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| supply_and_demand [2025/07/30 00:56] – created xiaoer | supply_and_demand [2025/07/31 20:02] (current) – xiaoer |
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| ======Supply and Demand====== | ====== Supply and Demand ====== |
| Supply and Demand is the foundational concept of economics, describing the dynamic relationship between the availability of an asset or service and the desire for it. Think of it as the ultimate market tug-of-war. **Supply** represents how much of something is available—be it barrels of oil, newly built houses, or shares in a company. **Demand** represents how much of that thing people want to buy. The constant interaction between these two forces determines the price of virtually everything in a market economy. This elegant mechanism, which the famous economist [[Adam Smith]] referred to as an "[[invisible hand]]," guides resources to their most valued uses without any central planner. For an investor, understanding how supply and demand affect asset prices is not just academic; it's the key to understanding why market prices move and how to find opportunities. | Supply and Demand is the fundamental economic model that determines the [[price]] of virtually everything in a [[market economy]], from a loaf of bread to a share of [[stock]]. Imagine a giant, invisible seesaw. On one side, you have **Supply**: the total amount of a specific good or service available for purchase. On the other side, you have **Demand**: the total amount of that good or service that people are willing and able to buy. The interaction between these two powerful forces dictates the price at which a transaction occurs. When supply is high and demand is low, prices tend to fall as sellers compete for buyers. Conversely, when demand is high and supply is scarce, prices are pushed up as buyers compete to get their hands on the limited item. This elegant, simple concept is the engine room of the market, influencing every buy and sell decision, and understanding it is the first step to understanding how markets work. |
| ===== The Two Sides of the Coin ===== | ===== The Basics: How It Works ===== |
| At its heart, the concept is a beautiful balance of two opposing forces. Let's break them down. | At its heart, the relationship between supply and demand is about a constant tug-of-war between sellers and buyers, eventually settling on a price they can both agree on. This agreed-upon price is known as the [[equilibrium price]]. |
| ==== What is Supply? ==== | ==== The Law of Demand ==== |
| //Supply is the total quantity of a specific good or service that a seller is willing and able to provide to the marketplace at a given price.// | The Law of Demand is simple and intuitive: |
| The general rule here is called the **Law of Supply**: all else being equal, as the price of an item increases, suppliers will attempt to maximize their profits by increasing the quantity they offer for sale. | * As the price of something goes **down**, people will want to buy **more** of it. |
| * **Example:** Imagine you're a toymaker. If your new action figure sells for €10, you might produce 1,000 units. But if a sudden craze drives the market price up to €30, you'll likely run your factories overtime to produce 5,000 units and cash in on the higher price. Conversely, if the price collapses to €2, you might halt production altogether. | * As the price of something goes **up**, people will want to buy **less** of it. |
| ==== What is Demand? ==== | Think about your favorite pizza. If the price drops to €5, you might buy it twice a week. If the price shoots up to €25, you might only consider it for a special occasion. The same logic applies to [[assets]]. When the stock of a great company is perceived as "on sale," more investors are attracted to it. When it becomes expensive, the number of willing buyers shrinks. |
| //Demand is the quantity of a good or service that consumers are willing and able to purchase at various prices during a given period.// | ==== The Law of Supply ==== |
| The counterpart to the law of supply is the **Law of Demand**: all else being equal, as the price of an item increases, the quantity demanded will fall. | The Law of Supply looks at the world from the producer's or seller's point of view: |
| * **Example:** At $200, you might eagerly buy the latest video game console. But if the price were $800, you'd probably think twice and might opt for a cheaper alternative or simply wait. If the price dropped to a bargain $50, you might even buy one for yourself and another as a gift. | * As the price of something goes **up**, sellers will want to produce and sell **more** of it (because it's more profitable). |
| ===== Finding the Sweet Spot: Equilibrium ===== | * As the price of something goes **down**, sellers will want to produce and sell **less** of it (because it's less profitable). |
| So, if sellers want high prices and buyers want low prices, how is a final price ever decided? They meet at a point called **equilibrium**. | If our pizza parlor can sell pizzas for €25, they'll hire more staff and fire up all their ovens to maximize output. If the price they can get is only €5, they might reduce their hours or even consider selling something else. For a company, a high stock price might make it attractive to issue new shares, increasing the supply. |
| The [[equilibrium price]] (also known as the [[market-clearing price]]) is the price at which the quantity supplied is equal to the quantity demanded. On a chart, this is the magical point where the supply and demand curves intersect. At this price: | ===== A Value Investor's Perspective ===== |
| * There is no shortage of the item (buyers find what they want). | For a [[value investing]] practitioner, the concept of supply and demand is crucial, but with a twist. The daily market price, driven by short-term supply and demand, is often a manic-depressive drama. A value investor's job is to ignore the drama and focus on the underlying plot: the company's true [[intrinsic value]]. |
| * There is no surplus of the item (sellers sell all their stock). | ==== Market Price vs. Intrinsic Value ==== |
| If the price is set too high, a **surplus** occurs because sellers offer more than buyers are willing to purchase. This forces sellers to lower prices to clear their inventory. If the price is too low, a **shortage** occurs as demand outstrips supply, allowing sellers to raise prices. This constant adjustment is what pushes the market price toward equilibrium. | The daily fluctuations in a stock's price are a direct result of shifts in supply and demand. A scary news headline can cause a flood of sell orders (high supply, low demand), tanking the price. A viral tweet about a "hot stock" can cause a rush of buy orders (high demand, limited supply), sending the price soaring. |
| ===== Supply and Demand in the Investing World ===== | This is where [[Benjamin Graham]]'s famous allegory of [[Mr. Market]] comes in. Mr. Market is your emotional business partner who shows up every day offering to buy your shares or sell you his. Some days he is euphoric and names a ridiculously high price (driven by excessive demand). On other days, he is despondent and offers a pitifully low price (driven by panic and low demand). A value investor understands that these prices are driven by temporary sentiment, not the long-term earning power of the business. The opportunity lies in buying from Mr. Market when he is pessimistic and the price is well below the company's actual worth. |
| This simple principle is a powerful force in financial markets, especially for stocks. | ==== Spotting Opportunities ==== |
| ==== Stocks as a Commodity ==== | Understanding supply and demand helps you interpret market movements and find bargains: |
| A company's stock is subject to the same laws of supply and demand. | - **When Demand Collapses:** Market panics, industry-wide bad news, or recessions can cause investors to sell indiscriminately. Demand for stocks plummets, and prices can fall far below intrinsic value. This is the value investor's hunting ground. You are not buying because the price is falling; you are buying because the price has fallen to a level that represents a bargain for a solid, durable business. |
| * **Supply of Stocks:** The supply is the number of shares a company has issued, known as [[shares outstanding]]. This number is relatively fixed but can change. For instance, a [[stock buyback]] reduces the supply of shares, which can help push the price up. Conversely, a [[secondary offering]] increases the supply, which can dilute existing shareholders and put downward pressure on the price. | - **When Demand Explodes:** In a [[bull market]], hype and "fear of missing out" (FOMO) can lead to irrational demand. Everyone wants to own the same popular stocks, pushing their prices to unsustainable levels. This is a time for caution. The supply of shares might be fixed, but the supply of foolishness is infinite. Paying a high price driven by frantic demand is a recipe for poor returns. |
| * **Demand for Stocks:** Demand is driven by what investors think a company is worth. This is influenced by many factors: strong [[earnings per share]] reports, positive news, innovative products, or broad economic optimism. When good news hits, more people want to buy the stock than sell it (demand > supply), and the price is bid up. When bad news breaks, more people want to sell than buy (supply > demand), and the price falls. | ===== Practical Takeaways ===== |
| ==== A Value Investor's Perspective ==== | * **Focus on the Supply of Great Businesses:** The supply of truly wonderful businesses with durable competitive advantages is, by its very nature, extremely limited. Your first job is to identify these companies. |
| Here's where a savvy investor gains an edge. While short-term price swings are driven by the frantic dance of supply and demand, a [[value investor]] plays a different game. They believe that the market often gets it wrong. | * **Use Demand as an Indicator, Not a Guide:** Don't buy a stock just because everyone else is (high demand) or sell just because everyone else is panicking (low demand). Use these demand shifts as opportunities to act rationally. |
| This is where [[Benjamin Graham]]'s brilliant allegory of [[Mr. Market]] comes in. Mr. Market is your emotional business partner who offers to buy your shares or sell you his every day. Some days he is euphoric and names a ridiculously high price (high demand). On other days, he is panicked and offers to sell his shares for a pittance (low demand). | * **Buy Pessimism:** When widespread fear causes demand to dry up, and prices for great companies become cheap, it's time to be greedy. |
| A value investor doesn't get caught up in Mr. Market's moods. Instead, they first calculate a company's [[intrinsic value]]—what it's truly worth based on its assets, earnings power, and future prospects. Then, they use the market's emotional swings to their advantage: | * **Sell Euphoria:** When irrational excitement creates absurdly high demand and prices, it might be time to consider selling, or at the very least, to stop buying. |
| * They **buy** when irrational fear creates low demand, causing Mr. Market to offer a price far //below// the company's intrinsic value. This gap between the low price and the higher intrinsic value is the famous [[margin of safety]]. | |
| * They **ignore or sell** when irrational exuberance creates high demand, pushing prices far //above// what the business is fundamentally worth. | |
| In short, a value investor uses the often-irrational fluctuations of supply and demand to buy wonderful businesses at a discount. | |
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