Why does a pack of gum cost 89 cents, not 89 Dollars?
The simple answer is called Supply and Demand. But, this isn’t so simple because a wide swath of the US population has no clear understanding of what supply and demand is and how they interact with it on a daily basis. We will attempt to tackle this in Chapter 2.
There is no resource in this world that is infinite. All resources have to be rationed to one degree or another. This happens through the economy. Economy is just way to move products, goods, and services from the people who are will to provide them (supply) to the people who want them (Demand).
You demand gum and someone agrees to sale you gum for $1. You buy the gum and all is well. Your demand for gum is satisfied, therefore your demand for gum is gone. Tomorrow, however, you want gum again. Now your demand for gum has returned. There is a twist this time. Someone else wants gum as well. What’s going to happen? The price will rise until one of the two individuals says they no longer want gum at the higher price. The first individual who no longer wants the pack of gum ceases to have demand for it. The second individual will purchase the gum at a higher price. We’ll say $2. Remember, the first individual only ceased to have demand because of price, therefore if the price comes down the first individual’s demand for gum will resume. That means the price of gum has to stay at $2. Value as explained in chapter 1 is the how much money it would take for you to part ways with it versus how much another person is willing to spend to part it from you. The value in this case is $2. Does the price of gum have to stay at or above $2? No. There are ways to bring the price of gum back down to $1 and satisfy both individuals demand for gum.
Someone out there sees that you are in demand for gum and he recognizes an opportunity to sale it to you. He also sees that you lost demand at $2. He’s going to sale it to you at $1. He accomplishes 3 things at that moment. First, he satisfies your demand for gum. Second, He undercuts the competition’s price because the competition can no longer sale at the higher rate. Lastly, he increases overall supply of gum.
The job of the supplier is riskier. Unlike the person who can just wake up and simply demand gum out of clear blue sky, the supplier has to calculate how many people are demanding a pack of gum. He also has to anticipate for how long the demand will last. Is this demand a fad, therefore it only last days or weeks, or is it long lasting and people will depend on these packs of gum for years to come?
Also, we think that demand comes before supply but sometimes it doesn’t. What if gum was invented today? Would you be in demand for it? Probably not. However, demand would grow over time as people tried gum, it becomes beneficial to their daily lives, and the benefits of gum spreads to others.
What would the initial price of gum be if it entered the market today? It would be high. Let’s say $10 per pack of gum. The reason is because the supplier had to risk his own capital (means money) to put gum on the market. Who would buy a pack of gum at $10 per pack? The rich, of course. However, the price of gum will fall as the supplier is able to get back his return on his investment, up production, and as other suppliers enter the gum market.
You might think that you have never seen this phenomena but you have. Think about the first iPhone when it entered the market and the subsequent competition that followed such as Androids. Think about limited availability of smartphones in 2008 versus the availability today in 2013. What is the overall effect of Supply and Demand on the Economy? We will continue to explore this phenomena in subsequent chapters.