Everyone’s heard that, due to the law of supply and demand, prices increase whenever there’s a shortage of something. That as consumers chase a limited number of goods, the price of those goods will rise. For example, if a bunch of people move to a new city, the price of houses goes up. And everyone says that it’s because of supply and demand. But did you know there’s a second component to this law? One that says as demand stays high, home builders will increase their production until prices eventually come back down?
People don’t know (or forget) about this second part but it belongs to the same economic law. Supply and demand says prices go up when there is a shortage in supply, and then come back down when supply is eventually adjusted.
Let’s continue with the example of home prices. Let’s say Edmonton builds and sells 1,000 homes per year. And let’s say a bunch of Newfies keep moving to Edmonton to alter this demand to 1,200 homes. What happens? Well, the price of an Edmonton home goes up (and a bunch of Newfies end up sleeping on the couch). But something else happens. Home builders expand their output to build more homes and additional companies go into the business. These two actions then increase supply to the point where the city builds and sells around 1,200 homes per year. And, in theory, the price goes back down to where it was at 1,000 homes per year.
So it’s wonderful that everyone understands the first piece of this law, but you should also know about the second.