This does not make sense? LAW OF SUPPLY AND DEMAND.?

[David Richards]

Imagine that a special edition CD of your favorite band is released for $20. Because the record company's previous analysis showed that consumers will not demand CDs at a price higher than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship shows that the higher the price, the higher the quantity supplied.

If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up because the supply more than accommodates demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower price will then make the CD more available to people who had previously decided that the opportunity cost of buying the CD at $20 was too high.

THIS EXAMPLE DOES NOT MAKE SENSE.

"the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price."

Well I thought that the Law of Demand states that the price of a product will usually decrease with increased demand as more people are willing to buy a good/service at a lower price? CONFUZZLED.

[Jared]

Believe it or not, the example makes complete sense. It's just hard to understand if you're not used to the wording. For instance, "yadadadadayaydyada opportunity cost blahalahahalbaahal" throws you off. You do not need to know what opportunity cost is at this point in time.

I suggest you think of demand and supply as a LINKED set of things... We use supply and demand to determine a price (or the market does).

Take a couple of examples:

I have 1 CD to sell, but there are no buyers. How much is it worth? (Arguably... nothing).
I have 1 diamond to sell, and it is a one-of-a-kind treasure, and EVERYONE in the market wants to buy it. How much is it worth? Well, technically, it is worth what someone is willing to pay for it; but, we normally refer to these things as being "priceless."

With that said, let me directly address your statement: "the price of a product will usually decrease with increased demand as more people are willing to buy at a lower price" --> NO! Not if the amount of product supplied is fixed, at least. People are always willing to pay a lower price to get the same good! Hell, everybody would be willing to buy everything for FREE, right?

In order to do these elementary problems, you need some constraints. Normally, you place a constraint on demand or supply (in this case we will use supply), and you do this by saying supply is FIXED (i.e. 20 were produced; 20 are in the market; there are only 20 to buy, and that's that).

Now, if you have 20 people (and 20 people only) who want the product, then you will expect the price to remain constant. However, if 30 people want it, then you have a SHORTAGE. If people have the choice, they will bid up the price. So, in the case of demand is greater than supply, the price should rise.

So that should satisfy you that increased demand (with fixed supply) does not lead to people being willing to pay less and less.

Let me give you a couple of real-world examples.

A hurricane is about to hit a city with one gas station. The gas station has 30 cases of bottled water, and 300 gallons of gas. 300 people want 30 cases of bottled water, and each wants 300 gallons of gas. Obviously, you have a shortage here. In this example the gas station owner is PROHIBITED BY LAW from raising the price on these goods (it's called price-gouging). If this were not true, you would expect the gas station owner to RAISE the price on bottled water and RAISE the price on a gallon of gas. By how much? Well, as much as the highest bidder is willing to pay.

You have effectively 1 unit of gas to sell and 1 unit of water to sell, and you have 300 people wanting 1 unit of gas and 1 unit of water. The person with the most cash will get the 1 unit of water and the 1 unit of gas, and he or she will pay much more for those products than they were selling for prior to the approach of the hurricane.

One place where you usually do not find such restrictions on price-setting is the stock market. The price of a marketable common stock, by definition, is SET by the market.

So, let's say Facebook, Inc. has 1,000,000 shares of stock to sell @ $100/each. They sell these into the market. What happens next? Well, if market has a lot of faith in Facebook, Inc., you should expect this FIXED SUPPLY of stock to sell for MORE than it's IPO price on the open market. This is when you see people become millionaires overnight. This, unlike the price-gouging gas station owner situation, is completely legal.

If, on the other hand, XYZ Corp. is willing to sell as many shares of stock as the market wants at $100, then you would not expect the price to increase. This is a more complicated situation. You would expect many people to pay $100 up-front, and then you would expect people to stop buying from XYZ Corp. and start buying on the open market -- maybe for less than $100. This tendency to cause the price of stock to go down is the REASON why corporations do not issue infinity shares of stock. They sell a fixed amount in hopes that demand will cause the price to RISE.

Fixed supply; quantity demanded exceeding quantity supplied --> leads to increase in price.