A market economy is based on supply and demand. Demand refers to what customers want and need. So, what they are demanding.
As well as what quantity those consumers are willing and able to purchase based on other economic factors. So, demand is what customers want or need, and how much they’re willing and able to purchase.
The next lesson: Forms of Unemployment, both lessons are included in Practice Tests.
The following transcript is provided for your convenience.
Supply refers to how much of something can be produced in order to meet demand, or how much suppliers are willing and able to sell. So, at certain times, people may want more than they can actually buy.
If there’s a recession going on and people aren’t making as much money, or aren’t able to pay for as many luxuries, they may want something but not necessarily be able to buy it. So, demand takes into account how much people are actually able to buy. Supply, people may want to supply more of something than they actually can. They may want to sell gold or diamonds, but there’s only a finite amount of those, and if they’re not able to produce more and aren’t able to bring in more to sell at a higher cost, then you have to take into account how much suppliers are actually willing and able to sell.
Now, when the needs of consumers meet the needs of suppliers, a market equilibrium price should occur, and this means that supply equals demand. People are buying exactly the amount of product as suppliers are able to produce. This price varies depending on the overall health of an economy, and the beliefs and considerations of individuals. If people believe something is worth more, they’ll pay more for it. If they believe something is cheap, they’re only going to pay a lower amount for it. If they are considering that something is safer or more reliable, than they may pay more for it, even though it may not have seemed like it was worth as much.
If they consider it, and they take into account other aspects, such as safety or reliability on a car, even if all the car’s components together wouldn’t be worth that much, since they’re safer and more reliable, and have a higher rating, maybe in a blue book value, then the individuals would be willing to pay more for them. For instance, the vehicle that gets the number one rating with consumer reports is going to be able to sell for more than vehicles that rated lower, even if before that, you were able to buy it cheaper. Now that it’s gotten a number one rating – it’s the safest, most reliable, best vehicle for its cost – now, they can sell it for more.
And the overall health of an economy – are you in a booming period of the economy, or are you in a recession? If people aren’t spending as much, suppliers may have to lower prices to get to that market equilibrium price. But the equilibrium price is when supply is meeting demand almost exactly. Now, what happens if supply or demand is greater than the other? If supply is greater than demand, think about it. What’s going to happen to the price? Supply is greater. We have more products than there’s actually a demand for. So, the price is going to go down, because the suppliers are still going to want to sell their product. So, since people aren’t demanding it as much, since people don’t want their product as much, the price will go down, in hopes that people will say, “Oh, well, this is a good deal now. I’ll buy it, even though I didn’t necessarily want or need it before.”
Similarly, if demand is greater than supply, what do you think will happen? More people want something than there is actually a supply of, more is wanted than can actually be produced. So, the price goes up. Remember, I talked about gold and diamonds. Well, gold is something that the prices continue to go up on because people aren’t able to just create it, and the producers, the suppliers, aren’t able to get as much of it to sell. So, when they get it, the price is going to go up because the demand is greater than the supply. People want more than is actually available, so the price goes up on that.
So, the basics of a market economy are how supply and demand interact to reach an equilibrium market price, or to see how the price is going to fluctuate based on supply and demand, the relationship between those two. The overall health of an economy, and the beliefs and considerations of individuals. So, basically, it’s always going to base on supply and demand.