Real-Life Math
The world of economics revolves around math. Every
study and every conclusion is a result of a mathematical analysis of compiled
data. One of the basic concepts of economics is supply and demand. What exactly
does that mean?
Well, let's look at the market for compact discs
(CDs) as an example. When CDs first came on the market, they were quite expensive
-- around the $20 range. Yet they only cost a few dollars to make. The difference
was a "premium" that suppliers were able to charge because there were only
a few companies making CDs.
Over time, more manufacturers entered the
CD market -- attracted by the high prices. These new manufacturers increased
supply. As supply increased, prices fell and with it the high returns for
manufacturers. This is supply.
Now let's look at demand. When
supply was limited and prices were high, the people buying were the ones willing
to pay the price to have a new product with superior sound quality. When supply
increased, competition for customers increased. Little by little, manufacturers
lowered prices to induce consumers to buy their CDs. As prices fell, more
people were able to enter the CD market.
This increased demand -- but
only for CDs at the lower price. Prices have fallen until prices now average
around $13. Some CDs sell for as little as $3 or $4. Many more people are
able to enjoy the superior sound of CDs! So much for demand.
Economists
use supply and demand theory to figure out where supply equals demand, and
at what price. This point is called an equilibrium.
Imagine you are
an economist working for an international consulting firm. A South Korean
conglomerate that is interested in building a new CD manufacturing plant has
hired your company. It's your job to figure out if the conglomerate should
build the plant or not.
You begin by looking at the demand side of
the CD market. You find the following:
Demand
Quantity demanded
(in millions of units) | Price |
| (x-axis) | (y-axis) |
| 25 | $25 |
| 50 | $20 |
| 75 | $15 |
| 100 | $10 |
| 150 | $5 |
When the price is $5, people want to buy lots of CDs. When it's
$25, they don't! Get out the graph paper. When you graph this information
the formula for this line equals:
y = -0.2x + 30
Now you look
at the current supply side of the market. You research how many CDs manufacturers
would make at various prices. These are your results:
Supply
Quantity supplied
(in millions of units) | Price |
| (x-axis) | (y-axis) |
| 150 | $25 |
| 100 | $20 |
| 75 | $15 |
| 50 | $10 |
| 25 | $5 |
When the price is $20, manufacturers want to produce lots of CDs
so they'll make lots of money. When the price is $5, the manufacturers
don't want to produce many because they don't make very much money.
You graph this information and the formula for the line equals:
y =
0.2x
Now find the point at which quantity demanded equals quantity
supplied. This is also called the equilibrium price. If the equilibrium price
is less than the market price, then the conglomerate should build the plant.
If the equilibrium price is greater than the market price, then they probably
shouldn't.