Economic Fundamentals: Supply and Demand
The beating heart of economics is supply and demand. Someone wants something and someone else is willing to supply it at a specific price. This interaction between a producer and a consumer is what’s referred to as a market. Typically, it is displayed on a graph like the one seen below:
This graph shows Price of a good or service on the Y axis and Quantity of that good or service on the X axis. As mentioned, interacting on these axes are supply and demand curves as notated by the S line and the D line. Supply, as seen here, increases as price increases, and inversely, demand decreases as price increases. This is due to an increase in profitability for suppliers as price increases and an increase in buying power for consumers as prices fall. The point at which these two lines intersect is the equilibrium and provides the equilibrium price and supply. This equilibrium is the point at which the consumer’s demand matches the producer’s supply. When demand or supply changes for whatever reason or cause, so too does the equilibrium price and quantity. These changes are what’s often referred to as the invisible hand, the term coined by Adam Smith in his 1776 book titled “The Wealth of Nations”.
An example of supply and demand is the housing market in the U.S. during 2020. As lockdowns took hold, demand for housing in suburbs and smaller cities skyrocketed as Americans desired more space to live and work. As demand increased, so too did prices. This was due to demand outpacing supply in these areas. With higher demand than available supply, a supplier is incentivized to raise price and capture more profit. An incentive to supply more houses is also created but due to the lag in time taken to construct and list new homes, sharp price increases took place before additional supply could meet the demand. Below is a graphical representation of the downstream outcome of this type of situation:
As demand for homes with more space increased, the demand curve shifted upwards and to the right. As supply increases to meet that new demand, a new equilibrium is eventually reached at P2 and Q2. Markets like this are fluid and dynamic so these curves, and the subsequent prices and quantities they lead to, can change frequently. If enough homes are built in a particular area, the supply curve will then shift down and to the right leading to a higher quantity of available homes. A lower price will also result as the buyer will have more homes from which to choose. Most markets have not seen this effect yet, but it is a longer-term outcome that may take place over the coming years as new home construction projects are completed in these areas. These interacting effects of supply and demand are what help keep prices from ballooning exponentially. This is an ongoing interaction and ultimately individual consumption choices will drive what changes come next.