In 2020 it was toilet paper. The store shelves were bare, clearly it was in demand, but it was also in short supply – and the explanations were swirling. Now (in 2022) it’s oil, housing, job openings, and seemingly a million other things.
Which is it? The supply? The demand? Or both?
It can be a bit confusing to make sense of “supply vs. demand” arguments (and economic “curves,” and…). It can help to look at what the words mean, and then I’ll share my favorite metaphor for remembering how nuanced these explanations can be.
Supply is how much of something exists. In the toilet paper example, it’s the toilet paper the stores have in possession to sell to consumers.
Demand is how much somebody wants the something. In the same example, it determines how easy vs. how hard it is for the stores to keep TP on the shelf as people keep buying it.
Supply = the stores. Demand = the shoppers.
When supply and demand are “balanced,” everything flows smoothly. According to the textbooks, if supply is high but demand is low – the price probably falls towards “cheap.” Conversely, if supply is low while demand is high – the price probably races towards the moon, or “expensive.”
This see-saw effect explains why your sort-of-friend’s book of terrible poetry can only be given to you otherwise you’d never buy it, and also why your dream home is unobtainable outside of you winning the lottery twice in a row.
In the real world, and going back to the toilet paper example, far too often stuff gets more complicated. People left the office and went home, where they expected a more home-y toilet paper versus a less cost-saving office bathroom version, and next thing you know the manufacturers have to change what they make for which stores are ordering to handle the customers all hoarding. It’s a messy process.
Enter this metaphor I learned from Tim Duy’s: Supply and demand is a lot like the two blades on a pair of scissors. You might think you know which one is doing the cutting, but it’s always both sides working together. You can’t have one without the other.
Whatever explanation of supply and demand you’re hearing or reading about in the headlines, keep that in mind. It’s tricky. It always works from two perspectives. And, it evolves over time. Supply and demand is an excellent mental model to understand but be sure to think of it in terms of the blades on a scissor so you can remember the reality of the tool.
h/t Tim Duy’s recent appearance on the Odd Lots podcast, “Tim Duy on the huge challenge the Fed now has in 2022.” I’m also a fan of Duy’s blog, Fed Watch.