IF YOU BOUGHT A PAIR OF BLUE jeans in 2011, you may have been shocked at the price. Or maybe not: fashions change, and maybe you thought you were paying the price for being fashionable. But you weren’t—you were paying for cotton. Jeans are made of denim, which is a particular weave of cotton, and by late 2010, when jeans manufacturers were buying supplies for the coming year, cotton prices were more than triple their level just two years earlier. The price of cotton continued to rise in early 2011, peaking in March of that year at a price of US$2.30 per pound. (Cotton is traded internationally in U.S. dollars per pound, the equivalent of 0.454 kg). It was the highest level since records began in 1870. The price of cotton softened subsequently but remained relatively high compared to historical standards.

And why were cotton prices so high?

On one side, demand for clothing of all kinds was surging. In 2008–2009, as the world struggled with the effects of a financial crisis, nervous consumers cut back on clothing purchases. But by 2010, with the worst apparently over, buyers were back in force. On the supply side, severe weather events hit world cotton production. Most notably, Pakistan, the world’s fourth-largest cotton producer, was hit by devastating floods that put one-fifth of the country under water and virtually destroyed its cotton crop.

Fearing that consumers had limited tolerance for large increases in the price of cotton clothing, apparel makers began scrambling to find ways to reduce costs without offending consumers’ fashion sense. They adopted changes like smaller buttons, cheaper linings, and—yes—polyester, doubting that consumers would be willing to pay more for cotton goods. In fact, some experts on the cotton market warned that the sky-high prices of cotton in 2010–2011 might lead to a permanent shift in tastes, with consumers becoming more willing to wear synthetics even when cotton prices came down.

At the same time, it was not all bad news for everyone connected with the cotton trade. In North America, cotton producers had not been hit by bad weather and were relishing the higher prices. Farmers responded to sky-high cotton prices by sharply increasing the farmland devoted to the crop. None of this was enough, however, to produce immediate price relief.

Wait a minute: how, exactly, does flooding in Pakistan translate into higher jeans prices and more polyester in your T-shirts? It’s a matter of supply and demand—but what does that mean? Many people use “supply and demand” as a sort of catchphrase to mean “the laws of the marketplace at work.” To economists, however, the concept of supply and demand has a precise meaning: it is a model of how a competitive market behaves.

In this chapter, we lay out the pieces that make up the supply and demand model, put them together, and show how this simple model can be used to understand how many—but not all—markets behave.