We’re gathering your questions about all things money and finances. Then we get your questions answered by the people who know best.
Murray asked how supply and demand works.
Why is it that if a manufacturer has produced a product and has established a cost to manufacture and then sells more than anticipated, the asking/selling price increases because there is a “limited supply?” The cost to manufacture has not increased due to scarcity. Why the price increase? Is this the philosophy of “demand what the market will bear?”
Tom Healy, a lecturer in the department of finance at the University of Illinois Chicago, said the short answer is yes.
“We see this all the time,” he said. “This is why refreshments at sporting events are several times what they cost you at the grocery store. This is why it costs you more to go to Disney World over spring break and over the holidays. This is why flights to Hawaii and exotic destinations are priced higher when people are less likely to be working and taking vacations. This is not something that we don’t encounter in our day-to-day life — flex pricing with rideshare companies is an example of that.”
Healy said it’s how competitive markets operate but sometimes society — or government officials — will intervene when prices rise to unacceptable levels such as creating laws to prevent price gouging during natural disasters.
“Free markets are free to operate as designed, up to a point,” he said. “But society, legislation [or the] government has throughout history … put limits on just how much markets can react to fluctuations in demand and in supply.”
There are certain industries where prices are based on the manufacturing cost, with an additional mark up “to achieve a desired profit margin,” described as a cost-driven approach. A company expects strong consumer demand regardless of price — an example would be medicine or gas — and the academic term for that is inelastic demand, according to Haley.
While it’s often seen in regulated industries or among businesses that deal with government contracts, companies still have to be careful.
“If you set the price too high, demand might not materialize and the product or service might not sell,” he said. “If you set the price too low, demand will swallow up available supply. The product will sell, but the manufacturer [or] the provider of that good or service will not have been able to maximize the value generated for what they have produced.”
He said competitive markets can reach an “equilibrium price,” when supply equals demand leading to stable prices. But you’ll see prices change when something upsets the equilibrium.
“You could see demand change as a result of increasing or decreasing personal incomes,” he said. “Supply can change. [It] can be impacted by changes in technology or changes in labor cost.”
Have a financial question you want answered by an expert? Leave us a voicemail at 312-321-2122 or email us at moneyquestions@suntimes.com.