Why is it that in economics, when demand is greater than supply, prices “automatically” go up? Isn’t it sellers that decide to raise prices because buyers are willing to pay more? Couldn’t sellers choose to not raise prices?

Question

Why is it that in economics, when demand is greater than supply, prices “automatically” go up? Isn’t it sellers that decide to raise prices because buyers are willing to pay more? Couldn’t sellers choose to not raise prices?

In: 821

Answer 1

They actually do not “automatically” go up.

Instead, economics presumes markets are ‘bidding markets’ where we ‘bid’ for the items we want–and if someone comes along and is willing to pay more, they pay more. (Like the stock market.)

In actual practice, what happens is that we run out of things: we saw that over the pandemic when grocery stores ran out of groceries, for example.

*Eventually* sellers who constantly run out of stuff *may* raise their prices–and a number of sellers (like Amazon) constantly experiment with trying to raise their prices to see what people are willing to pay.

And *eventually* over time, if there are shortages, sellers may raise their prices for the long-term, which results in things like inflation. (Some markets, like commodities, incorporate bidding as an element to those markets, so [price discovery](https://en.wikipedia.org/wiki/Price_discovery) happens much faster than at a clothing store.)

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More often than not, most sellers try to set their prices at the cost to make a thing plus a small profit to cover their costs and provide a return to the investors who invested in that company. And that often means when something goes up in the short-term (like the cost of fuel), companies wind up eating those prices in the short term, and readjusting their prices in the long term.

Likewise, companies are reluctant to lower prices in the short term because they fear competitors will do the same thing and they don’t want to find out if their competitors are more efficient than they are.

But–in the long run–prices *tend* towards an equilibrium dictated by the supply/demand curve.

But the theory does not dictate how long it takes to reach an equilibrium: it may be milliseconds (like on most modern stock market exchanges); it may be decades (as we tend to see in retail).