Why is the law of supply and demand important?
Hello, this is Jeff Bowers, Certified Financial Planner with Plan2Retire. Today I will explain one of the most important things you need to know about money, the law of supply and demand. I will also go over some examples in everyday life that illustrate the law of supply and demand.
What is the law of supply? Well it says that the quantity of a good, like gasoline, or a service, like cable TV, goes up as the selling price of that good or service goes up. When the quantity of a good or service goes down then the price goes down.
The law of demand says that the amount demanded of a good or service falls as the price goes up. When the price of a good or service goes down then the amount demanded of that good or service goes up.
Now let’s move past the textbook talk to some real life examples.
Recently, many businesses were forced to close and a lot of people were either out of work or were working from home and driving much less. It’s estimated that about 70% to 80% of our energy use is for transportation. So, with a lot less people driving there is less demand for gas so the price of gas has dropped significantly. Now that we are seeing more people go back to work, you will likely see the price of gas increase due to the demand for gas increasing.
What do you think will happen to the price of toilet paper in the next few months? Well, once people realize they don’t need a three-year supply of toilet paper, the demand will likely drop hence the price may come down.
So just to review, when the demand for something increases you will likely see a price increase then the opposite happens when the demand goes down, the price will likely drop. Demand and prices work opposite of each other.
To review; when the supply of item goes up then the price goes up as well. And when the supply of an item drops then the price drops. So, supply and price go in the same direction.
I always say if you are going to understand anything about money you need to understand the law of supply and demand.
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