This mythical "law" is often stated in this way: "when supply is low and demand is high, prices rise; and when supply is high and demand is low, prices go down."
The first part of the myth is the claim that there really is such a law and that it's as basic as the law of gravity. The fact is that there is no such thing as a "law" of supply and demand. It's not even a hypothesis or a theory. It is no more than someone's opinion and some people love to use it as a simple excuse for rising prices because it provides an unprovable explanation and makes it sound like it's due to forces beyond our control.
The second part of the myth is the implication that prices rise and prices go down all by themselves, as if a ten cent increase in the price of gasoline overnight was due to gremlins or mysterious "market forces" and everyone woke up and saw the new price with great surprise, including customers, dealers, and producers.
Let's blow that myth out of the water right now. Prices rise because someone - some person or group of persons - raise the price.
To make it even more clear, an individual human being - or group of human beings in agreement - decide to charge more for a particular product or service. Or to charge less; that happens, too. And that's all there is to it, folks. No mystery whatsoever. People raise and lower prices.
The important thing to look at is "why do they do it?"
When we examine that, we discover that the "law" of supply and demand is even more of a myth.
Prices may be raised by people for several reasons:
- To cover increased costs of producing a product or service. This may happen because demand for the product or service has grown so strong that the producer has to invest in more goods or services in order to produce enough of his or her own product or service to supply the demand. Examples would be someone increasing the price of gasoline because unions have increased wage levels or because the people in charge of the governments of oil-producing countries have raised the price of their oil. This comes close to the supply and demand model, but the amount of price increase is still decided by people (it is almost never exactly the same as the increased costs for lots of reasons).
- To cover costs of projected investment in research and development of products and services that don't exist yet, and for which there is naturally no supply and demand. This reason is often used by oil companies and drug companies, among others.
- To make more profit than is currently being made. This is often described as "charging whatever the market will bear," meaning whatever people are willing to pay. For this to work there has to be sufficient demand for something, but it doesn't matter whether there is a lot of supply or not. Some years ago an oil-company executive was publicly quoted as saying, "We are going to get the American people to pay $4.00 a gallon or more for gasoline." This is also seen in products and services that have established a popular brand name that people are willing to pay more for, even though comparable products may be a lot cheaper. Gucci jeans are no better than (and maybe not as good as) Levis. Apple computers are more expensive than PCs because they are Apple computers, not because they are more expensive to make or because there aren't enough of them to go around. On the other hand, some people who work for oil-producing governments or diamond companies may decide to arbitrarily restrict the availability of their products even when the supply is abundant, so they can create a false impression of limited supply and fool other people into thinking that the Law of Supply and Demand is working.
- To hedge their bets in a time of economic and/or political uncertainty. When some people begin to lose confidence in the future, they have a tendency to raise the price of their goods and services "just in case" in order to make as much as possible before everything falls apart. When more and more people start doing this it's usually called "inflation." Again, this has nothing to do with supply and demand.
Prices may also be lowered by people for several reasons:
- Because the cost of producing good or services has been reduced. Sometimes this happens when sufficient demand inspires and stimulates a search for more efficiency and is not necessarily related to supply.
- Because the producer wants to expand his or her market. One way to increase demand is by making the product or service more affordable to more people, and it may be done in conjunction with "a)" above. Examples are the early automobile industry and the electronics industry. My first car, a 1937 Chevrolet (used, of course) cost me $40.00. The first laser printer I bought for Aloha International cost $5000.00, and the latest one was about $500.00. Again, This has little to do with supply.
- Because supply is greater than demand. Producers of goods with too much inventory may lower prices just to get rid of it. Usually this happens when the cost of maintaining the inventory begins to be more than the value of the goods. In terms of services, providers may lower their prices when there is too much competition. On the other hand, in the same market some people will create a brand name and raise their prices in spite of the supply on hand.
- Because the producer wants to attract customers for other products or services. This is sometimes called selling a "loss leader." The price is purposely lowered on a particular product or service, perhaps at a loss for the producer, for the explicit purpose of creating an opportunity to display more expensive products or services. Special sales or bonus services of all kinds are used in this way, regardless of supply and demand.
- Because not enough people are willing to pay the price that is being asked, no matter what the supply and demand are. Another economic myth that used to be popular was "Build a better mousetrap and the world will beat a path to your door." Sounds good at first, but the hard fact is that it all depends on what you are charging for it. The intrinsic value of goods or services, the perceived value by the producer, the perceived value by the potential customer, and the psychological value of the most the customer is willing to pay may all be very different. If you think your product or service should be worth $1000, even though the cost of producing plus a reasonable percentage of profit makes it worth $200, and your potential customer agrees that it might be worth $500, but isn't willing to spend more than $300 for that type of product or service, you might have to lower your price to make any sales, no matter how many people like the product or how much of it you have.
The long and short of it is this: people raise prices, and people lower prices. And supply or demand may or may not be factors in making their decisions. Prices do not raise or lower themselves.
Author: Serge Kahili King