Supply, Demand, and Price

As a schoolboy, I was taught that demand has a direct relationship to price, and that supply has an inverse relationship to price. Chances are very good that you were taught the same. And it's important to know how supply and demand affect price, but that is very far from being the whole story. Price affects supply and demand, as well.

The Laws of Supply, Demand, and Price

• Increases in supply cause downward pressure on price.
• Decreases in supply cause upward pressure on price.
• Increases in demand cause upward pressure on price.
• Decreases in demand cause downward pressure on price.
• Increases in price tend to attract more resources to production.
• Decreases in price tend to divert resources away from production.
• Increases in price tend to reduce demand.
• Decreases in price tend to stimulate demand.

When supply, demand, production, and price are all allowed to affect each other naturally, there is a constant trend towards equilibrium in all of them. Then, the things we want most are taken care of first, and as inexpensively as possible. Almost everything that is produced is bought and used.

This is the core of the free market system. Prices are allowed to move freely, so people know what use of their resources will bring them the most money. And, all other things being equal, that is what they do. It all works really well until somebody (that is, the government) starts meddling with prices.

EDIT: this really was too much to do at once. I have decided to break the giant wall of text into several posts.

In this series:
Supply, Demand, and Price | Price Caps | Price Supports | Restricting Supply | Excises | Subsidies