Thursday, October 02, 2008

Supply and Demand in Action

It is amazing to watch the interaction between supply and demand in action close up. Of course, if you do not make the decisions on bringing a product to market it is easy to miss.

One complaint I frequently see lodged in the papers and others spouting populist demagoguery is how supply and demand arguments are rubbish as gas stations always have gasoline. That is, always having gas means abundant supply. However, supply and demand are not about wishes the idea of supply and demand is about reality – actual purchasing and selling. I recall my econ teachers and profs trying to stress this but the idea of actual purchasing and selling needs more emphasis.

I am a part of a group that runs a booth at the local Octoberfest. We make and sell a popular food product. We always had lines and sold a lot of the product which at our first Octoberfest we sold it for $1.50 a piece. At both events we were unable to keep up and had long lines, we sold a large number of the product and made a good profit. Next summer we increased our price to $2.00 same story (however we had made even more of the product).

However, this summer we increased our price again to $3.00 a piece. What happened? Our lines were shorter, we were able to keep up with demand and our gross income was identical to previous years with less work and less investment! Why would any rational person now go back to $2.00 or less?

While I have yet to perform a full analysis I am certain the increase in price improved our bottom line. In fact, we were able to make more money with less investment and less people-hours of work.

Were fewer customers able to purchase our product, yes. So? We do not owe them the product we worked hard to produce it they need to show some appreciation of that work. Were we gouging? I suppose you could characterize it that way, but if you wanted a similar product for cheaper all you had to do was walk less than a block up College Ave and visit some our friendly competition or even further up and buy essentially the same product from less than friendly competition for $2.00 a piece.

You see, what happens when a gas station accidentally sets the price to $2.54 per gallon? They develop long lines but do the long lines indicate profit being made? Not necessarily.