I have a question about economics. I never studied this sort of thing, but I think I need to understand the basics to survive out there in the real world, right? So, here’s my dilemma: I think I only sort of understand supply and demand. I understand that rare things can be valuable. What I don’t understand is how things can become more or less valuable, when the amount or number of them isn’t changing. How can gold get more or less valuable? It’s not like we’re getting a bunch more gold somehow, right?
Your question is a good one, and you’ve identified the principle that is more important for examining it in its most basic form. Supply and demand are indeed the factors at play here, but you forgot that they are two separate subjects. The supply of gold may stay the same while its value changes, because the demand for gold can change. Why that happens is a question all its own.
Let’s back up a little. The principle of supply and demand is a very basic rule in economics, and you may already understand how it works. High demand and low supply are factors that, with all else held equal, raise prices in a free market. Low demand and excess supply drive down prices. You can move around supply and demand numbers to create different situations and have different net effects on prices.
Let’s say you have a precious piece of jewelry with an exotic diamond on it. You could find an expert who specializes in appraising rare colored diamonds, learn how much it is worth, and then decide if you should sell it. Its high value will be due to its low supply, because of the diamond’s rarity. Demand shouldn’t be a problem, as plenty of people are in the market for jewelry.
Now, let’s imagine that you have a great deal of cheap, non-perishable food products; the kind of stuff that wholesale distributors might sell in bulk. Now, you don’t have much in the way of scarcity, because the supply is high. However, wholesalers still make money, because they offer products that are in demand. Because they deal in bulk, they save money using economies of scale.
Now, let’s take our two examples, and apply a new problem: in our fantasy world, the economy just crashed. If you’re holding that jewelry, and you want cold, hard cash, you may be in trouble. The supply is still low, but where is the demand? With stocks plunging, people may not be eager to spend money on flashy jewelry.
Or, will they? After all, the gems and metals in the jewelry are permanently scarce. In a recession, you may see the value of gold and other commodities rise relative to stocks. In uncertain times, these stores of value look appealing–and up goes demand!
What about the food? Well, supply is still high. Is demand lower in a recession? Perhaps, but the impact is lower for our hypothetical wholesalers, because we’re selling food. Food is necessary in good times and bad, so demand can only lessen so much. Goods like this are said to be elastic. They are resistant to changes in demand because they are so necessary.
Now, let’s put it all together. Goods are more valuable when they are rare, and less valuable when they are common. They are more valuable when in demand, and less valuable when nobody wants them. However, the same factors that make demand drop for one item can cause a rise in demand for another, making values fluctuate, even if demand remains constant. The reverse can happen, too. Also, some goods are resistant to factors that might otherwise change demand or supply. Combine all these factors, and you begin to see just how complex even this simplified vision of our economy can get!
“Supply always comes on the heels of demand.” – Robert Collier