Supply and demand is one of the basic principles of economics and the free market. The amount of supply of a product combined with the demand of a product will determine its price.
Here are some examples of how supply and demand works.
Example #1: The Price of Oranges
In this case we will look at how a change in the supply of oranges changes the price The demand for oranges will stay the same. The demand curve doesn't change.
In the first year, the weather is perfect for oranges. Orange farmers have a bumper crop. This increases the supply of oranges. Because there are so many more oranges on the market, the farmers reduce the price of oranges in order to sell all of them.
Graph showing the supply shift to the right. This causes the price to drop.
In the second year, there is a terrible drought. The amount of oranges produced is reduced dramatically. Because the demand stays the same, but there are fewer oranges to sell, farmers raise the price of the oranges.
Graph showing the supply shift to the left. This causes the price to increase.
Example #2: Designer Jeans
In this case we will look at how a change in demand can change the price of designer jeans.
When a new style of designer jeans was introduced, they were the height of fashion and very popular. Everyone wanted to own a pair of these jeans. The designer ordered more of the jeans, but still had a limited amount to sell. With demand so high, the designer could charge a very high price for the jeans.
Graph showing demand increasing as supply stays the same.
A year later, however, things changed. People grew tired of the jeans and they were no longer popular. The demand for the designer jeans fell. The only way the designer could sell any was on discount racks. The price dropped significantly.
Graph showing demand decreasing causing the price to drop.
Example #3: Finding the Right Price
Let's say you invented a new product. It cost $10 to make the product. How much would you sell the product for? Well, it would have to be more than $10 to make a profit, but what is the perfect price? You first try to sell the product for $100, but no one buys it. So you lower the price to $50 now you sell 100 of them. When you lower the price again to $25 you sell 1000. This is great! When you lower the price to $12 you sell 5,000.
Of the above options, what is the best price for your product?
$50: At $50 you make $40 on each item. Selling 100 items, you make $4000.
$25: At $25 you make $15 on each item. Selling 1000 items, you make $15000.
$12: At $12 you make $2 on each item. Selling 5000 items, you make $10000.
The best price is $25. At $25 you will make the most profit.
Other Examples
If there was only one pizza restaurant in a town and then a new pizza place opened, the demand for pizza from the first restaurant would drop.
The price of gasoline often changes with the demand throughout the year. As people drive more in the summer, gasoline prices tend to rise.
If a large company leaves a small town, many people will be out of work or have to move. This can reduce the demand on housing causing home prices to drop.
Note: This information is not to be used for individual legal, tax, or investment advice. You should always contact a professional financial or tax advisor before making financial decisions.
