#41) Supply and Demand Made Easy

Hello, and welcome back to "Always Be Better" with Mel Windham.

Today we're going to explore Supply and Demand, as we begin our journey into Economics. I'm hoping to share the simplest concepts to make this easier to understand.

First off, Economics is all about incentives. As money flows freely, people are producing and consuming, and the quality of life increases. But what makes a person want to part with their money? And what makes a person want to produce something? What are the incentives? If we understand this in the big picture, we can then help to create a prosperous environment to allow for maximal efficiency and productivity, so everyone can be happy.

Let's start with a simple example: ice cream. We want to sell it, and we have 9 potential customers. Each of them has different tastes. So let's ask: how much are they willing to pay for an ice cream cone?

Alfred is really picky. He'd rather eat pie than ice cream, so he'll only pay $1. This means, if we charge $1 or less, he'll buy a cone. If we charge more than $1, then he'll say, "no deal," and buy something else.

Ivan, on the other hand, really, really loves ice cream. So much so, he'd pay $9. To most people this sounds expensive, but maybe Ivan has a lot of money to spend, or it's simply the value he places on an ice cream cone.

The other 7 customers fall somewhere in between. I'll just fill in the rest of the chart.

Person	Price
Alfred	$  1
Betsy	$  2
Carl	$  3
Diana	$  4
Evan	$  5
Francine	$  6
George	$  7
Holly	$  8
Ivan	$  9

Now -- let's fill out another chart. Say I set the price at $1. How many people are going to buy a cone? Let's see. Alfred will buy one, because we're at his price. Betsy will, too, because she's willing pay anything up to $2. So, they're all going to buy a cone -- all the way down to Ivan. So -- 9 people will buy.

What if we set the price at $2? Alfred will say: no thanks, but the other 8 will still pay. So -- 8 people.

We can continue filling out this chart -- all the way down to $9, where only Ivan will buy.

Price	# of People
$    1	9
$    2	8
$    3	7
$    4	6
$    5	5
$    6	4
$    7	3
$    8	2
$    9	1

And then we can graph it out, like this:

On this graph, price is listed on the left, and the number of buyers across the bottom. And this should make sense: the lower the price, the more people will buy.

If we draw a line through these dots, we can see an overall pattern. This accurately captures the incentives of our customers. We call this Demand, and it usually has a downward slope. If we understand this, it can help us set the correct price.

Now let's switch gears and look at the ice cream suppliers. What are their incentives?

Well -- we have 9 suppliers, and I'm one of them. Jack is the best and most efficient producer. He has an army of ice cream machines, so he can make an ice cream cone for really cheap. He's willing to charge anything down to $1.

I'm kind of middle of the road. In order for me to make any kind of profit, I need to charge at least $4. Robert, on the other hand, has a terrible ice cream setup, so he needs to make at least $9 a cone, or he'll lose money.

Everyone else falls in between, like this:

Person	Price
Jack	$  1
Karol	$  2
Laura	$  3
Melvyn	$  4
Nancy	$  5
Oliver	$  6
Peter	$  7
Queen	$  8
Robert	$  9

Just like before, we can ask: what if ice cream is selling at $1? How many of us would produce ice cream cones? Well -- not me, because I'd lose money. So, I'd be out. The same with Robert. Only Jack would be in business, so that would just be 1 supplier.

At $2, two of us can sell. At $9, all of us can sell.

If we chart this out, it would look like this:

This is our Supply graph. Note how the line goes up instead of down. This is because, as the price of something goes up, it will attract more producers, so more products can be made. Makes sense.

What I've shown you so far is greatly simplified. In real life, though, we're going to have many customers and many producers. If we look at everything as a whole, it's better to think of total number of ice cream cones, instead of number of people. Also, in real life, these curves are going to be more curvy.

Here's one possible scenario for our overall supply and demand curves:

As soon as we place both curves on top of each other, we can immediately see an equilibrium price at $3. At that price, 5000 ice cream cones are produced, and 5000 ice cream cones are purchased.

If we set the price higher at $5, suppliers would produce around 7000 cones, while consumers would only want to buy around 3000 cones -- not a good situation. And if the price were lower -- at $2, the situation flips. Suppliers wouldn't want to produce so much, but consumers would demand more. In either case, competitive pressures would push the price toward $3, where happiness appears to be maximized.

Well -- it wouldn't be a good outcome for me. Because -- remember how I needed to charge $4 to stay in business? Well -- if I charged that high a price, customers would go to other ice cream parlors charging $3, and I'd be out of luck. My best bet would be to close up shop and try some other venture. Dang.

And there we have it -- Supply and Demand in a nutshell. We can dive in deeper in later videos, but that'll have to wait till next year. I already have something else planned for our next economics video in a couple of months -- a fun experiment.

But next week we'll explore something completely different: Information Overload, and how we might overcome it. Yeah -- that'll also be fun.

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