4.2.3 Supply and Demand

What are the origins of contemporary economic globalization?


Look at an example of the invisible hand: Imagine a ten-year-old kid named Evan. He wants to make money to buy a bike. He has limited skills, limited resources, and limited free time. What can he do?

Evan lives within a couple of blocks of Commonwealth Stadium in Edmonton. It's a hot July Saturday afternoon, over 30ºC.

The crowds will start passing by to a late afternoon game in about an hour. The Calgary Stampeders are in town. The game will be sold out. Who can tolerate being outside in that kind of heat? People would have to drink litres of pop! Evan's mom just bought a couple cases of no-name pop from Costco — Evan doesn't even like no-name pop!

Then it hits him — an idea. What if he sold the pop to people on their way to the game? Mom was hesitant about the idea. After all, it was a great sale, about a quarter a can. Evan tells her he'll buy them from her for 30 cents each — payment after he sells them! She still doesn't want to give them up, but she knows how much Evan will bug her if she doesn't, so she gives in. Evan can have the pop, but she wants every can accounted for.

Commonwealth Stadium

Now, imagine Sally is one of fifty thousand people on their way to the game. Sally, her husband, and three children are complaining already about the heat and about being thirsty. "Why didn't you think to bring some pop?" Sally's husband asks.

Sally sees a kid standing behind a card table on the front lawn of a house. A sign is taped to the card table: Pop — $1. Outrageous! No-name pop for a dollar! But then, Sally remembers the huge crowds and long line-ups at the stadium. "I'll take 5," she says.

If each consumer is allowed to choose what to buy and each producer is allowed to choose what to sell, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community and, hence, to the community as a whole.

This is the
the invisible hand
the concept that a community is improved by individuals acting in self-interest

In his book, The Wealth of Nations, Adam Smith claimed that individuals acting in their own best interests promote the good of their community. This concept is important in the development of capitalism.
invisible hand at work. A ten-year-old wants to make money. He sees a need in the thirsty football fans that walk by his house before every home game. Economists call this a
demand
the desire and ability to buy a good or service

Usually, when demand is high for a product, its price. When demand for a product is low, the price goes down. For example, if crops are poor, the price of wheat should rise because demand is high. In Africa, the prices of used cars from Europe are very high because new cars are very expensive.
demand. A ten-year-old kid has cans of pop to sell. This is called the
supply
the quantity of a goods or services that a producer is willing to provide at a particular price

For example, music CD producers are willing to produce CDs for sale from between $10 to $25, which gives them enough of a profit incentive to keep producing CDs. (Of course, a store can sell them for other prices than the manufacturer's prices.)
supply. The price is an unspoken agreement between the kid and his customers. The kid is willing to sell the pop for a dollar a can. Fans are willing to buy them for the same price.

Demand: The blue line represents
demand
the desire and ability to buy a good or service

Usually, when demand is high for a product, its price rises. When demand for a product is low, the price goes down. For example, if crops are poor, the price of wheat should rise because demand is high. In Africa, the prices of used cars from Europe are very high because new cars are very expensive.
demand for pop.

  • In this case, demand is the number of thirsty fans walking by Evan's house.

  • The red line represents Evan's
    supply
    the quantity of a goods or services that a producer is willing to provide at a particular price

    For example, music CD producers are willing to produce CDs for sale from between $10 to $25, which gives them enough of a profit incentive to keep producing CDs. (Of course, a store can sell them for other prices than the manufacturer's prices.)
    supply of pop. He is trying to sell the pop for the most amount of money he can get, and the fans are trying to buy it for the cheapest possible price. At some point, the two must meet!

  • The price for which Evan is willing to sell his pop is equal to the amount fans are willing to pay for it. 

  • Now, let's say Edmonton was playing Toronto on a cool October evening. Evan discovers people will not buy his pop for a buck, but if he drops the price, they would buy it. He'd still be making a profit. It just would not be as high.

Competition: What would happen if Amala from next door sees how successful Evan has been at selling no-name pop and, a couple of games later, sets up her own stand?

It's another hot day and the Calgary Stampeders are back in town, so the demand for pop is just the same but the supply has suddenly increased. People are used to buying from Evan, so Amala drops the price of her pop to $0.75 to attract customers. To keep up with the competition, Evan must do the same. This can be graphed as follows:

Supply:

In this case, the supply has increased, so the price decreases.

Sellers come into the market to sell the pop until the profit was nearly zero.

That is, if a can of pop costs the seller 30 cents, he would sell it for almost the same price.

This is known as
perfect competition
the most competitive market possible, where the supply equals the demand

Perfect competition rarely exists, if ever. The results include the following:

  1. Many buyers and sellers: Many small producers and consumers are included in a given market, each so small that its actions have no significant effect on others. The market sets the price.
  2. Homogeneity: Goods and services are essentially the same.
  3. Perfect and complete information: All firms and consumers know the prices set by all firms.
  4. Equal access: All firms have access to production technologies, and resources are perfectly mobile.
  5. Free entry: Any firm may enter or exit the market.
Perfect Competition. Five conditions must be met for perfect competition to occur.

  1. There are many buyers and sellers.
  2. Goods and services are essentially the same.
  3. Firms and consumers all have access to the same information.
  4. All firms have access to production technologies and resources.
  5. All firms may enter or exit the market.

This is how Adam Smith's invisible hand works. Thirsty Edmonton Eskimo fans are making their way to Commonwealth Stadium. They want something to drink. Evan wants to make money and he recognizes this need. People are thirsty; he'll supply them with pop. Maybe, as he gains experience, he'll realize that some people prefer bottled water or flavoured water or juice or juice-like drinks. If he wants to make more money, he'll determine what people want and he will supply it. At the same time, others will see how much money Evan is making with his drink sales and want to do the same.

How are increased profits made? Consider Evan again. By the following year, he has expanded to sell other types of drinks as well as chips and chocolate bars. His investment of time and money is relatively small; however, it is significant for an 11-year-old.

However, during the winter, a 7-11 has opened across the street. Its brand identity, large selection of snack food, and Big Gulp with almost 2 litres of carbonated sugar water for $1.79 has brought Evan's business to a standstill. There is no demand for his product. After his initial success, he could not compete with a big corporation. He ripped up his sign, folded his card table, and went back into the house. He left the pop on the lawn. People could take it for all he cared! He still hates no-name pop!