the price of any product (other things being equal),
the greater
the quantities that buyers will be willing to purchase. And vice
versa. For as the price of anything falls, it becomes less costly rel-
ative to the buyer’s stock of money and to other competing uses
for the dollar; so that a fall in price will bring nonbuyers into the
market and cause the expansion of purchases by existing buyers.
Conversely, as the price of anything rises, the product becomes
more costly relative to the buyers’ income and to other products,
and the amount they will purchase will fall.
Buyers will leave the
market, and existing buyers will curtail their purchases.
The result is the “falling demand curve,” which graphically
expresses this “law of demand” (Figure 2.2). We can see that the
quantity buyers will purchase (“the quantity demanded”) varies
inversely with the price of the product. This line is labeled D for
demand. The vertical axis is P for price, in this case, dollars per
pound of coffee.
Supply, for any good, is the objective
fact of how many goods
are available to the consumer. Demand is the result of the subjec-
tive values and demands of the individual buyers or consumers. S
tells us how many pounds of coffee, or loaves of bread or what-
ever are available; D tells us how many loaves would be pur-
chased at different hypothetical prices. We never know the actual
demand curve: only that it is falling, in some way; with quantity
purchased increasing as prices fall and vice versa.
We come now to how prices are
determined on the free mar-
ket. What we shall demonstrate is that the price of any good or
service, at any given time, and on any given day, will tend to be
the price at which the S and D curves intersect (Figure 2.3).
In our example, the S and D curves intersect at the price of $3
a pound, and therefore that will be the price on the market.
To see why the coffee price will be $3 a pound, let us suppose
that, for some reason, the price is higher, say $5 (Figure 2.4). At
that point, the quantity supplied (10 million pounds) will be
greater
than the quantity demanded, that is, the amount that con-
sumers are willing to buy at that higher price. This leaves an
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The Mystery of Banking
Chapter Two.qxp 8/4/2008 11:37 AM Page 18
At a price of $5 for coffee, only 6 million pounds are pur-
chased, leaving 4 million pounds of unsold surplus. The pressure
of the surplus,
and the consequent losses, will induce sellers to
lower their price, and as the price falls, the quantity purchased
will increase. This pressure continues until the intersection price
of $3 is reached, at which point the market is
cleared
, that is,
there is no more unsold surplus, and supply is just equal to
demand. People want to buy just
the amount of coffee available,
no more and no less.
At a price higher than the intersection, then, supply is greater
than demand, and market forces will then impel a lowering of
price until the unsold surplus is eliminated, and supply and
demand are equilibrated. These market forces which lower the
excessive price and clear the market are powerful and twofold:
the desire of every businessman to increase profits and to avoid
losses, and the free price system, which reflects economic changes
and responds to underlying supply and demand changes. The
profit motive and the free price system
are the forces that equili-
brate supply and demand, and make price responsive to underly-
ing market forces.
On the other hand, suppose that the price, instead of being
above the intersection, is below the intersection price. Suppose
the price is at $1 a pound. In that case, the quantity demanded by
consumers, the amount of coffee the
consumers wish to purchase
at that price, is much greater than the 10 million pounds that they
would buy at $3. Suppose that quantity is 15 million pounds. But,
since there are only 10 million pounds available to satisfy the 15
million pound demand at the low price, the coffee will then rap-
idly disappear from the shelves, and we would experience a
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