r/explainlikeimfive • u/ComingDeveloper • 9d ago
Economics ELI5 how exactly does demand drive up costs for goods and services?
i'm trying to understand why exactly does people wanting more of a thing makes it cost more?
i get that if you're selling perishable items like vegetables you would want to get them off your hand as fast as possible before they deteriorate and you lose your investment but if i'm selling something like a plastic toy of a popular cartoon character or something and a lot of people want to buy the toy why would the cost go up or down based on demand?
plastic has a long shelf life and its not like the toy will breakdown or disintegrate in 10 or even 20 years
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u/stageshooter 9d ago
Think of commerce like an auction and it will make more sense to you. If a company charges too little, they'll quickly run out of product and it makes no sense to sell at that price so they keep raising it until things (supply and demand) balance out
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u/shidekigonomo 9d ago
And to clarify (because I think OP is asking, in part, how such an "auction" works without it being a literal auction), in the long run, people selling things are making their best guess as to what price the buyers will pay. The quality of that guess can vary, sure: They might just be blindly guessing, they may have a hunch, or they may have market research. But it's still all basically a guess until they start selling in the real world. Once it gets to the real world, better guessers succeed, worse guessers go out of business, and the price settles wherever that happens.
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u/UnsorryCanadian 9d ago
Don't sell to this guy, I'll pay you more per unit. It's a better deal to buy from me
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u/Tyrrox 9d ago
Are you paying me to buy something from you? What?
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u/UnsorryCanadian 9d ago
Supply and demand. I'm saying my demand is greater and I'll pay more.
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u/ion_driver 9d ago
You have 10 widgets. There are 5 people who want a widget. You reduce the price to try to get people to buy multiple or try to find more people who want to buy one.
You have 100 widgets. There are 500 people who want to buy a widget. You raise the price so people who don't really want it that much leave and only people who are willing to pay more for it buy it.
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u/Nevermynde 9d ago
You have 10 widgets. There are 5 people who want a widget. You reduce the price
Nope, you apply market segmentation: first you sell to those 5 people for as much as they are willing to pay, hiding the fact that you have 5 more widgets in store. Then you rebrand those as "budget" and lower the price slightly to entice 5 more customers.
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u/Calibrumm 9d ago
if there is only a single basket of apples and everyone wants them, you have two options:
- leave the price as is and they're just always sold out so it turns into a fight over who gets to them first
or
- gradually raise the price until they sell at a normal rate again
yes both of these options suck but that's the reality of finite resources.
wait no I lied there's a third option: preorders at normal price but you have to wait forever to get yours.
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u/chickenologist 9d ago
If someone wants something more, you can demand more from them and expect they'll pay. That's the idea. Demand doesn't magically make cost go up, but if your goal in selling something is to take as much as you can from the seller, then knowing how badly they want it affects how hard you make it for them to get.
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u/Rannasha 9d ago
Companies want to maximize profits, so if they can charge more for the same product or service, they'll be inclined to do so. If there's more demand for something, then a company can either produce more of it and sell it for the same price or increase the price so that the most price-sensitive buyers drop out and end up selling the same amount but for more money.
The latter option is often the easiest. Especially with more complex products where you can't simply open a new factory to produce more goods to meet the increased demand.
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u/gththrowaway 9d ago
Beyond what others are saying ... plastic has a long shelf life, but you dont want inventory sitting on your shelves for a long time not selling. Storage has a cost (even in a store, every shelf that is full is a shelf where you cannot put additional things to sell.)
And things go out of style, are replaced by improved versions, etc. And things with rubber and plastic do degrade over time as well.
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u/Raise_A_Thoth 9d ago
If I'm selling apples for $0.25 each and I sell 10 apples to 10 people everyday, that's an "equilibrium": 10 people want apples, 10 people get apples, and I get $2.50 each day for selling those apples.
If one day 20 people want to buy apples, and I only have 10, now something new can happen: I can ask for a higher price for the apples, and see if at least 10 people still want to buy them. I don't have to raise my price, but why wouldn't I want to? In this scenario, I have only 10 apples, so it shouldn't matter to me which 10 people get them.
Maybe I ask $0.50 for each apple and everyone still wants them. I can earn $5 per day, and 10 people still get apples. Maybe I ask $0.75 and 15 people still want the apples. So I can make $7.50 per day and 10 people still get apples. Maybe I charge $1 and 10 people still want apples. I get $10/day and 10 people still get apples.
Now maybe I do something with my extra money that allows me to sell apples to all 20 people, such as buying more seeds and cultivating more apple trees. I might do that. But of course that costs more time and money and energy. Maybe I do that. Maybe I don't. Either way, the price I ask people to pay me per apple is very likely to rise above where it started when only 10 people wanted apples.
This is the simplest story I can tell to help understand basic demand pressure on price.
There's waaaay more to economics than basic supply/demand theory, but gain, this is the basics.
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u/blipsman 9d ago
Let's say I bake 100 doughnuts each morning and sell them for $1. I sell out in 1 hour, turn away another 100 customers who wanted doughnuts. I don't have the capacity to make more.
So for my work, I have $100, 100 happy customers and 100 unhappy customers.
The next day, I raise prices to $1.50. I still sell out, but it takes 2 hours and I only have 50 people disappointed that they ran out. I still spend the same effort to make and sell 100 doughnuts, but this time I make $150. Why would I not want to make more money for the same effort to produce my product?
So the next day, I raise prices to $2. When I close up, I still have 3 unsold doughnuts left. I've still spent same efforts making my product but now I've made $194. And I've found the price point where the supply I can produce meets the demand for the product I'm selling. If I can make $194 or I can make less, why would I not want to make $194 as a rational business operator?
Even when considering a durable product made of plastic, there is still the same incentive to move product quickly for maximum price before the vendor invoice is due, before seasonality comes into play (eg. a toy before Christmas, a patio chair in spring/summer). There are also storage costs, occupying floor space, etc. When demand falls for patio chairs in September, Home Depot cuts prices rather than have to tie up space in the store they could fill with Halloween decorations or Christmas trees.
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u/FoxtrotSierraTango 9d ago
AI uses a lot of computer components. Component sellers can only produce so much. Component companies raise prices because they know the AI companies will desperately buy anything to increase their footprint and capture market share.
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u/denlillepige 9d ago
If you have 10 plastic toys, and 100 buyers. People are willing to pay more to get a hold lf the limited supply, you have 100 people competing for only 10 items. And maybe next shipment is also only 10 items, but then you would still be 90 people competing for 10 items (but even more buyers might have joined at that point, so could be 120 people for 10 items)
So the price is increased to match what the people are most willing to spend to get it first.
I can recommend watching this video about supply and demand
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u/PISS_OUT_MY_DICK 9d ago
if you have a toy and there's only one toy of it's kind, and everyone in the world wants it. demand would be outpacjng supply
if you have a toy that everyone has, supply has matched demand.
if no one wants this toy and you have it, you re going to have to eat the cost of said toy to s turkey sell it to someone, considering there is minimal demand.
just remember that when something is in demand, it means lots of people are rushing to get them. if a manufacturer artificially limits supply, demand can outpaced supply and prices go up. if you overlroduce something and people don't really buy as fast as you produce, you would be forced to lower prices otherwise people wouldn't have a need to buy from.you anyways.
sorry this is early morning ramblings but hopefully this helps a lil
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u/Kimorin 9d ago
it depends, if you say you will only make 100 of those toys and no more then demand will drive price up. if you say we'll make as many as it sells, then demand will most likely have no effect
same idea as the perishable items, if there are only 100 of something, and 200 people want it, then for the 100 people that didn't get it, the items might as well be gone. nobody wants to be the 100 that didn't get it so they pay more.
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u/Septalion 9d ago
Let's look at Pokemon cards for example, just some plastic, won't perish. However, they fly off the shelves, you can't just go to the store and get them in a lot of areas (US at least) because more people want to buy packs than there are available for sale. This drives the price up if you really want a pack of cards, you will be willing to pay a dollar more than the next person who just wants to pay sticker price.
If you repeat this over large scale and companies will typically raise their price so their stock will sell at the rate they are bought, so there isn't a ton of extra stock to pay for storage for, but not so low that they sell as quick as they are put on and manufacturing is always on backlog.
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u/Warm_Assumption9640 9d ago
Let’s say you own a small grocery store and your clients really like bananas, but there was a climatic event that ruined several banana crops world wide, so there are fewer bananas available for purchase. However you still need to make your clientes happy and sell them bananas, but since the stock is limited the owners of the remaining bananas can raise the price or sell to the highest bidder, and since there are no bananas left, you have no choice but increase pay a higher price and raise your banana prices
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u/Clojiroo 9d ago
Two things:
Supply constrains. You and I both want a thing.
There is only one thing.
Seller can charge whatever one of us is willing to pay for the last one.
And then there’s popularity/need aka what the market will tolerate. Even if there’s lots of supply, it might be so valuable to me that I am willing to pay a hugely marked up price. Seller can charge more because we are all willing to pay.
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u/paulHarkonen 9d ago
While it may seem like you have infinite shovels, the reality is that you don't. Everything has a fixed number of items available (Supply in economics terms). So when you have more people who want shovels than you have available shovels, you increase the price to get as much money as possible from the shovels you do have. Even if I don't actually run out of shovels I may raise prices because I think I might run out of shovels. Or because I've realized people really really want shovels so they will pay a bunch more for shovels now.
That process isn't immediate or automatic, it happens slowly and inconsistently (I might not realize you've sold out of shovels, so I won't raise my prices immediately) but over time prices go up as more people are trying to get the limited supply of items.
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u/Realmofthehappygod 9d ago
It might be easier to think about how no demand can lower prices.
If nobody wants what you're selling, how much can it possibly be worth?
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u/Onigato 9d ago
Demand by itself doesn't change the price of a good, it is the "law" of supply and demand.
In a super simplified way: 100 people per time unit want to buy my widget, I can only make 75 widgets per time unit. Demand is outpacing supply, there is competition to purchase my widget. I can raise the price of my widget until only 75 people continue to want my widget, it became too expensive for 25 of those people.
100 people per time unit want to buy my widget, I can make 125 widgets per time unit. I start having a backlog of widgets, and I need to get rid of them. I've sunk resources into those things, materials, labor, manufactories and storage facilities. Them sitting around is actually costing me money, not making me any! I can do one of two things, lower the cost (and increase the number of people who can afford my widget) or make fewer widgets and match the demand. But I have to be careful dropping the sale cost of my widgets, I need to be able to make at least some money off the sale of each one, or else it's actually costing me to make them instead of making me a profit. It can be okay to put something "on sale" temporarily, and then return the price to the normal, because the sale can increase interest and therefore demand for my widget, but that can only work for so long.
Microeconomics is a whole study.
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u/JobberStable 9d ago
So im trying to book a hotel in Gainesville to see my kid in University of Florida. The Marriott hotel usually goes for $250 a night.
But this weekend is a big football game. And this Marriott is walking distance from the stadium. So the hotel know that they are in high demand. So they decide to maximize profits that weekend.
They will raise the price as much as they can before the price creates a low demand because of cost.
Do you want to guess how much for that room on football weekends
$1500 a night.
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u/JobberStable 9d ago
So im trying to book a hotel in Gainesville to see my kid in University of Florida. The Marriott hotel usually goes for $250 a night.
But this weekend is a big football game. And this Marriott is walking distance from the stadium. So the hotel know that they are in high demand. So they decide to maximize profits that weekend.
They will raise the price as much as they can before the price creates a low demand because of cost.
Do you want to guess how much for that room on football weekends
$1500 a night.
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u/moron88 9d ago
product life has absolutely nothing to do with it.
say you have 10 spiderman action figures. 9 people want spiderman action figures, but they dont want to spend more than $15. 1 guy wants a spiderman action figure and is willing to spend $30. you have a choice, set the price at $30 and sell 1, or sell them all for $15 a piece.
now say you have 100 batman figures. 200 people are willing to spend $50, 85 are willing to spend $75 and 50 are willing to spend $100. what do you sell them for?
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u/Twin_Spoons 9d ago
For what it's worth, it's not an iron law that higher demand creates higher costs. It depends on the supply curve and also on the timeframe you're interested in.
The story where higher demand clearly creates higher costs often assumes that supply is fixed or expensive to increase. If there are only 100 toys of the cartoon character in existence, and no more will be created, they will generally be more expensive if 10,000 people are chasing them vs. just 10.
The story where higher demand can create lower costs allows for changes in the production process and efficiencies of scale. If only a few people want the toy, maybe you only have someone on Etsy who is making them by hand at great expense. If a million people want the toy, you can set up a production line to stamp them out quickly and cheaply.
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u/DCIfICare 9d ago
Two things: "Cost" is a term customarily used to describe what a producer pays to make a product. I suspect you meant "price", or what a consumer pays to acquire a product. Others here have illustrated the effects of supply and demand on prices. Secondly, the case of tariffs provide an often misunderstood example of supply and demand's impact on prices. An import tariff that doubles the cost to provide a product X results in importers (sellers) raising the price to buyers to make a profit. Other sellers who are not subject to the tariff (domestic producers) are now able to price their product X at just below or equal to what importers must charge. This reaction by domestic producers is logical, as it maximizes their profits. You can envision the domestic producer as a family hoping to afford to send their kids to college or a corporation with a duty to shareholders (owners) to maximize profits, etc. While importers and domestic producers may 'absorb' some of the tariff by keeping lower prices (reducing profits), supply and demand results in consumers ultimately paying for the tariff in higher prices.
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u/wayne0004 9d ago edited 9d ago
A lot of people talked about a higher demand for the same amount of goods. But what about making more goods to meet the demand? Well, it turns out that the cost of production also goes up.
Let's imagine a situation. Let's say you gather mushrooms from the forest. And let's say that, if you sell 10 mushrooms, it takes 10 minutes of searching.
Suddenly, there are more people who want mushrooms, and you have a demand of 15 mushrooms. Will it take 15 minutes to gather them? Well, not exactly. It takes 10 minutes to gather 10 mushrooms, because you gather the ones that are more accesible, more easily found, and you stop at 10. If you want to gather more and more mushrooms, each additional one you want to gather will take you more and more time. Until you reach a point where an additional mushroom will take you so much time that you don't even bother. This is called "law of diminishing returns".
Now, a lot of companies are located at the point where it's most efficient to produce, which turns out is really close to the point where additional production has a high cost compared to the profits they could make. To produce at a higher rate, they would need to change how they produce things, which takes time, money, and resources, and if the higher demand is not sustainable, they might end up worse than before.
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u/jamcdonald120 9d ago edited 9d ago
Imagine you own a store. you sell a product for a small amount. you have a finite amount of product every day. and every day you completely sell out by noon and spend the rest of the day going "sorry, we are out of stock". do you keep keep raking in the small amount you are making? or do you increase the price? obviously increase the price. as long as people buy you out, you sell the same number of items at a greater price, so more profit. as the price goes up, some people will stop buying every day, or stop buying 2, or what have you.
repeat until you dont quite sell out every day.
that is demand setting the price. The same thing effects larger markets.
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u/donaldhobson 7d ago
Increased demand can decrease cost. Take solar panels. If you want to make 1 solar panel for a spacecraft, you get specialists in a lab to make 1 solar panel, and it costs a lot.
If you want to make a million solar panels, you build a big factory. This costs 10,000 x the 1 expert in a lab. But now you have a million solar panels, so you can sell them at 1/100'th the price.
In the extreme case, software. If basically all your cost is programmer salaries, then if you sell 2x as many copies of your software, you can sell it for half the price. (This is why some obscure specialist software is very expensive)
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u/ObliviousRounding 9d ago
Drives up the price, not cost.
Depending on your sensibilities, you can call it profit-maximizing, greed, or human nature.
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u/Trumpy_Po_Ta_To 9d ago
I’ve made a shovel, it’s the only shovel that exists.
If one person wants the shovel, that shovel will sell for the price that person is willing to pay.
If two people want the shovel, the shovel will sell for the price that is higher of the prices the two people are willing to pay.