How does The Law of Supply and Demand work?

I am going to ask you a weird question: What was the demand for cars in year 1120? Someone could answer without any hesitation: “None, there was no cars at the time!” However, imagine following situation. If you were standing next to road and asking every single horse rider in 1120: “Would you like to have a vehicle that will let you move around much faster? You could travel up to 1000 km per day in comfortable way.” Majority of the riders, except from a few horse riding enthusiasts, would say: “Of course I would, it would save me time and effort!”

I will dare to say that demand for cars existed ever since the first man travelled by land for the first time. Of course it was unspoken demand, because no one was able to name a car as a solution to his transportation problems, but surely everyone wanted to make their travels more effective and efficient. It was only supply that was missing. Nowadays we can hear from mainstream economists that we need to increase demand, which is not high enough. However it is worth to remember, that people’s demand is unlimited. We, as a human beings always want to make our lives easier, to have more time and live our lives more convenient. There is always a demand for goods and services that are going to help us to satisfy our needs. Therefore, we must find someone who is going to provide us with those – we need supply for our demand.

Mark – who was a pencil producer, operated on a market in a small town. He was producing handmade pencils in quantity of 100 per month. His cost of production was 15 dollars per pencil. He was selling them for 20 $ for one piece and was able to sell all that he produced every month, so his profit was 500 $. However, this price was way too high for poorer people and only rich ones could afford them. Poor people were pretty upset with the fact they have nothing to write with. They used to say to Mark: “I would love to buy a pencil from you, but the price is too high for me.” Mark knew that demand for pencils is high but he was neither able to produce more of them nor lower the price. The only way to earn more was either increasing prices or lowering production cost.

Mark chose easier way at first. In order to increase his profit, he announced that his pencils will now cost 22 $. It turned out that he sold only 70 of them in following month because some customers chose cheaper, less convenient quill pen instead of expensive pencil. Mark earned 490 $. It was less than before! He realised that there is no sense in this price strategy, and decided that he is going to lower price of pencils by lowering production cost. He anticipated that it would help him to get to more customers. He took a loan from a bank and using the money he bought a machine from distant country. The machine was way faster, way more precise, and used less material per pencil. Thanks to the machine, his productivity went up, and he was producing 200 pencils per month instead of 100. Total cost of production was 10 $ so Mark was able to lower the price to 15 $ and he was selling all produced pencils at that price. His profit increased to 1000 $. He quickly paid the loan and his quality of life increased significantly.

Now, we can point out some lessons from the story. Firstly, Mark throughout whole story did everything to increase only his own income. He wasn’t worried about poor people, who couldn’t afford to buy his pencils. He didn’t lower the price because he was a philanthropist but because the solution was more profitable for him. At first he wanted to increase prices, but he lost part of his customers and earned less than before the increase. Afterwards, after lowering prices, he didn’t lower his profit of 5 $ per pencil. This shows us that, his drive to earning more wasn’t hurting anyone. In fact it was just the opposite. Because of his will to earn more, he found the way to produce more and cheaper, and by that he was able to reach greater number of customers. The side effect of his idea was higher wealth for the whole community.

On the free market, prices are falling because of higher productivity. Peter Schiff in his book “How an economy grows and why it crashes?” wrote that before the inception of FED, prices in USA were falling steadily throughout almost 150 years, just because of higher and higher efficiency of production. Those who are afraid of blood-thirsty capitalists should realize one important thing. The only thing the capitalist can do to us without government assistance is to offer us his products. We, as a customers, can buy it or not. The capitalist will earn only if he would offer us a good or service that we want in decent price. He is going to do that faster and more effective, when he won’t be interrupted. Our rising standard of living will be a side effect.
There are some exceptions to the law of supply and demand. You can read about them on our website econclips.com. For more subscribe our channel on YouTube, like us on Facebook and follow on Twitter.