Demand can also increase or decrease as a product goes in or out of style. When famous athletes or movie stars create a popular new look in clothing or tennis shoes, demand soars. When something goes out of style, it soon disappears from stores, and eventually from peoples closets, too.
If people expect the price of something to go up in the future, they start to buy more of the product now, which increases demand. If they believe the price is going to fall in the future, they wait to buy and hope they were right. Sometimes these choices involve very serious decisions and large amounts of money. For example, people who buy stocks on the stock market are hoping that prices will rise, while at least some of the people selling those stocks expect the prices to fall. But not all economic decisions are this serious. For example, in the 1970s there was a brief episode when toilet paper disappeared from the shelves of grocery stores, because people were afraid that there were going to be shortages and rising prices. It turns out that some of these unfounded fears were based on remarks made by a comedian on a late-night talk show.
The final factor that affects the demand for most goods and services is the number of consumers in the market for a product. In cities where population is rising rapidly, the demand for houses, food, clothing, and entertainment increases dramatically. In areas where population is fallingas it has in many small towns where farm populations are shrinkingdemand for these goods and services falls.
Changes in Supply
The supply of most products is also affected by a number of factors. Most important is the cost of producing products. If the price of natural resources, labor, capital, or entrepreneurship rises, sellers will make less profit and will not be as motivated to produce as many units as they were before the cost of production increased. On the other hand, when production costs fall, the amount producers are willing and able to sell increases.
Technological change also affects supply. A new invention or discovery can allow producers to make something that could not be made before. It could also mean that producers can make more of a product using the same or fewer inputs. The most dramatic example of technological change in the U.S. economy over the past few decades has been in the computer industry. In the 1990s, small computers that people carry to and from work each day were more powerful and many times less expensive than computers that filled entire rooms just 20 to 30 years earlier.
Opportunities to make profits by producing different goods and services also affect the supply of any individual product. Because many producers are willing to move their resources to completely different markets, profits in one part of the economy can affect the supply of almost any other product. For example, if someone running a barbershop decided to sign a contract to provide and operate the machines that clean runways at a large airport, this would decrease the supply of haircutting services and increase the supply of runway sweeping services.
When suppliers believe the price of the good or service they provide is going to rise in the future, they often wait to sell their product, reducing the current supply of the product. On the other hand, if they believe that the price is going to fall in the future, they try to sell more today, increasing the current supply. We see this behavior by large and small sellers. Examples include individuals who are thinking about selling a house or car, corn and wheat farmers deciding whether to sell or store their crops, and corporations selling manufactured products or reserves of natural resources.
Finally, the number of sellers in a market can also affect the level of supply. Generally, markets with a larger number of sellers are more competitive and have a greater supply of the product to be sold than markets with fewer sellers. But in some cases, the technology of producing a product makes it more efficient to produce large quantities at just a few production sites, or perhaps even at just one. For example, it would not make sense to have two or more water and sewage companies running pipes to every house and business in a city. And automobiles can be produced at a much lower cost in large plants than in small ones, because large plants can take greater advantage of assembly-line production methods.
All these different factors can lead to changes in what consumers demand and what producers supply. As a result, on any given day prices for some things will be rising and those for others will be falling. This creates opportunities for some individuals and firms, and problems for others. For example, firms producing goods for which the demand and the price are falling may have to lay off workers or even go out of business. But for the economy as a whole, allowing prices to rise and fall quickly in response to changes in any of the market forces that affect supply and demand offers important advantages. It provides an extremely flexible and decentralized system for getting goods and services produced and delivered to households while responding to a vast number of unpredictable changes.
Taking advantage of new opportunities while curtailing production of things that are no longer in demand or no longer competitive was described as the process of creative destruction by 20th century Austrian-American economist Joseph Schumpeter. For example, Schumpeter discussed how the United States, Britain, and other market economies helped many new businesses to grow by building systems of canals (such as the Erie Canal) during the mid-19th century. But then the canal systems were replaced or “destroyed” by the railroads, which in turn saw their role diminished with the rise of national systems of highways and airports. The same thing happened in the communications industry in the United States. The Pony Express, which carried mail between Missouri and California in the early 1860s, went out of business with the completion of telegraph lines to California. In the 20th century, the telegraph was replaced by the telephone. Time and time again, one decades innovation is partially replaced or even destroyed by the next round of technological change.
In the modern world, prices change not only as a result of things that happen in one country, but increasingly because of changes that happen in other countries, too. International change affects production patterns, wages, and jobs in the U.S. economy. Sometimes these changes are triggered by something as simple as weather conditions someplace else in the world that affect the production of grain, coffee, sugar, or other crops. Sometimes it reflects political or financial upheavals in Europe, Asia, or other parts of the world. There have been several examples of such events in the U.S. economy in the 1990s. Higher coffee prices occurred after poor harvests of coffee beans in South America, and U.S. banks lost large sums of money following financial and political crises in places such as Indonesia and Russia.
The ability to respond quickly to an increasingly volatile economic and political environment is, in many ways, one of the greatest strengths of the U.S. economic system. But these changes can result in hardships for some people or even some large segments of the economy. For example, importing clothing produced in other nations has benefited U.S. consumers by keeping clothing prices lower. In addition, it has been profitable for the firms that import and sell this clothing. However, it has also reduced the number of jobs available in clothing manufacturing for U.S. workers.
Many people think the most important general issue facing the U.S. economy today is how to balance the benefits of quickly adapting to changing economic conditions against the costs of abandoning the old ways. It is vital for the economy to adapt quickly to changing conditions and to focus on producing goods and services that will meet the most recent demands of the market place. However, when businesses close because their products no longer meet the demands of the market, it is important to make retraining or new jobs available to workers who lost their means of making a living.
PRODUCTION OF GOODS AND SERVICES
Before goods and services can be distributed to households and consumed, they must be produced by someone, or by some business or organization. In the United States and other market economies, privately owned firms produce most goods and services using a variety of techniques. One of the most important is specialization, in which different firms make different kinds of products and individual workers perform specific jobs within a company.
Successful firms earn profits for their owners, who accept the risk of losing money if the products the firms try to sell are not purchased by consumers at prices high enough to cover the costs of production. In the modern economy, most firms and workers have found that to be competitive with other firms and workers they must become very good at producing certain kinds of goods and services.
Most businesses in the United States also operate under one of three different legal forms: corporations, partnerships, or sole proprietorships. Each of these forms has certain advantages and disadvantages. Because of that, these three types of business organizations often operate in different kinds of markets. For example, most firms with large amounts of money invested in factories and equipment are organized as corporations.
Specialization and the Division of Labor
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