Supply and demand are the two forces that decide what we produce, buy and consume. Supply refers to the number of things that sellers make at a certain price. Demand refers to how many goods and services consumers buy at a certain price. And if you go out and get a cup of coffee for $3, it’s because the two forces met at this price following a phenomenon known as emergent order.
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Welcome to our short course in economics where we learn how we make choices when unlimited human wants meet limited resources. Supply and demand shows how people coordinate their decisions by communicating through prices. “Supply” refers to the number of goods and services that sellers produce at a certain price. “Demand” refers to how many goods and services consumers are willing to buy at a certain price.
the force behind a coffee price
Let’s assume there is just one coffee shop on the market, but 100 people who drink coffee. The price of coffee is $3 per cup, and the people each drink one cup per day. We can illustrate this with a diagram showing the price per cup of coffee on the vertical axis and the number of cups of coffee consumed on the horizontal axis. At $3, 100 cups are demanded. What do you think, how many cups of coffee would these 100 people drink if the price of a cup were to increase to $8?
understanding supply and demand
While at $3, a 100 people drink a cup of coffee, at $8, maybe just 30 do. And at $12, there could be as few as 10 people interested in purchasing a cup. However, at $1 per cup, demand could go up to 150 cups a day, because some of those original 100 customers are now drinking two or more cups.
This is what economists call a demand curve. It shows how much quantity is in demand at each price. The curve usually slopes downward because economists assume that the lower the price the higher the quantity demanded.
The supply curve shows the number of goods or services sellers are willing to provide at a given price. It curves upward because the higher the price, the more supply.
As we already know, at $1 the people on the market demand 150 cups a day. However, the owner already pays $1.20 for the beans per cup. Which means, he can’t sell a cup for just $1. If the price were to be $12 per cup, the owner could hire two additional staff, while supplying up to 150 cups. Unfortunately, only 10 customers would buy at that price. And that’s not enough to cover the costs of the business. The sweet spot happens to be $3. At this cost, the owner can hire one employee and happily supply the 100 cups a day that are demanded at that price.
Supply and demand on one graph look like this: At $12 the owner can supply 150 cups. But only 10 people would buy a cup of coffee at that price. At 1 dollar he can’t supply any. But demand would be at 150 cups of coffee. The two curves meet at $3 and 100 cups. Let’s now assume circumstances change.
The summer was very hot, and there was only a little rain, which left many coffee bean crops destroyed. The poor harvest yielded a low supply of beans. As a result, more traders bid for the limited amount of beans, leading to an increase of price. The shop owner now buys the beans from the farmer at $2 for the beans per cup. Can he still sell at $3? He tries and decides to let go of his employee and begins serving coffee all by himself. But he cannot meet the demand of all his customers. If the government were to force him to keep the price fixed, as some do through so-called price controls, queuing would be part of everyone’s life.
To reduce the wait times for his clients and make up for the increased cost of the beans, the owner decides to increase the price of the coffee to $4.5. The supply curve now shifts to the left and at $4.5, the shop will sell 70 cups of coffee per day. Typically, the higher the selling price of a good, the greater number of people willing to supply it. This means that there will likely be more competition soon.
In real life and within a free market, if you drink coffee at $4.50, it’s not the basis of an economic calculation, but the result of an endless dance of trial and error between sellers and buyers that lead them to reach an unspoken agreement about what works best for both. This phenomenon is referred to as emergent order.
quantity demanded vs demand
Before we summarize, please note that economists differentiate between “quantity demanded” and “demand”. A change in the “quantity demanded” happens due to a change in price, like we explored when the price dropped and the quantity demanded increased. A “change in demand” happens when the environment changes. Let’s imagine that many people in the market become more health-conscious and think that coffee is bad. If that happens, the entire demand curve shifts downward, and at $3, not a hundred buy coffee but just 40.
- Supply is the amount provided at each price
- Demand is the amount purchased at each price
- The Final Price is the result of an emergent order
If you are up for it, we will now ask you to help us understand today’s price of coffee. Post your thoughts in the comments below!
Search for a Coffee Price Chart and you’ll find a graph showing the price of coffee in US Dollars. Then tell us:
- What’s the price of one kilogram of coffee today?
- What do you think are the reasons that have caused the price to fluctuate in the past 5 years?
- Supply and Demand – Wikipedia
- Supply and Demand – Econlib.org
- Law of Supply and Demand – Investopedia.com
- Read more about the topic and find lots of additional resources
- Should prices be allowed to rise freely or should the government restrict prices? Listen in as Munger and EconTalk host Russ Roberts discuss the human side of economics after a catastrophe.
- Watch the movie American Factory. The documentary takes a thoughtful – and troubling – look at the dynamic between workers and employers in the 21st-century globalized economy.
- Watch this documentary on YouTube to understand how every day, millions of sailors, truck drivers, longshoremen, warehouse workers and delivery drivers keep mountains of goods moving into stores and homes to supply what consumers demand.
- Richard McKenzie, the author of Why Popcorn Costs So Much at the Movies, talks with EconTalk host Russ Roberts about a wide range of pricing puzzles.
Ask your students to search for a Coffee Price Chart and you’ll find a graph showing the price of coffee in US Dollars. Then ask them to find out:
- What’s the price of one kilogram of coffee today?
- What do they think are the reasons that have caused the price to fluctuate in the past 5 years?
In addition you may challenge them to search for three coffee shops in the neighborhood that charge their customers different prices. Which one sells their coffee expensive and which one cheap? Was that price really set by the owner of the shop, or is it the result of constant changes in supply and demand — and the final price the phenomenon of an emergent order?