Our economic system is called capitalism, and its basic engine is called the market. A market economy is made up of buyers and sellers. Buyers try to get what they want for the lowest price possible, and sellers want to get the most money they can for the things they are selling. Together, this push-pull effect helps keep the market system in balance.
One of the mechanisms that helps maintain this balance is called supply and demand. The central principle of supply and demand is that prices are determined by the levels of supply (amount of items available) and demand (degree to which an item is desired). If more people want to buy a particular kind of product, the price will increase. If fewer people want that kind of product, the price will decrease. Supply is quite similar. If there is a low supply of a particular product, the price will be higher than if there is a glut of similar resources on the market.
How does this interaction of supply and demand affect pricing? What happens if supplies run low of something everyone needs in order to live? Let's find out more.
In this lesson you will:
- Learn about supply and demand, market forces, and price-gouging.
- Debate the validity of extreme price increases by exploring a hypothetical post-disaster scenario.
- Examine the reasons for price increases when supplies of a product are low.
- Consider other ways of distributing limited supplies.
Together, market forces of supply and demand help to keep the capitalist system in balance. Occasionally, however, events occur that appear to throw off that balance. Earthquakes, floods, and other natural disasters often cause extreme shifts in the supply of and demand for certain items. Ready to learn more? If so, then it’s time to enter the THE DISASTER ZONE.
Do you think Mr. Green's solution was fair? Can you think of other ways the water could have been distributed? Would you have purchased the water at the price Mr. Green charged?
Some people would refer to Mr. Green's pricing as "price gouging." The term price gouging refers to cases in which people take advantage of a situation like the earthquake by charging much, much more than what would be considered "fair" in regular circumstances. Discuss with the class whether you think this is what Mr. Green did.
- What are the advantages to a seller who uses this pricing strategy?
- What are the disadvantages?
- What do you think will happen to Mr. Green's business over the long-term, when the disaster is over and the water supply is restored?
Think about some of the ideas you brainstormed for alternative methods of distribution during "The Disaster Zone" activity.
Are any of your ideas more “fair” than charging extra money for the water? Do any of them favor one group over another? On a separate piece of paper, or together with your teacher and the rest of the class, make a list of all the alternatives you thought of for distributing the water. Next to each one, write down who is favored and who does worse in each distribution scenario.
All things considered, which scenario do you think is the best?
How might water suppliers be enticed to make an extra effort to increase the supply of water in this earthquake-stricken town, if water is distributed via the pricing mechanism?
How will this cause the price of water to begin to decrease?
In a market economy, supply and demand are the primary determinants of pricing. When the supply of a product outpaces the demand for that product, prices will naturally go down as sellers compete for consumers. When the supply of a product is not able to keep up with the demand for it, prices increase - sometimes dramatically - in response to the sellers' ability to attract consumers.
Other methods of distribution of products can be considered, but none would be any more or less "fair" than exchange of money for goods or services - the dominant method of distribution in a market economy.
If someone asked you to explain the principle of supply and demand, could you do it? Get together with the person sitting next to you and answer the following questions on paper (write one paragraph or less per question):
Answer each question in one paragraph or less.
- How do fluctuations in levels of supply and demand affect prices?
- What can happen when demand for something is extremely high and the supply is extremely low?
- What are some of the ways in which scarce supplies can be distributed?
The charge of price-gouging is often leveled at the petroleum industry. Learn more about the complexities involved in determining whether a producer is price-gouging or simply responding to supply and demand in this “Marketplace” segment. Play through 2:50. The text of the discussion is available, or an audio version can be heard using Real Player.