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Where do prices come from?

Whenever I teach microeconomics I spend about 40% of the class on supply and demand. For me, supply and demand is by far the most useful tool for conveying the economic way of thinking. I find it strange that it gets dismissed by some as unrealistic because the conditions for perfect competition rarely apply in the real world.

Supply and demand is supposed to be unrealistic. It has to be. It is trying to capture the main thing about prices. When people want more of something than is available, the price tends to rise. When people want to sell more of something than people want to buy, the price tends to fall.

There’s no such thing as supply and demand. It’s a way of thinking. It’s a way of organizing the chaos of all the different transactions that take place in a market yet that are linked because of competition and arbitrage.

In this essay for the Library of Economics and Liberty, I try and explain the ideas behind supply and demand without using graphs. It’s part of a series of essay I’m writing for the site on economic fundamentals.

Here’s my graphical treatment of supply and demand for those who want to work a lot harder.


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