Principle #6: Markets work well with competition, the rule of law, information, incentives, and property rights.
Objective:
Determine the pressure on price, quantity exchanged, and employment caused by a change in demand or supply
Why you want to learn this
Well this is the biggie! We promised that you would learn how and why prices change. You can apply this lesson to any market so you can look at labor markets and figure out what is likely to happen to the wage in a job that interests you. Here it is and it is pretty simple. Enjoy.
Effects on Price and Quantity Exchanged
You know that changes in demand will cause a change in the price of the product and the quantity that is bought and sold (exchanged) in the market. Similarly, a change in supply will cause a change in the price of the product and the quantity that is bought and sold (exchanged) in the market.
Demand Changes
The effect of a demand change is pretty easy. If buyers want and are able to pay more for a product (their income has increased or more people have moved into the market, or a successful advertising campaign has improved their opinion of the product, or any of the PRINTE factors have changed in favor of the product), that increase in demand will drive the price up. In addition, if none of the supply factors (GINEW) have changed, suppliers will attempt to squeeze more of the product out of their current resources. An increase in demand will cause an increase in price and an increase in quantity exchanged in the market; a decrease in demand will cause the opposite effect. So demand changes are easy…both price and quantity exchanged move in the same direction as the change in demand.
Change | Effect on Price | Effect on Quantity Exchanged |
Demand Increases | Increase | Increase |
Demand Decreases | Decrease | Decrease |
Supply Changes
This also is pretty easy. If the weather is better than expected, or input costs fall, or any of the GINEW factors improve, supply will increase, quantities exchanged will increase and prices will fall. If the opposite occurs, weather is very bad, or the government imposes restrictions on products, or there is a negative impact of any of the other GINEW factors, price will rise and quantity exchanged will fall. So still easy but not quite as easy as demand; price moves in the opposite direction, quantity exchanged in the same direction.
Change | Effect on Price | Effect on Quantity Exchanged |
Supply Increases | Decrease | Increase |
Supply Decreases | Increase | Decrease |
Often, when people see a price increase they will attribute it to some plot by evil people whose sole purpose is to make buyers’ lives miserable and to make obscene profits. In fact, regardless of whether suppliers are saints or sinners, unless governments intervene, prices can’t change unless there is a change in supply or demand. So, if you see a price decrease you know for certain that one of three things has happened – either demand has decreased, supply has increased, or both. If you see a price increase you know for certain that one of three things has happened – either demand has increased, supply has decreased, or both. In a market that is less than competitive, some individuals or groups may have the power to manipulate supply or demand, but they can’t change the price without changing either supply or demand.
Three steps of market analysis. To understand the impact of market changes on the price and quantity exchanged, three steps are necessary.
Identify the market in terms of product, time, and place. The market for sand at the beach in the summer is different from the market for sand in the mountains in the winter. The market for heavy coats in the summer in California is different from the market for heavy coats in the winter in Alaska. The market for surfboards in Southern California is different from the market for surfboards in Nebraska. Product, time, and place are important in identifying markets.
Identify the change in the market as a change in demand or supply and identify the direction of the change. Is it an increase or a decrease in demand or supply?
What pressure was or will be the impact on price, quantity exchanged, and employment in the market?
Important note:
A change in demand cannot cause a change in supply in the short run. A change in supply cannot cause a change in demand in the short run.
Bottom Line
In a competitive market with no government intervention, only two things can change the price of a product…a change in suppliers’ ability to supply, and/or a change in buyers’ willingness and ability to buy. It’s a matter of supply and demand, now and forever!
To identify the impact of an event on a market, three steps are necessary
Identify the market…product, time, and place
Identify the change…supply or demand, increase or decrease
Pressure on price, quantity exchanged, and employment in the market
You try it
For each of the events below, identify the impact on supply or demand and the pressure on price, quantity exchanged and employment by indicating I for Increase and D for Decrease.
DEMAND
The recent California drought. The market for artificial grass in California in 2023
Demand _____ Price _____ Quantity exchanged _____ Employment in the industry _____
The San Francisco Giants win the World Series. The Market for Giants hats and other gear immediately after the last game
Demand _____ Price _____ Quantity exchanged _____ Employment in Giants’ gear stores _______
The population in Detroit decreases. The market for housing in Detroit after the population decline.
Demand _____ Price _____ Quantity exchanged _____ Employment in real estate ________
SUPPLY
Drought in California. The market for water in California during the drought
Supply _____ Price _____ Quantity exchanged _____ Employment in the water industry _____
Disease, theft, and drought. The avocado market in California
Supply _____ Price _____ Quantity exchanged _____ Employment of avocado pickers ______
Oil prices increase. Oil is the major input in gasoline. The market for gasoline in California after the oil price increase.
Supply _____ Price _____ Quantity exchanged _____ Employment in gas stations
57% of agricultural workers are undocumented. Undocumented workers are deported. The market for fruit and vegetables in the US after deportation.
Supply _____ Price _____ Quantity exchanged _____ Employment in agriculture in California ______
THE ECONOMICS OF THE PANDEMIC
1. How did the pandemic affect;
a. The demand for air travel? The number of people flying? Employment in the airline industry?
b. The demand for hotel rooms? The number of people working in hotels?
c. The supply of sports events? The quantity exchanged of sports events. The number of workers participating in sports events?
d. The supply of restaurant meals? The demand for restaurant meals? The number of people eating in restaurants? The number of people working in restaurants?
e. The demand for products supplied by businesses in close proximity to entertainment events? Number of people working in those businesses?
f. The demand for all home delivery services and people working in those markets?
g. The demand for live chickens and the number of people raising live chickens for sale?
h. The demand for sourdough related products and the number of workers in the sourdough industry?
i. The demand for TVs, office furniture, office equipment, sheds and workers in those industries
j. The demand for houses in rural areas and the number of construction workers in those areas?
2 . How will the recovery from the pandemic affect all of the above?
3. Why has the price of housing skyrocketed?
How has the tariff on Canadian lumber affected the supply of lumber in the U.S.?
How has the pandemic affected the demand for larger houses, rural houses? Why?
4. When a friend says that an increase in the price of a product is ridiculous, how do you respond?