The Principle of Supply and Demand

One of my most vivid memories in high school was in 11th grade, when my economics teacher, a big, stout football coach who I will affectionately call Mr. G, explained to our class the principle of supply and demand. The first day, he drew a graph of a basic supply and demand table and said, “This explains almost everything there is to know about money and the flow of money.” After that, every morning, he would throw us each a stack of practice problems, each duller than the last. The routine continued for the last two weeks of the year, which he had reserved for personal finance.
Going back to Pareto’s Law (See Blog 1) or the 80/20 rule, the principle of supply and demand does indeed explain the majority of how money works. I’ll attempt to recreate Kurt’s lecture.
Let’s take a look at the basic price-quantity graph above with the example of the cost of a teddy bear (TB). The red line represents supply — the total bears available to purchase. The blue line represents demand — how much people are willing to pay for a bear.
The point that the red line and blue line intersect is called the equilibrium point. By following the horizontal line all the way to the left, we get the fair market price for a single bear. When we follow the vertical line all the way down, we get the number of teddy bears available to the market.
As British mathematician George E. B. Box once said, “All models are false, but some are useful.” There is almost always a deviation from the equilibrium point that the graph failed to predict and take account for. An example would be investors buying up all of the bears to drive down quantity. Another example is a large retailer going out of sale and dropping the price of the bears by half to clear its inventory.
The lines in the graph can also be shifted.
An increase in supply is the same as shifting the red line to the right. An example would be the talking teddy bear distributor deciding to double the number of teddy bears on the market from 1 million to 2 million bears.
An decrease in supply is the same as shifting the red line to the right. An example would be the talking teddy bear distributor deciding to decrease the number of teddy bears on the market from 1 million to half a million bears.
An increase in demand is the same as shifting the blue line to the right. An example would be twice as many customers wanting to buy the product because of good word of mouth and advertising.
An decrease in demand is the same as shifting the red line to the right. An example would be half as many customers wanting to buy the product because of poor word of mouth and lack of advertising.
Mastering the principle of supply and demand is a prerequisite for mastering money.
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