general directions, the actual slope is hard to figure out. If company A builds a new factory for making widgets, how will that affect the supply curve for widgets? If there's a new fad in North America of teenagers wearing bellbottom pants, how will that change the demand curve? Surely the demand will go up, but by how much and at which supply level? In general, the real world changes too often to ever map out the complete supply-demand relationship fully before it changes again.
The amazing thing about the market is that, just because each person does the thing that's best for them, the result is that every single product's market comes pretty close to its proper equilibrium price. Certainly it's not perfect, but I can tell you how I can tell that nobody's ever found a better way of finding these equilibrium prices: if anybody had a more efficient way of finding these prices (through a computer program or a complicated mathematical equation, for example), then they could use it to make a killing on the commodity markets of the world. Since no one person seems to have any particular control of the commodity markets, it seems clear that nobody is better at predicting the proper prices in the markets than the market at a whole is. The end result of everybody's doing their own thing is what's called emergent behavior. A whole lot of individuals following relatively simple rules can have a net effect that's far larger and more complicated than those simple rules would suggest.
Neat.
All together, I would say that the market is the second most powerful discovery of human prehistory (after agriculture; I'm not a big fan of fire or the wheel). It is a way to actually solve the apparently intractable problems of production and distribution of goods in a human society. Ants have their pheromone systems to arrange huge groups of themselves into a semblance of order, we humans have our markets. The trouble is that markets don't always work the way we'd like them to.
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