What’s in This Chapter?

Why do prices of houses, cars, gasoline, and food fluctuate? Why do prices of stocks and bonds change all the time? Why do interest rates vary? Why do teachers and nurses make modest incomes and television celebrities make millions of dollars? What explains the increases and decreases in the foreign exchange value of the dollar?

In a free market economy, the answer to all these questions is this: “It is because of changes in supply and demand.” When the demand for a product increases, then the price increases in the short term, and vice versa. When the supply increases, then the price decreases, and vice versa.

The mechanism of changing prices in a free market economy is powerful. When buyers want more of a product, and are willing to afford it, they communicate this by buying more of the product. This increases the product’s price. The higher price gives producers an incentive (and the financial ability) to make more of the product. The subsequent greater supply satisfies the greater need. The greater supply eventually also brings the price back down. Overall satisfaction and the nation’s wealth increase.

The free market system described above has many advantages and has led to high standards of living in many industrialized nations. It has some disadvantages, as well. Most economists agree that the advantages of a free market outweigh the disadvantages.