Supply is a measure of how much of something there is. It’s pretty simple and self-explanatory.

Demand is a measure of how much that something is wanted in an economy. It’s also pretty self-explanatory.

What’s a bit more complicated – and what needs to be grasped – is the relationship between those two.

Supply & Demand want to exist in a state of equilibrium. This is the ideal state where the supply perfectly matches the demand for it. That state is also difficult to reach.

If they are not in a state of equilibrium, then the value of supply will change to match the demand.

At this point, ‘value’ is represented in price which is expressed in a given currency, though neither of those are technically required for understanding how supply & demand works.

If the demand is higher than the supply, then the price of the supply increases. By increasing the price, the demand lowers because those demanding it are gradually less willing to obtain the supply.

If demand is lower than supply, the price of supply will decrease which causes demand to rise. This continues until a state of equilibrium is reached.

Now, I stated that Supply & Demand is more of a law of nature…but what does that mean? It means that technically everything is in some form affected by some kind of Supply & Demand…because it’s just a natural result of scarcity.

Think about it like this: if the number of predators in a given ecosystem increases, then the population of prey will start to decrease as well. This causes a ‘collapse’ if the population of prey is too low, which results in the population of predators crashing. Eventually, a state of equilibrium is reached in which the population of prey and predators matches to a degree where both survive long-term.

This is basically just a “market economy” in nature…just that most people don’t think of it like this.

As Supply & Demand is just a thing, it also means that not understanding how it works can result in serious misjudgements and misunderstandings about how the economy works and what solutions can/should be implemented.

An engineer who doesn’t know how to count isn’t going to be a good engineer, right?

We represent ‘value’ in money because, for the purposes of trade, it’s convenient. That’s it.

If we didn’t have money, we’d either be forced to rely on barter or credit. And then we’d switch to money really fast anyway.

Credit is itself a complicated topic that I’ll choose to ignore for now because it isn’t necessary to understand the basics.^A;B)

What is ‘value’? Well ‘value’ is an abstract^C) which roughly represents how useful/wanted a given thing is.

Gold is, in a practical sense, less useful than copper. But because gold is shinier and prettier than copper, it’s desired by people more, which is what makes it more ‘valuable’.

Let’s use an example. Let’s say that I make two hotdogs. It cost me $0.50 to make each hotdog. Some guy comes along and agrees to pay $1.50 for it. Then you come along and pay me $2.00 for the hotdog.

Which of those three prices represents the true value of the hotdog?

The answer is that none of them do. This is because ‘value’ – and, by extension, the ‘price’ – is relative. All of them are a ‘correct’ representation of the value of the hotdog, just that what’s ‘correct’ varies based on the surrounding context.

The reason some guy paid $1.50 while you paid $2.00 is because those are the prices that we had agreed upon. He was willing to pay $1.50 for the hotdog and I agreed to sell it to him for that amount. Meanwhile, you were willing to pay $2.00 for it, so I agreed to that too. If you had known the other guy had paid less, you’d probably want to pay that much too.

Basically, every price of any good or service is individually negotiable like this.^F) There are parts of this ‘equation’ that are kinda, sorta, not really set in stone – like me spending $0.50 to make each hotdog – but this generally applies.^G)

Does this mean that all prices are actually nonsense and, in fact, nothing is worth anything? No, it doesn’t. Prices may be individually negotiable (‘Individually subjective’), but if we factor in everything else the situation changes.

Now let’s move on to the part that is ‘Collectively Objective’.

It may seem like the difference between what you and that guy paid for the hotdog is quite significant…if we consider the hotdog market as a whole, that perspective may change.

Let’s say the price of hotdogs in this particular market drifts between $1.25-$5.00. Now we can see that, actually, there isn’t that big of a difference between those prices at all. If a hotdog were sold for less or more than that, that would have been a significant difference.

It’s generally here that ‘market conditions’ start being brought up, which simply refers to what the given situation is in a particular market (or ‘the market’^H;I) as a whole):

• How are the things being sold and how they relate to everything else in the market.
• What affects the demand of the things being sold. (Besides everything else.)
• What affects the production of the things being sold.

And we could go on and on.

So why am I selling the hotdogs at that specific price? Well, because I’m probably looking at my competitors.

Maybe I see that my competitor is selling hotdogs at a fixed price of $2.50. So I’m trying to undercut him by being more flexible with pricing on the one hand and for consistently selling at a lower price. My competitor may choose to respond by lowering the prices himself.

This is competition and it can manifest in thousands of different ways, so I’ll leave that for later.