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Supply and Demand

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What $100+ billion global industry sells a product that many people typically can obtain easily from another source free of charge? The bottled water industry! This industry began its meteoric rise in the early 1990s, and today, the ubiquitous bottle of water has changed the way we live. It also has created new concerns regarding the environmental impact of the billions of plastic bottles used and discarded.

The bottled water industry took off as consumers changed their hydration habits, spurred by greater awareness of the health benefits of drinking water, including weight loss, illness prevention, and overall health maintenance. As water consumption increased, people started wanting something more than just ordinary water from the tap. They desired water that was purer, more consistent in taste, or infused with flavor or minerals. Plus, consumers wanted water that was easy to carry. Bottled water was the product consumers wanted, and the market was willing to provide it.

Bottled water comes from many sources, both domestic and foreign, and consists of either spring water (from natural springs underneath the Earth’s surface) or purified water (ordinary tap water that undergoes a complex purification process). As the industry grew, new varieties of water were made available. Water from exotic faraway springs, vitamin-infused water, flavored water, and carbonated water were some of the choices consumers were given. The total amount of water produced for the bottled water industry continued to increase as long as there were customers willing to pay for it in the market.

In the late 2000s, falling incomes from a deteriorating global economy, concerns about the harmful effects of discarded plastic bottles on the environment, increased use of home water purification devices, and even some laws against the use of bottled water eventually halted the market’s growth. The economy has since improved, and the bottled water industry responded to the environmental concerns by using bottles made from recycled plastic or by using new technologies to reduce the plastic content in water bottles, again responding to the desires of consumers. As a result, sales increased again.

Consumers have many choices of what water to buy and where to buy it. Even so, the bottled water market is one in which prices vary considerably depending on the location of purchase. A single bottle of water of the same brand might cost $0.69 at a grocery store, $0.99 at a convenience store, $1.25 from a vending machine, $1.49 at a local coffee shop, and $3.00 or more at a theme park, sports stadium, or movie theater. How can the same product be sold in different places at so many different prices?

This chapter analyzes the various factors influencing how consumers value goods in different settings and circumstances. We also study how producers take costs and incentives into account in determining what products to produce, how much to produce, and what prices to charge. The interaction between consumers and producers within a market determines the prices we pay.

In any given market, prices are determined by “what the market will bear.” Which factors determine what the market will bear, and what happens when events that occur in the marketplace cause prices to change? For answers to these questions, economists turn to supply and demand analysis. The basic model of supply and demand presented in this chapter will let you determine why product sales rise and fall, in what direction prices move, and how many goods will be offered for sale when certain events happen in the marketplace. Later chapters use this same model to explain complex phenomena such as how wages are set and how personal income is distributed.

This chapter introduces some of the basic economic concepts you need to know to understand how the forces of supply and demand work. These concepts include markets, the law of demand, demand curves, the determinants of demand, the law of supply, supply curves, the determinants of supply, and market equilibrium.