You know sometimes you accept a phrase or expression thinking you’re comfortable with it like ‘Ad Hoc’, ‘Blondes have more fun’ or ‘Monopolies Commission’ (how dare they only have the one). Today’s article is for Newbies, who sort of know about Supply and Demand, but might want to brush up on the thinking behind it.
Hold on; come back. I’ll keep it quick and simple.

Cast your mind forward to the 2011 Rugby World Cup in New Zealand. Ireland are riding on the crest of a wave and you and your mates paid $50 apiece for tickets to all the group games, but decide to ‘wing it’ on seats for the final stages.

Demand
All the Irish games were attracting good crowds and you’re all glad you bought your tickets early. But while you’re staying out in Wanna Massa Land a slime ball in a trench coat approaches you,

“Ere mate, you wanna buy some tickets for tonight’s top match between Georgia and Luxembourg? I can get you 5 for $40 each.”
He’s having a laugh of course. It’s a 30,000-seater stadium and unlikely to be more than half full. Neither side have scored a try and there’s little demand for tickets at face value.

“No chance pal, not at that price,” you say and wander off.

Later on the same guy crawls from under his rock, Fosters in one hand, a cross-looking Skippy in the other, and offers you the tickets for $30. Four of your mates put their hands up, saying they’ve nothing better to do so they’ll have some, but the rest would rather spend the money on a few pints. A swift offer at $20 gets rid of another 8 tickets. That evening on you way to the pub the slime ball comes running over, “Mate I’ll level with you. Me Sheila’s got ‘er arse in the fridge and the barbie on an’ I’m late. I’ve got as many tickets as you want, going for $10 each.” Wahey tulip! That’s more like it. The remaining 12 of you decide that at that price it’s worth popping along, if only to wind your mates up.

Very crudely, that’s the Law of Demand, which says that generally the lower the price the greater the demand.

As the price of the tickets fell, the demand increased.

Supply
Led by a rather old Brian O’Driscoll the Irish boys get through to the semi-final against the sheep-worrying All Blacks. You’ll be lucky to get tickets for this one; the game will be an all-ticket sell-out with a whole nation looking for a way in. You track down slime ball and tell him that you need 24 tickets and to see what it will take to find the supply.

Later that day he catches up with you to report his findings.
“At $130 each there’s some disappointed Aussies who’ll let you have their 5 tickets, for $150 I can get you 10 tickets, for $170 I can get 15 off your fellow countrymen who are happy to watch it in the pub and for $220 I can get the whole lot of you in with the prawn cocktail brigade.”

And that is the crude version of the Law of Supply; the higher the price the more people want to sell and hence the greater the supply.

As the price rises so does the supply.

Hey! What always happens to New Zealand in the World Cup? There’s more likelihood of them choking than Paris Hilton in that, err, home movie. So it’s an Ireland verses Argentina final. You, your mates and the rest of Ireland are up against the Argies bidding for those tickets. But there’s a load of thoroughly miffed Kiwis with seats who could be persuaded to sell so there’s a two-way market.

This is where the supply and demand come together; the higher the price, the more tickets that will come available. However if the price rises too much some fans will settle for watching in a pub just outside the ground.

So a chart would look something like this:

The key point to note on this chart is that where the lines cross, supply equals demand. It’s the point where the price will settle (economists call it the equilibrium price) and also where the price will stay until there is a change in either supply or demand.

Back in the real world
So it’s all just commonsense really. If you want something enough you’ll pay up for it. If you’re not fussed you might be persuaded if the price drops enough. And if you’re selling you’d prefer to sell more at a higher price; if you need to get shot you’ll drop the price to attract buyers.

This very simple principle determines how the markets trade; sure we can dress it up in fancy jargon like ‘inflation expectations’, ‘purchasing power parity’ and ‘discounted cashflows’ but it all boils down to whether the demand is stronger than the supply or vice-versa. To justify this being an investment, rather than a fantasy sports article, lets have a quick butchers at two of the main markets:

Forex
Demand for a currency comes in several forms: When interest rates go up, or are expected to go up, investors fancy parking their money in that currency. The obvious example has been the carry trade where investors sold the Yen and invested in currencies with high interest rates like the Kiwi, Aussie Dollar and Sterling (you can get more on this by reading FX And Interest Rates Or A Tuna Sandwich). Oil and gold are priced in Dollars, so there’s a natural demand for the currency to pay for these commodities. If some big German firm decides to take over a UK company (sounds like the EU Treaty) then it will need to buy Sterling to pay the shareholders, which would push the Euro down against Sterling.

An increase in supply can come from governments simply printing more money, but also from the currency reserves of other countries. Hey, this is topical because for ages many countries in the Middle East and Asia have held massive amounts of Dollars as their reserve currency. But recently they’ve been reducing these amounts in favour of buying the Euro. This has increased the supply of Dollars to the market, and boy has the price fallen!

Shares
Equities amuse me cos their supply and demand (the imbalance of buyers and sellers) is often the result of nothing more than a stockbroker changing its recommendation. Remember, an analyst uses statistics like a drunk uses a lamp post-for support rather than illumination.

A large investment house being persuaded to buy/sell a huge block of shares can cause this imbalance. A great example of demand causing the price to rise is a takeover situation, when investors know that there’s one or two groups who are very keen on buying their shares. The opposite effect can often be seen on the share price of the acquiring company. If they need to raise billions to pay for the takeover they may decide to sell more shares in their company. That increases supply and so pushes the price lower.

There you go guys; now that you understand the concept, remember that behind the fancy words, theories and long-term forecasts there’s two groups; those buying and those supplying (selling). Whether it’s cup final tickets, currencies or a Nintendo Wii at Christmas, the key is finding out which side is in control.

Happy Trading