What Happens When Demand Increases?

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How will I explain the phenomenon of rising prices after a disaster to my seven-year-old son? I’ll say something like this.

You know there was a big storm in the Northeast. We saw it on television. There was flooding, there was a big fire, trees were down, and now there’s no electricity in a lot of places. It’s pretty miserable.

People want clean water, food, and gasoline. They want to be able to clear away the trees that fell and they want to be able to run their generators if they’re without power. Normally, they could get these things, but because of the storm not only do they need more, but it’s hard for these things to get in. The normal supply lines are cut. So they want more and there’s less than usual around.

We’ve talked about scarcity before. It’s when there is a limited amount of the things we want. Right now, the things that they want are scarce. Demand has increased.

We’ve also talked about what happens when demand increases. When demand increases, prices go up. Prices just tell us how much of this thing is available. It’s information. Like when there’s a bad drought, the price of tomatoes goes up because there are fewer tomatoes to sell. The opposite is also true. When there is a lot of something, the price goes down. If I have a tomato farm and I have twice as many tomatoes one really good year, the price of tomatoes will go down. You can tell how much of something there is by its price.

This is the situation in the Northeast right now. Demand for gas, clean water, generators, and things like that has increased. What happens to prices when demand increases? Right. Prices go up.

You’ve seen this happen in daddy’s ebay business. When he’s down to the last ten of an item, he hikes up the price. It’s still available if someone really wants it, but those last ten are really really valuable. When he gets more in stock, he lowers the price again.

Remember how your brother asked you what you would do if you only had one cup of water each day? You said you’d drink that water. And if you only had two cups, you would use the second cup for keeping clean. And if you had three cups you would use the third cup for growing plants. And if you had four cups you might use the fourth cup for playing in the sprinkler or something. You understand when things are scarce, you use them differently. You economize. They are more valuable when there is less. Everyone understands that.

Anyway, back to the storm. Let’s say daddy sold things that would be important in an emergency. He has a store that sells gas, water, ice, and flashlights. He knows that as a storm approaches the demand for these things will increase and that perhaps his supply line will be severed for many days. He won’t be able to get more for a while. He will have a limited supply–like when you only have three cups of water. When demand increases, he’s going to raise prices. People won’t be able to buy as much. They’ll have to think about how they use what they buy. This keeps things on the shelves longer and when someone desperately needs a thing, it is more likely to be there for them. That’s really important during an emergency. It can even save people’s lives. Now, some people would say that it’s mean of daddy to raise prices when demand increases. But that’s not true. He’s simply letting people know that it’s time to economize. They need to think hard about how they want to use things. He’s just passing along information. And there’s good reason for him to do it. He’ll make more money if he’s doing the right thing. It also makes it worth his while to go to the store and keep it open for the one guy who really, really needs something. When the prices go up, he’s not going to sell as much, but he still has to be there. If he keeps his prices low, he’ll sell out and close his store.

So, what we know is that when demand increases, prices go up. When demand decreases, prices go down. Those are just laws. Like inertia. We just have to know that they’re laws and that they’re always in effect. We shouldn’t be surprised by them.

Some people try to suspend law and make it so store owners can’t increase their prices as demand increases. That’s really bad. It doesn’t work and it leads to more shortages because people won’t economize on their use of the scarce goods and services. If they aren’t properly priced, the consumer doesn’t know how valuable it is. They might buy the last flashlight to entertain their children in the dark when a guy two blocks over needed that flashlight to find something really important–like maybe the gas shut off–in the night. When things cost more or when we have less of a thing we really think about how we use it. If the prices don’t give us that information, that causes more problems in an already bad situation.