Good morning & happy Monday!
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
Benjamin Graham, economist
What a great quote from a masterful economist. Put another way, the market in the short term can make no sense whatsoever, but in the long term it has no choice but to make perfect sense. Valuing the worth of a business second by second can be pretty crazy, but on a long-term basis the price will make total and complete sense. Good, solid, profitable companies will have their stock priced as it should. Poorly run, unprofitable companies will see a long-term poor stock price.
I was talking to a realtor friend of mine recently discussing how high real estate prices are right now and how houses are just selling for astronomical prices. We agreed that there is a housing shortage and I stated “the best solution for high home prices is high home prices.” He completely agreed.
What does that mean? How can high prices be the solution to high prices?
Well, if prices are high it becomes very profitable for homebuilders to build and lots of new home construction will begin. I am seeing new neighborhoods popping up all over the place. Once these homes all become available the inventory shortage will be corrected and the prices should start to cool off.
The most basic of all economic understanding is on full display here … the law of supply and demand.
When demand exceeds supply prices are high. When supply exceeds demand prices are low.
This is such a simple concept, but so fundamental to understanding markets that I would like to discuss in this a bit further.
Let’s use a hypothetical example to illustrate this law. Let’s say the newest iPhone is released but Apple is only making 1,000,000 of them. Let’s say the price is $1,000 each (crazy how expensive phones have gotten recently, but I digress). Now, let’s say there are 2,000,000 who are willing to pay $1,000 for the phones … what will that do to the price of the phones? It will increase the price … 1 million phones, but 2 million people want to buy the phones. If the phone price raises to $2,000 each then lets say there are only 750,000 people willing to pay that price, then Apple will be forced to lower the price or be stuck with 250,000 unsold phones. Apple wants to sell as many iPhones as they can at the highest price people are willing to pay. I as a consumer what to purchase the iPhone for as low of a price as I can.
See, in most cases in the capitalist market system the seller wants to charge as high of a price as they can and the consumer wants to pay as low of a price as they can. The price is basically the price the buyers and sellers agree upon.
Prices affect our decisions all the time.
I love to travel. If I find a great deal on a trip I am much more likely to take the trip. If a trip is priced high then I am likely to not take that trip and instead go somewhere else, or maybe not even go at all.
Last week I was blessed to take my family to Yellowstone. We had an amazing time! That trip planning began when Southwest airlines offered a promotional $129 each way rate to their new route to Bozeman, Montana (1 hour from Yellowstone). Had that price been $499 each way I would not have taken the trip, I would have found another destination for the vacation, or maybe not gone at all. I am a rational consumer … there are 333 million Americans, most of whom are rational consumers. We are all deciding every day what the price is we are willing to pay for various goods & services. Southwest airlines wants to price that flight at the highest point possible, but still make sure the plane is full.
If you are hungry and walk into a restaurant and find a hamburger costs $100 there, what are you going to do? If you are like me, you will probably find another place to eat. Alternatively, if you find a pair of shoes you’ve had your eye on for a while that is normally $100 on sale for $19, what are you going to do? Probably buy they shoes, and maybe an additional pair or two.
So, no matter how you slice the pie, the principals of supply & demand are ALWAYS at work.
Next week I’ll address how the Federal Reserve (the government) uses monetary policy as a means of directing consumer behavior and thus the economy. Sneak peek … it involves supply & demand 😊
Kinda’ feels like Economics 101 here … but hopefully the conversation is helpful.
As September wraps up and we start the 4th quarter of the year, please never hesitate to reach out with questions, thoughts, etc. We are honored to help any way we can.