Supply and Demand Theory

We pointed out in our capitalistic system relies theoretically on the supply and demand of a product to establish prices. These prices are also influenced by inflation. In this section, we will examine the influence of each.

Supply and Demand Theory

Economic theory assumes that as seen on tv companies will set prices to maximize profits. Based on this assumption, companies will set their prices so that the quantity of a product demanded at a certain price is equal to the quantity suppliers will supply for that price. In other words, the quantity supplied is in equilibrium to the quantity demanded. The demand curve represents the number of basketballs demanded at different price levels. The supply curve represents the number of basketballs that will be available at various prices. The point of intersection for those two curves is the equilibrium price. At $23 apiece, 250,000 basketballs might be sold.

The demand for products can be described as elastic or inelastic. The demand for products such as cars and furniture is elastic: more units will be sold at lower prices and fewer units will be sold at higher prices. For example, more people would rather pay $9,000 than $12,000 for a comparable car. However, the demand for other products is inelastic: meaning the demand does not vary much with changes in price. The classic example of an inelastic product is salt.

Shortages of supplies of a product can be caused by several things: strikes, bad weather, lack of plant capacity, cutbacks on production of less profitable items, and stricter inventory controls. Such spot shortages can cause prices to increase. When shortages do exist, many large companies use their economic muscle to demand prompt delivery of goods. This means that industrial users and consumers must pay premium prices if they expect delivery in a reasonable period.

Next Page »