I take my responsibilities to help my fellow man very seriously.  I’m going to attempt to make a big step in that direction today by explaining supply and demand.  I learned this in the ninth grade, again in college and I have applied it throughout life.  Understanding this basic tenet of economics is crucial to understanding government, public policy, business and each other.

It’s sadly apparent to me that many people either don’t know about this, don’t understand the implications it has on human behavior or believe that it’s only a theory or opinion.   No.  It’s a law.  It’s a fact.  It doesn’t change.

First, we have understand that economics is the study of how to manage unlimited human wants in a world of limited resources. There’s only so much to go around.

Friends, I’ve taken it upon myself to create a basic supply-and-demand chart. We could be talking about any product that has value — from a wheelbarrow full of wood chips to a mammogram to a pack of chewing gum to a gallon of gasoline.   Anything.   Those are all scarce resources.  We are always trying to look for efficiency in economics — trying to reach an equilibrium between supply and demand.

At price of $0, the demand for our hypothetical item is unlimited, but supply is non-existent, because there is no incentive to produce the item.  (That incentive would be profit!)   At $2, you see that there is some supply, but demand is also reduced.  Our equilibrium is at $5, where supply is able to meet demand.   And at $10, there is plenty of incentive to produce supply, but demand is almost zero.

Now, let’s say an advertising campaign has increased demand for our hypothetical product.  The supply curve remains constant, but we shift the demand curve to the right.

The new equilibrium is found at $6 or $7.  Higher demand with a constant supply pushes the price higher.

But if a third party comes into the market and caps the price at $5 for our hypothetical product (perhaps through legislation), there is a problem.  The consumer might like the fact that his desire to have our hypothetical product has risen while the legislation has capped the price at $5.  But the producer, who still getting only $5 for something that naturally should cost $6 or $7, is not going to increase supply.

This creates a shortage.  That’s the red area on the chart.  It indicates the gap between lower supply and higher demand.   In time, there are a number of factors that may cause a producer to increase supply — maybe technological advance or changes in the prices of the items he uses to manufacture the product.  But in the meantime, expect a shortage.

Our consumer still loves the idea of paying only $5 for our hypothetical item — but they’re harder to come by.

Notice how the producer gains nothing in our model by keeping the price artificially high.  At a $10 price, the gap between low demand and high supply is called a surplus.  That means our producer will have a big dusty warehouse full of our hypothetical item, because it’s too expensive.

So, that’s how that works.