Supply and Demand - Explained

supply and demand are the fundamental basis upon which economics and finance are built understanding these simple concepts will open you up to understanding all subsequent economic topics and will help you to better consider the implications of government action regulation taxation consumer habits and even the stock market if you're new to economics or need a refresher about the supply-demand relationship then this video is for you so let's dive in supply and demand have been understood by human beings throughout history if you had a lot of something and another person wanted what you had there was an agreement which could be reached between the two of you where both parties could benefit this relationship though well understood for millennia was not well explained until the scottish philosopher and father of economics adam smith wrote it down in the first ever economic textbook an inquiry into the nature and causes of the wealth of nations or just wealth of nations for short in this book smith noted that water and diamonds fetch very different prices this so-called water diamond paradox seems almost ridiculous of course a diamond costs more than water but why water is essential for human life we can't get more than a few days without it diamonds on the other hand have almost no practical value and in smith's day many people went their whole lives without ever seeing a diamond in person and therein lay the difference between the two prices even the water has much more demand than a diamond being demanded by everyone everywhere almost every day water is common and makes up almost 70 percent of the earth's surface it is not hard to come by water in most places diamonds on the other hand require a lot of labor to extract are hard to find and generally quite small because the supply of diamonds is so much less than water and the cost associated with their extraction is so much greater the price consumers are willing to pay for a diamond is higher this relationship though abstract is represented in nearly every transaction we encounter when we talk about supply and demand and economics we normally draw a very simple graph we show an x-axis which indicates the quantity of a given product then we show the y-axis which represents the price of a given product we then draw a demand curve the demand curve can be thought of as a function which slopes down and to the right this means that there are consumers who demand a given quantity of this product at any given price for example consumers demanding a product on the far left side of the demand curve are willing to pay a very high price for a small total quantity of something in the case of a product like oil this can be thought of as organizations like airlines who require oil in the form of jet fuel regardless of the price in order to operate their business they may not buy as much oil based jet fuel when prices are higher but they will be buying it because their existence requires it this can also represent wealthy people who purchase a product regardless of price because they have a very low utility for money like when you buy designer brands and products simply because of the name not because they do anything in normal sports shoe couldn't it as you move towards the left side of the demand curve you can see that the total quantity increases because as the price decreases more consumers are willing to purchase that product at a lower price in the case of oil this can be thought of as a product like petroleum jelly where there exists many substitutes for a given product consumers don't have to use petroleum jelly but if the price is low enough it could incentivize them to use it over alternatives now we need to add the supply curve the supply curve normally shifts up and to the right intersecting the demand curve at some point there are special exceptions to the supply curve sloping down but that's a very very unique case and we will discuss this scenario in a later video for now consider that nearly all supply curves look like this one think of the price for the supply curve as what suppliers the sellers in the economy want to get for their product if they sell for a lower price then the seller will not likely produce as much of that product but as prices increase the sellers are willing to produce much more of a given product the point at which these two lines intersect is called the equilibrium price this is the level at which the price and quantity of a given product will settle in an economy at this point the sellers are happy to supply the maximum amount of quantity at a given price and consumers are happy purchasing a given quantity at a given price if the price were higher or lower you are left with unhappy sellers or unhappy buyers and this is shown in the form of shortages or surpluses where consumers don't get enough of what they want or suppliers have too much of something left over in properly functioning economies this shouldn't happen however in poorly functioning economies unhappy sellers and consumers are the norm now we can move the supply and demand curves let's start with the demand curve first demand can change for a variety of reasons perhaps consumer taste changes and what was once popular is now unpopular like cd disks we can see the demand curve shift down this means consumers are willing to pay less for a product and therefore the equilibrium price moves with the shift in demand a lower price and lower total quantity demanded likewise demand could increase as the population grows the product reach is expanded to new countries or people generally want more of a product like smartphones we can see the demand curve shift up resulting in more total quantity demanded as well as a higher price but what about supply supply can also shift up and down but for different reasons than demand if the supply curve shifts up it could be a result of a few things perhaps the cost of producing an item has increased and now the supplier requires a higher price per unit produced this shifts the curve up and therefore increases the equilibrium price while lowering the total quantity supplied the curve could also move down if the component of the product has become cheaper or if more of the product has been found like a new oil reserve that was previously undiscovered this would shift the curve down which lowers price and increases the total quantity supplied there are many other things to consider in supply and demand dynamics like taxes subsidies and elasticities which will all be discussed in a separate video what we hope you've learned today is the fundamental underpinnings of economic theory which will help propel you forward in interpreting real world economic concepts for yourself we hope you've enjoyed this video if you have questions or thoughts about supply and demand leave a comment below also if you want to learn more about economics and finance don't forget to like and subscribe so you can see more 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