Supply and Demand Is One

Supply and Demand is one of the fundamental principles of economics. It is important to understand the principle of supply and demand if one is to understand an economy, to evaluate an economy, or to predict the future of an economy. Essentially, the principle of supply and demand determines the price of any particular good or service. The price level of the good or service is determined by the point at which the quantity supplied equals the quantity demanded. The law of supply and demand says that, on a graph, the price level will move in the direction of the point that makes the quantity supplied and the quantity demanded equal. That means that if there is too much of something, or a surplus, the price will go down. If there is not enough of something, or a shortage, the price will go up (Supply and Demand). Using a thorough description of supply and demand, a question will be answered: How do government-set prices affect the daily lives of citizens of the United States of America?

Demand

The first thing that must be understood is that demand and supply are determined separately. Sellers determine supply and buyers determine demand. Demand is defined as the desire to own something, the ability to pay for it, and the willingness to pay for it (Sullivan). Some important factors that affect demand are the price of the good, the price of related goods, tastes, preferences, and expectations.

For the purpose of explaining this, breakfast cereal will be used as an example. In any given grocery store, customers have the option of buying name brand cereal or store brand cereal. If a mother wants to buy Cheerios for her children to eat, she can either buy Cheerios or the store brand equivalent. Since they are made by a trusted name brand, Cheerios are more expensive, even though the ingredients in Cheerios and the store brand may be very similar. The mother's decision to buy Cheerios or the store brand is influenced by both the high price of Cheerios and the lower price of the store brand. But there are other factors at play. The mother will buy the more expensive Cheerios if she is not confident that the store brand will meet her children's expectations, if her children find that the store brand does not taste the same, or if the mother or the children simply prefer Cheerios.

Another factor that will affect the mother's decision in this case is her income. The store brand of cereal will fill the stomachs of her children, which is the ultimate purpose. If her funds are low, she will buy the store brand regardless of her own preferences or the preferences of her children because of the lower price.

2. Supply

Supply is the amount of a product that will be available to customers (Mankiw). The factors affecting supply include the price of the good, the price of related goods, technology, expectations, price of inputs, and government policies and regulations (Colander 90). While there is no law of supply, the price of a good and its supply have a direct or positive relationship. That is, as the price of a good increases, the supply will increase. As the price decreases, the supply decreases. The price of related goods also affects supply. Staying with the example of breakfast cereal, Cheerios are made primarily from oats, so oats and Cheerios are related goods. The relationship between a good and related goods is inverse, or negative. That means that if the supply of oats goes up, the supply of Cheerios goes down and vice versa (Melvin & Boyes).

Inputs are the things necessary to make the good, including land, labor, energy, and the raw materials from which the good is made. The prices of these things affect the supply of the good, but these prices can be affected by technology. If a technological advance takes place which somehow makes it easier to produce the good, then that will also affect the supply of the good (Samuelson & Nordhaus). The expectations of the supplier are another important part of supply. Sellers have expectations concerning the future of the market condition and how it will affect their product. If a supplier expects the demand for the product to increase, the supplier can quickly increase the rate of production to meet the new demand with enough of a supply (Goodwin). Finally there is the factor of government policies and regulations. Government intervention can have a very large effect on supply. Government intervention can come in the form of health regulations, taxes, electrical rates,-hour and wage laws, gas rates, and zoning regulations. Suppliers have to concern themselves with all of these factors when determining how much of their product they will insert into the market.

3. Market Equilibrium

Market equilibrium takes place when, on a graph, the supply curve and the demand curve intersect. Market equilibrium is reached when the quantity supplied and the quantity demanded are equal (Sullivan). When this happens, the market for that particular product will remain in equilibrium until either the supply or the demand changes. Some economists believe that market equilibrium is most likely in a free market, which is a market that is free from regulation by a governmental body. This theory is based on the belief that a surplus in good will lead to price cuts and a shortage in goods will lead to price increases. This natural ebb and flow will lead to a balanced market, in the estimation of the economists who hold this theory (Faulkner).

4. Government-set Prices

In a controlled market, the government regulates how things are produced, and how goods and services are used, priced, or distributed. In a controlled market, suppliers have to meet a number of government-imposed regulations in order to do business within the confines of the country. The federal government can set a price ceiling or a price floor on a good.

When a price ceiling is imposed, no supplier can legally sell a product for more than the price of the ceiling. The rationale behind setting a price ceiling is that it provides the consumers with access to some "essential" good or service that was previously unaffordable because the equilibrium price was too high. This seems to work well for the consumer, but it only works well in theory. While price ceilings are successful in providing consumers access to the good in question, it also creates a shortage because the price ceiling is below the equilibrium. Once a government-created shortage exists, so does the potential for chaos. If the shortage is unregulated, the goods can potentially be distributed unevenly. This can lead to the rise of a black market in which the good are obtained in an illegal manner. This also prevents the natural market adjustment to increasing supply that would result in high prices, which in turn would eliminate some buyers from the market.

While a price ceiling is designed to help protect consumers from prices that are too high, a price floor is designed to help protect suppliers from prices are too low. Neither solution is perfect. While a price ceiling can potentially lead to the emergence of a black market, a price floor can generate excess supply and waste. A price floor can encourage suppliers to produce more, but this does not necessarily have a positive effect on demand. The United States has been called a mixed market, that is, a market that has elements of being both free and controlled (CIA).

4. Effects of the Population

If the United States economy is a mixed market, in what way are the daily lives of the population affected by governmental policies? Some economists believe that government intervention in the pricing of goods has a primarily negative effect on the population. One example of this negative effect took place in 2007 when Congress was considering a farm bill. The federal policy was to raise the prices of milk to help farmers make more money, thereby keeping them in business in order that they may continue to supply the American public with more milk and dairy products. In his article "The Madness of American Milk Prices," Chris Edwards opines that this governmental policy is illogical. He argues that, "If Coke and Pepsi got together and agreed to hike prices, they would be prosecuted. But with milk, raising prices is government policy," (Edwards).

In addition to this price-hiking policy, Congress added an income support program for dairy farmers in 2002, which gives the farmers money when prices fall below target levels. Not only that, but the government also has barriers on the import of some dairy products, including milk, butter, and cheese. These policies have a direct effect of the American public because they lead to high prices of milk and dairy products (Edwards).