Module 5: Supply and Demand: Introduction and Demand

Module 6: Supply and Demand: Supply

Module 7: Supply and Demand: Equilibrium

Module 8: Supply and Demand: Price Controls (Ceilings and Floors)

Module 9: Supply and Demand: Quantity Controls

Economics by Example: “The Coffee Market’s Hot; Why Are Bean Prices Not?”

If you bought a pair of blue jeans in 2012, 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, a particular weave of cotton. In 2011, when jeans manufacturers were buying supplies for the coming year, the price of cotton climbed to more than triple its level just two years earlier. In March 2011, the price of a pound of cotton hit a 141-year high, the highest cotton price since record keeping began in 1870.

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 2011, 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 underwater 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 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 the United States, cotton producers had not been hit by bad weather and were relishing the higher prices. American farmers responded to the sky-high cotton prices by sharply increasing the acreage they devoted to the crop. None of these measures were 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 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 market behavior that is extremely useful for understanding many—but not all—markets.

In this section, we lay out the pieces that make up the supply and demand model, put them together, and show how this model can be used to understand how most markets behave.