Almost every holiday season, the most popular "must have" toy is in short supply. And there's usually a strong secondary market for the item – with parents paying well over the retail price just to make their children happy. Then, in January, stores reduce the prices of their remaining holiday items – cards, decorations, and so on.
Why do parents – and stores – behave this way? The answer is in the laws of supply and demand. Together, these laws give us strong clues about what to produce, how much to produce, and how much to charge. Because supply and demand play such a central role in our economy, it's important to understand how they operate – and how you can use them to analyze decisions about price and quantity.
The Law of Demand
Demand, in economic terms, shows how much of a product consumers are willing to purchase, at different price points, during a certain time period.
After all, we all have limited resources, and we all have to decide what we're willing and able to purchase – and at what price. As an example, let's look at a simple model of the demand for a good – let's say, gasoline. (Note that this example is illustrative only, and not a description of the real gasoline market.)
If the price of gas is $2.00 per liter, people may be willing and able to purchase 50 liters per week, on average. If the price drops to $1.75 per liter, they may be able to buy 60 liters. At $1.50 per liter, they may be prepared to purchase 75 liters. Note that while some gas usage is essential – driving to work, for example – some use is optional. Therefore, as gas prices drop, people may choose to make more optional trips during weekends, and so on.
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