What is Supply and Demand?
Florida (FL) is one of the largest orange producing State. In early January of this year, FL had a deep freeze which impacted the orange crops. A few weeks ago we posed a question – what should happen to the orange juice (OJ) prices due to the freeze? We received some good email responses.
To understand impact to the OJ price we decided to discuss the basics of economics – Supply and Demand.
What is Demand?
The demand is how much quantity of Goods or Services are desired by buyers.
What is Supply?
The supply is how much quantity of Goods or Services are available in the market.
For example, you like one glass of orange juice (OJ) every morning with your breakfast. Your mother buys a carton of OJ weekly to supply seven glasses of OJ. Let’s assume that if you had to pay for a glass of OJ you would be willing to pay $1 per glass from your allowance to your mom. In other words, demand for OJ is one glass per day, price is $1 per glass, and accordingly the OJ supply exists to meet the demand.
Now, your pesky older brother suddenly also decides to start drinking OJ with his breakfast. He is also willing to pay $1 per glass as you are from his allowance. Mom is happy that OJ, a good source of Vitamin C, is now consumed by both kids. The OJ demand increases while the supply still remains the same for now. More demand with same supply increases the price of OJ to say $1.25 per glass.
What happens to the demand for OJ? Demand doubles to two glasses per day. What happens to the Supply?
Let’s say that your mother does grocery weekly and can’t go to the grocery store during the week. The OJ Supply will drop, and fast. In other words, for the time being although the demand has doubled, the supply has remained for only one glass per day. How would you react to the OJ supply and demand imbalance? It depends. So let’s look at a few scenarios –
If your mom is willing to bring in more OJ home which meets the demand without adding more cost to her, then you and your brother can continue to enjoy the OJ supply at the same price as $1 per glass. In other words, as the demand increased the supply increased proportionately without additional cost, and the price remained the same.
What if your mom says, now that she has to carry more OJ every week, the cost is not $1 but $1.25 per glass from your allowance? In other words, as the demand has increased, the supply also has increased proportionately but with an additional cost of $0.25 per glass added by mom (look at the first curve on the top of this page but now with $1.25 per glass price. Therefore, the OJ price has increased accordingly from say $1 to $1.25 per glass. Now you have a choice to make. If you like the OJ so much that you are willing to pay more than $1 per glass and let’s say that your brother also feels the same then the OJ price will get established for $1.25 per glass.
Now if suddenly, your brother stops drinking the OJ which leaves extra OJ supply in the house. This causes the OJ supply and demand imbalance. In other words, more supply of the OJ than demand.
Unless the OJ is consumed in time, it will spoil. Soon your mom will stop buying extra OJ and the supply will be reduced to meet the demand. In this simple example, hopefully your mom cuts her additional cost she had to incur to satisfy the increased OJ demand, and therefore, the OJ price should come back to $1 per glass again.
Let’s apply the Florida Freeze example to the above. The cold weather tells us that it could impact the orange crop, which in turn reduces the orange supply while the OJ consumption by people has not changed as yet. In other words, the supply impacted downward, while the demand stayed the same. In theory, reduced OJ supply to the demand should at least cause the OJ price to rise until a supply-demand balance is re-established.