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Supply & Demand Runs Our Economy

Voters have called inflation the most important issue for the November election.

CENTRAL, Texas — Why are we seeing all of this inflation? That's a complicated question with a complicated answer.

But one thing is for sure, the laws of supply and demand completely control the market economy that we live in. So why is everything more expensive? And what controls the prices on the items we buy? 

Certified Financial Planner, Neil Vannoy, says a market-based economy like ours, the prices of goods and services are determined by two primary factors: “Supply and Demand."

"The law of supply and demand refers to how these two factors work together to affect the prices we pay for the things we buy," Vannoy mentions.

So with prices up, does that mean that the goods that we want are more scarce? 

Vannoy told us basically, "yes." Adding, "Prices move in the opposite direction of supply. So, when the supply of a good or service goes down – like we're seeing with the worldwide disruption of supply chains – prices tend to go up. And as the supply goes back up when supply chains and other disruptions are fixed, prices will decline."

So, when the supply chain gets resolved, will that solve all of our problems?

Not so fast! If demand is still high, then the prices we pay will remain high as well.  "Prices tend to move in the same direction as demand. Prices go up when demand goes up and go down when demand drops. This relationship is easy to understand if you look back at the prices of things like N95 masks, Lysol, and other cleaners during the early days of COVID," Vannoy continued. "Stores ran out of these items due to limited supply, and the large demand for them led to skyrocketing prices from resellers on Amazon, eBay, or other websites."

Vannoy says that we can spend and produce ourselves out of this problem, but it will take competition and plenty of supply. "Prices are signals to business owners, and high prices often signal high profits. So when the price of a good or service increases, not only will existing suppliers will increase their output to take advantage of the high price, but new suppliers will also be drawn to the market by the high prices. So high prices lead to increased supply, and increased supply leads to lower prices."

Inflation is often described as "too much money chasing too few goods." In the U.S., we've seen both a large increase in the supply of money as well as a large decrease in goods and services. According to the tax foundation, only Singapore spent more as a percent of GDP than the us in response to the covid pandemic. Here this is the "too much money" part since boosting the supply of money, will decrease its value, and can cause prices to rise. 

We also have supply chain and other problems leading to "too few goods" that consumers want, which leads to increased prices.

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