Some Of The Curious Things About Supply & Demand

When it comes to goods and services in the free market, four things will happen: 

1) Increase in Supply

2) Decrease in Supply

3) Increase in Demand

4) Decrease in Demand

I'm sure readers who've been with me this long won't need explaining what the direction of the price and quantity arrows take with the various increases and decreases (here's a wiki page if anyone is unapprised).

The reason I'm writing this is that although most people know the basics, there is often a very wrong assumption made. Given the size and complexity of the market, it's fairly obvious that the variances on prices, supply and demand are impossible to predict precisely in the future, and hard to keep track of in the present. For this reason, in the short term it is not at all unusual to see prince increases and quantity increases for the same product (ditto decreases).

When we see cucumber or coffee or cereal consumption on the up (or down) while at the same time seeing the prices on the up (or down) it is simply a sign that within the laws of prices, supply and demand there are often underlying, unforeseeable events that add a bit of disorder into the mix. That is to say, in the short term, supply and demand arrows are not immutable; they are indicators that predict longer term behaviour, especially if one changes other things stay relatively constant.

Imagine Tom Joad eats lots of rice and a small amount of fish. As rice becomes harder to come by and the price starts to rise, his food budget is strained to the extent that he is has to cut back on fish and demand even more rice. The increased demand ramps up the price further and Tom Joad experiences a vicious rice-fish circle. Contrary to popular opinion, rising prices can in principle lead to increased demand, not decreased demand (this is what is referred to in economics as a 'Giffen good'). 

Put it this way, generally speaking though, if the consumption of rice, fish, cucumber or oranges steadily drops, you can be quite sure that in the long term production and (or) prices will be altered to match, and that's a general rule that's fairy reliable.

About 25 years ago in the UK, petrol pump protesters brought the country to a standstill by creating a shortage of fuel - and there was talk recently of it happening again. Naturally, prices increased and many angry consumers declared that when one or two firms hike up their prices on a particular product that that means they have a monopoly on that product. Not only is that usually not the case, it mostly reveals just the opposite; it exhibits healthy competition – it is competition revealing scarcity in this case that raises prices.

If something is in short supply (like, say, oil when there is a domestic crisis or trouble in the Middle East) it is assumed that the increase in price is due to a monopoly company hiking up its prices. If a company really could increase their supply with a supply restriction, they wouldn’t ned to wait for a domestic crisis or trouble in the Middle East to do so. The economy doesn’t facilitate the simultaneous profit from unrest and a single monopoly. 

At the time of the petrol crisis in Britain, some people even suggested that there should be a mandatory cap placed on individual sales – say of £30 or £40. As I said at the time, that’s a bad idea – a £30 or £40 cap on individual petrol sales probably would not have had the desired effect that many think – it would more than likely increase overall consumption, because even more people would head to the garage, and that would also cause more misallocation. 

It is as crazy as trying to regulate the crude oil supplies by legislation – one might as well forget the near-ineluctable law of economics, which says that prices go up when things are in short supply. That is exactly what happens – price controls play a part in controlling the wholesale level, meaning refiners minimise their fuel supply, meaning the prices at the pump go up, not down. Lower supplies means you pay more at the pump, so oil regulation has a bad effect for the consumer.