Quick! What’s the most useful economic concept?

For me, it’s the law of supply and demand – the fraternal twins that move markets all over the world, the yin and yang of economics, the muggles and wizards of Potterian fantasies, the Optimus Prime and Megatron of financial markets (ok, ok…I stretched that a little bit too far. Let’s not turn one of them into the evil one). I would even go as far as to say you have no business investing your money if you haven’t conquered this idea.

Yeah, ‘conquer’ as in know it like the back of your hand. As in navigate through the concept with your eyes closed. Investors who have intimate knowledge of the tugs and pulls of consumer and producer surpluses can harness that knowledge so they don’t get whipped silly by bear markets and irrational exuberance in financial markets.

Harvard economics professor Greg Mankiw explains here how this concept is at the heart of the workings of market economies. If you crave for more readings (because you are blessedly nerd-ic), read the lecture notes from the Massachusetts Institute of Technology’s Sloan School of Management on this concept. As you read, you will see why supply and demand affects prices, market dynamics, and why its related to the Invisible Hand of Adam Smith, that long-dead white man who is, until now, still called the Father of Economics.

Here, RFP Speaks’ Joseph James Lago offers a simple explanation how supply and demand affects stock prices:

The demand side is represented by the buyers, the supply side is represented by the sellers. If the buyers believe that the company is not worth its current stock price, they will demand a lesser price. This will be manifested by decreased demand. If the sellers realize that buyers are not willing to buy at the existing price, they will rush to sell to any available buyer at their price. This increases the supply, effectively pushing the price down. The reverse will happen if buyers believe that the stock price is cheap, and the sellers realizing the increased demand, effectively pushing prices up.

The idea is, all these selfish interests put together in a witch’s brew cannot prevent the price of whatever commodity – stock, oil, gold, water, electricity, dollar, peso – from reaching its rightful level. There are things, however, that could spoil the brew and these include inefficiencies creating fake demand like monopolies, poor taxation and, yes qwerty, improper government intervention like central banks defending currencies.

Knowledge of the law of supply and demand will also help make more sense of business news (if only so you can appear like a deep thinker in front of your boss at mancom meetings :-)).

Look at the business papers today and you’ll see the dynamics of supply and demand at work.

Headlines in the Philippine Daily Inquirer and other newspapers point to imminent water and power shortages. If water and electricity were publicly traded commodities and not regulated by the government, you could expect the increase in demand matched with inability to increase supply to result in price increases.

With holiday economics now a law, I bet you’re already thinking of places where you can go to unwind, right? I know, I am! So there will be increased demand in tourism-related services. The competition in that sector is increasing, though, so if supply is higher than demand, you can even expect Philippine Airlines and Cebu Pacific to keep giving out P1 seats on their airplanes (provided there are only two of you in the family that’s traveling hehe).

BIR is rushing to recover its revenue shortfall and has thus given its regional examiners marching orders to target 30% of its taxpayers for auditing by yearend. I can hear the doctors, lawyers, consultants and businessmen scrambling to call their accountants to prepare the documents. Here, you will see increased demand for accounting services because of the not-so-invisible hand of government.

Jollibee’s Tio Pepe’s Karinderia is a classic example of a company’s efforts to fulfill a perceived demand for a certain need. I don’t know about you, but I think that’s the best way to find your niche in a business. I’m positive that Tio Pepe will escalate the price war in the fast food industry. Matira matibay.

One caveat, however. The principle of supply and demand is a principle. It’s a concept. It’s an idea from economists long gone. It can be used to forecast certain things like price movements. It can be used in policy making because it reveals inefficiencies, improper government interventions, and better ways of doing things.

Economists like to believe they know a lot of things and can foresee what will happen using their models and computations. But put all of them in one room and you will be hard-pressed to find two who will completely agree with one another. What I’m saying is, let the principle guide you. Just don’t be too confident because of it.

This just in from a friend:
“Mahirap labanan ang katamaran. Nakakatamad kasi eh.”

So, if you didn’t make it to the end of this blog. I totally understand. :-p

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