The Supply Curve

Now that we've got the demand curve down, let's move on to the supply curve. A supply curve shows how much of a good suppliers are willing and able to supply at different prices. As with the demand curve, there's a supply curve for every good and service. And again the ideas are the same, so let's look at the supply curve for oil.

We see an intuitive relationship between price and the quantity supplied. As the price goes up, the quantity of oil that companies are willing to supply increases. In this example, in a low price, $5 per barrel, let's say 10 million barrels of oil are supplied per day. At $20 per barrel, 25 million barrels are supplied, and at $55 per barrel, 50 million barrels are supplied. So in general, a higher price means a greater quantity supplied.

Let's delve deeper and see why. Oil exists all over the world, but it's not equally easy to extract. In some places like Saudi Arabia, it's really easy to get oil out of the ground. It's costs about $2 a barrel to extract. Oil in the US, like from Alaska, is a lot deeper and getting it out cost more, at least $10 per barrel. And producing oil from an oil rig, like the Atlantis rig in the Gulf Coast, is even more expensive. That rig has to descend more than a mile underwater before drilling even begins.

When oil prices are relatively low, the only suppliers that can turn a profit are those who can get to the oil cheaply, like Saudi Arabia. As the price goes up, other suppliers in Nigeria, Russia, and Alaska, who have higher extraction costs, start to become profitable so they can enter the market. As the price gets higher, even the most expensive extraction techniques become profitable. The supply curve slopes upward because the only way the quantity of oil can be increased is to exploit higher and higher cost sources of oil. As the price of oil goes up, the depth of the oil wells goes down. With this simple line the supply curve summarizes the way suppliers respond to a change in price including how suppliers will enter and exit the market depending on the price.

So far, we've said things like if the price goes down, buyers will want to buy more or if the price rises, suppliers will want to sell more. But we haven't said anything about how prices are determined. That's the subject for the next video, Equilibrium.

The Demand Curve

Supply and demand are fundamental concepts in economics. Usually, they're represented by a graph like this. So what does this mean? Well, let's start with the demand curve. In short, a demand curve shows how much of a good people will want at different prices. What happens when there's a big sale? Well, at a lower price, people buy more. More shirts, more pants, more video games, and they do stuff like this. This is what happens on Black Friday when retailers lower their prices to get people to buy stuff for Christmas.

The demand curve illustrates the intuition for why people go nuts on Black Friday. Price is shown on the vertical axis, and quantity is shown on the horizontal. Here's the normal price, and here's the Black Friday reduced price. Simply put, the quantity demanded increases as the price gets lower.

But let's delve a little deeper. There's a different demand curve for every good or service out there, but the ideas are the same. So, let's look at the demand curve for one of the most important products in the world -- oil. Oil is used in a wide variety of products, from fueling cars and planes, to heating homes and making plastic for rubber duckies. Looking at the demand curve for oil, we see a familiar relationship between price and the quantity demanded. At a high price, $55 per barrel, there's a relative low demand, let's say five million barrels. At $20 per barrel, 25 million barrels are demanded. As the price goes down, the demand for oil increases. And at $5 per barrel, 50 million barrels of oil are demanded.

But, there's more to why the demand curve looks like this. As we mentioned before, oil has many uses. Some of those are high-value uses. Uses for which oil has few substitutes. An example would be jet fuel. Right now, you can't fly jets on corn or natural gas. If you want planes that fly, you're stuck with using oil. Other uses are low-value uses like making gasoline or plastic for these guys. When oil prices are relatively low, the oil that is being demanded is used for high and low-value goods alike. As the price of oil goes up, so does the price of making plastic and gasoline. And at some point, the cost of these value used products will get high enough that some people might skip buying a rubber ducky altogether or buy a substitute like a wooden bath toy. Same goes for gasoline, as the price rises, people will economize. They'll buy more fuel efficient cars or forego that road trip completely.

For these consumers, the benefit of buying these products is too little to justify the cost. At these high prices, the demanders that are left are the ones who value oil the highest. For them, the benefit of, say, having planes that fly outweighs the increased cost. They still demand oil. So, with a simple line, the demand curve summarizes all the many and diverse ways that people respond to a change in price.

Introduction to Economics

I love economics. I began studying economics when I was 13 and I haven't stopped yet. Economics really has changed my life and the whole way I see the world. What's so powerful about the discipline is just how much it shapes how you understand everything around you.

But perhaps you're asking, what's my incentive to learn economics? Well, that's a great question. You've already hit on a key economic insight, incentives. For example, why is the service at a local restaurant typically so much better than from the cable company? - Or why do laws which supposedly protect endangered species, sometimes end up with more of those animals being killed? - Or why do big toy companies sometimes advocate for regulations which raise their costs? Incentives are the key.

Another example might help us explain. Way back in 1787, the British government hired sea captains to ship convicted felons to Australia. Conditions on those ships were just awful. On one voyage, more than one-third of the men died and the rest arrived beaten, starved and sick. The public was outraged, newspapers called for better conditions, the clergy appealed to the captains' sense of humanity, and British Parliament passed regulations requiring better treatment of these prisoners. Unfortunately, those attempted solutions simply didn't work. The death rate remained shockingly high.

So Tyler, as a good economist, how would you solve this problem? - Well, there was one economist at the time who came up with a novel solution. It was implemented and it basically worked. Instead of paying the captains for each prisoner who embarked to Australia, the government would pay the captains only for the prisoners who arrived alive. Overnight, the incentives of the sea captains changed. The survival rate of the prisoners shot up to 99%. As one observer put it, economy beat sentiment and benevolence.

So what's your incentive to learn economics? People hear that I'm an economist and they ask me about managing their money. And economics does have some lessons for investing in the stock market, but economics is much broader than that. It's the study of human action, how people make choices, and how they should make choices under scarcity. Economics will help you with your choices, whether picking a career, parenting a child, or deciding how much education is a truly worthwhile investment. Overall, economics will give you a deeper understanding of the key issues of our time.

Economics can be hard. Retraining your brain to look at the world in a different way, isn't always easy. But the reward is a new set of eyes to see the world. So are you ready to begin?

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