Supply and Demand (introduced in Economics 2) do not take place in a vacuum. People, generally, have to want something before they buy it. Even the richest of people do not have unlimited resources to spend—or unlimited time to spend—so decisions have to be made. If I am planning a vacation, I should know the limits of my resources—how much of a vacation I can afford and how much time I can spend. I would also need to know what I wanted to do. If I had $10,000 to spend and three weeks of time off, I would still have decisions to make. That much money might buy me a week in Paris (with travel), or two weeks skiing in Aspen. If my first choice is Paris, then I know that I am giving up the opportunity to spend two week skiing in Aspen and hanging out with movie stars. When calculating the cost of something desirable, whether a night out with friends or a college education, it is always useful to consider the second best choice. By going to Paris, I give up Aspen. If I go to Aspen, I give up Paris. The second best option is called the opportunity cost.
By Robinseed - Own work, CC BY-SA 4.0,
Every decision we make has an opportunity cost: marriage (or not), college (or not), accepting a job, quitting a job. . .
These decisions—to buy something at the price it is being offered or to sell something to a willing buyer—take place in a market. We usually think of markets as places—grocery stores and the like—but in economics a “market” is more of a relationship than a place. Prospective buyers create demand at different prices. Producers create supply. When buyers and sellers reach an agreement to make an exchange at a given price, they have become part of a market.
“Market” is a very broad term. It can, of course, mean an individual store where customers spend money on toothpaste or shoes or whatever. In that sense, a market is indeed a place. (But, then we have to ask, If Amazon is a marketplace for everything, “where” is it?)
Less narrowly, “market” can refer to the availability and demand for a specific commodity, either in a specific place or globally, at a specific time. For example, in August of 2015, the Broadway musical Hamilton, which had opened a few months earlier at the Public Theater in New York City to outstanding reviews, moved to the much larger Richard Rogers Theater near Time Square. Demand for tickets to this unlikely rap musical based on the life of the first Secretary of the Treasury was intense. Tickets sold at the box office for $800 (which is a lot, even by Broadway standards) were being scalped for $3000. Even at those prices, demand greatly exceeded the very limited supply available (The Richard Rogers Theater has 1400 seats. Once tickets were sold, as they generally were months ahead of time, the chance to see the play on the night you wanted—or any night—was gone unless you happened to know a ticket scalper). Broadway performers usually perform eight shows a week. Supply was not flexible. Demand was seemingly infinite. For months, ticket prices went up and up until, finally, the producers of Hamilton hired a separate cast and opened in Chicago and, then in other cities, increasing supply and gradually meeting the incessant demand to be in “The room where it happens.” As supply increased, prices began to fall.
Something similar happens when a hurricane or other natural disaster hits a community. Suddenly, people discover that they have, among other things, no electricity. No sooner do the winds die down but everybody who can get to a hardware store goes looking for a home generator. Usually, every generator in stock is sold out within an hour. As generators arrive from other, more distant stores, they are sold as soon as they hit the shelves.
If you owned the hardware store, and if you knew that the going price for a home generator was around $2000, but you also knew that demand for generators was high while supply was very low, what would you do? You could double the price of generators and make a killing. Or, you could keep the price the same, limiting your profits while looking out for the well being of your community.
In many states, raising prices for necessary commodities during a crisis is labeled a crime: price gouging. Store owners who take advantage of the desperation of their neighbors are condemned as bad citizens. Sometimes they face stiff fines—costing them more than the windfall profits they made as a result of the shortage. But, some economists argue that raising prices for generators and other emergency supplies is exactly what should happen. When prices go way, way up, everybody within a thousand miles with a few generators to sell will load up the truck and head to the disaster area, hoping to make a quick profit. And, because thousands of people will be doing just that, the market will be flooded with generators. Demand will be high, but so will supply. Prices will quickly fall back to a reasonable level and people desperate for generators will be able to get one. If generator owners fear being forced to sell at a “fair” price, they won’t bother taking them to the disaster area. Generators won’t be expensive, they just won’t be available at any price.
On a different scale, economists talk about the global oil market, the stock market, the market for illegal drugs and stolen art.
If you are reading this essay with any care at all, you probably have already thought of an objection. Even in a single town with neighboring pizza places, not all pizzas cost the same. One place may have a better reputation, better service, or occupy a more popular restaurant district. Others, maybe just as good, cost less.
This is a legitimate objection. For the most part, when economists draw supply and demand charts, and especially in introductory economics classes, they assume that the imaginary pizzas or tacos or pumpkins they use to illustrate their lectures are fungible. That is, they assume that one pumpkin is exactly like and interchangeable with any other pumpkin.
Some things are, indeed fungible. You might notice that neighboring gas stations tend to charge exactly or very nearly the same price for regular unleaded. That is because, essentially, a gallon of gas is completely interchangeable with any oher gallon of gas. The same is true for different grades of crude oil. A tanker load of “Light Sweet Crude” from Mexico can be swapped out for a different tanker of Light Sweet Crude from Alaska. Corn, wheat, steel, ingots of gold, are all fungible. A farmer, therefore, who produces thousands of bushels of wheat a year, has no choice but to accept the price offered by “the market.” His wheat is no better or worse than anyone else’s. It is, essentially, fungible.
Are soft drinks fungible?
Coke and Pepsi do not taste exactly alike. Coke has a little less phosphoric acid and perhaps touch more vanilla than does Pepsi. That tends to give Coke a slightly sweeter, vanilla taste than the more citrus-tasting Pepsi. But can you really tell the difference? Both soft drinks are mostly made up of carbonated water and corn syrup. At the grocery store, they usually cost very nearly the same. In this case, we would say that they are not exactly fungible (fans of one or the other can tell the difference, after all). But they are close substitutes. If the store is out of Pepsi, or if Coke is having a two for one sale, most people will not hesitate to substitute one for the other.
All of this also assumes that fans of Coke or Pepsi have a free market to choose either or neither, and the vast corporations that produce both products are free to make and sell their product to consumers. Both can advertise. Both can decide on the prices to charge (one thing they are not allowed to do in the US is to agree (or fix) the price between competitors. The US has a free market economy.
Mostly.
Famously, when John Pemberton served the first Coca-Cola to customers of his pharmacy in Atlanta in 1886, the fizzy, refreshing concoction had just a dash of cocaine in it. There was nothing controversial about cocaine in 1886, but by the beginning of the 20th century, the Progressive Movement in America came to take a dim view of cocaine and outlawed it in 1906. Coca-Cola did not wait for the legislation, removing the cocaine from the Coca-Cola in 1903.
In fact, the American Free Market System is far from completely free. Car makers have to make their cars reasonably safe. Food producers cannot poison their customers, even if doing so would be more profitable. Labels have to reflect what is actually in the product and products must be safe for their intended use. Even drugs have to be proven safe and effective before they can be prescribed and sold in the US. We might describe the US (and most of the world) as having a regulated free market.
While most of the countries of the world have markets that are regulated to one degree or another but still essentially free, some countries have adopted economic practices associated with socialism. While socialism is a loaded term, it can have a wide range of meanings. Some governments are best described as “democratic socialist.” They have freely elected governments and a great deal of private enterprise, but prioritize the well-being of workers over the economic power of business owners. Democratic socialist states usually have powerful labor unions, high taxes to discourage the accumulation of great wealth, and freely available healthcare and retirement programs. Major industries are often state-run or heavily state-regulated. Much of contemporary Western Europe can be described as democratic socialist.
Other countries built their economic systems on ideas associated with Karl Marx (1818-1883), who argued that the only thing of real value was labor. Businesses that profited off of the labor of their employees were, in effect, using their control of the means of production (such as factories or farms) to steal the value of labor from the workers. “Property is theft” served as a stirring call to revolution in the early 20th century. Property, in this context, meant the factories and other “means of production” that employed workers, succeeded by paying the workers less than their work was worth, thus stealing the value of their work. The Soviet Union (1917-1992) attempted to implement this kind of economic and political system with reliably unhappy results. While the Soviets celebrated their status as the world’s first “workers state,” it was much more accurately described as a command economy. Committees of bureaucrats and other experts determined the amount of goods to be produced and the price for which they would be sold. These decisions often reflected the ideological concerns of the governing Communist Party and rarely met the needs of ordinary people. The modern People’s Republic of China, Cuba, and Vietnam identify themselves as Marxist states, although critics have challenged how truly they hold to Marx’s ideals and if their working people are better or worse off for it.
The Soviet Union (whose economy and government collapsed in 1992 to become the modern states of Russia, Ukraine, Belarus, and others) was the preeminent socialist state (until it collapsed). Beginning in 1917, the free market, with its messy laws of supply and demand, was replaced with an economic system consisting of committees which would determine what products would be manufactured and at what price they would be sold. Competition seemed to be wasteful, so consumers were able to buy only those goods that the production councils thought were needed. As a result, popular items were always in short supply and unpopular items spent years piling up on store shelves. Cars, vacuum cleaners, and other consumer products were notoriously unreliable, expensive, and hard to get because producers had no reason to make them better. Western travelers to the Soviet Union and Eastern Bloc knew to pack a few cartons of American cigarettes as “gifts” to taxi drivers and waiters.
On the other hand, the modern People’s Republic of China is an industrial powerhouse, causing some critics to wonder if it can be considered a socialist country at all.