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Helping to keep the buying power in money is the responsibility of every individual member of society.
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We all know that prices are important because they determine how much and what we can afford to buy. It is equally important to understand that prices are partly determined by how much and what we actually buy. What we buy determines what goods and services will be produced, and what is produced determines what kind of jobs are available and how much we can earn.

When the entrepreneur decides what and how much to produce, we refer to this function as the allocation of resources. He/she allocates resources through the price system. Our kind of economic process is sometimes called the price system because it is kept running by a continuous flow of decisions about what we are prepared to sell and how much we will charge for it, and what we want to buy and how much we will pay for it.

Most prices are determined in the BUSINESS SECTOR. The BUSINESS SECTOR is a broad economic term which covers the production and distribution of all goods and services, except those which are produced by government. The doctor and the lawyer or the engineer and the accountant who produce a flow of services are regarded as belonging to the BUSINESS SECTOR just as much as the factory worker who helps to produce goods. Goods are of two kinds. The thing we normally buy in stores are called consumer goods because they will be used up or consumed by us. Other goods such as machinery, sand and concrete blocks are called capital goods or sometimes investment goods. The BUSINESS SECTOR uses capital goods in order to produce consumer goods. The price of services is determined in the same way as the price of goods.

We call this method of determination the law of supply and demand. To understand the principles of supply and demand, let us look at what might happen in a very small and simple Ivatan market.

The law of supply and demand

If a great many people want to buy camote (sweet potato) today, but only a small number of camote (sweet potato) are offered for sale, the prices will go up because there will always be some people willing to pay more to make sure they get the camote (sweet potato). This is called rationing effect of price because it is the price which determines who will get the camote (sweet potato) if there are not enough to go around.

If a great many camote (sweet potato) are offered for sale, and only a few people want to buy them, the price will fall because the vendor will want to sell her/his extra stock and she/he knows there will always be some people willing to buy more, at a lower price.

If there are several vendors selling camote (sweet potato), the price will also tend to fall because each vendor will expect buyers to shop around until they find the best price.

If the price of camote (sweet potato) is high because they are in short supply, the people who could not or would not pay the high price tend to buy something else instead. If rice are plentiful and cheap today, they may buy rice. This is called the substitution effect. This substitution effect is most important because it explains why the price of one good affects the price of all other goods. If many more people decide to buy rice because the price of camote (sweet potato) is high, then the supply of rice will be short, relative to the demand, and its price will go up -- so some people will decide to substitute again, and so on.

We can see the substitution effect in our own food markets. If insufficient hogs were brought to market, the price of pork rises. Many people decide to substitute beef for pork so the price of beef rises. People then begin to substitute poultry for beef, and the price of poultry rises. When all food prices rise, people must either save less or spend less on other things.

Since people are very complicated creatures, a number of complications tend to arise in the economic process at the same time. But what happens when the price of pork rises is an interesting illustration of how the circular flow of real wealth through the economic process is governed by price decisions.

This same flow of price decisions also works to correct a shortage or surplus of supply. If the price of camote (sweet potato) is high, the vendor will try to increase the supply of camote (sweet potato) because the more she/he can sell at a high price, the more profit she/he will make. It is likely that other vendors, attracted by the high price, will also try to supply more camote (sweet potato). But as soon as they are successful, the shortage will disappear, and the price of camote (sweet potato) will fall.

The vendor who found herself/himself with so many camote (sweet potato) that she/he had to sell at bargain prices to clear the market, will soon stop supplying so many. And when fewer camote (sweet potato) are available, the price will rise. Notice that the vendor selling rice, who was affected by the price of camote (sweet potato) in the first place, will react in the same way.

We can sum up these various forces at work in the market by saying that the seller is always seeking the highest price he/she can get and that the buyer is always seeking the lowest price she/he can find. These two opposing forces are a constant check on one another tending to balance the quantity of camote (sweet potato) supplied with the quantity demanded. The price will be just sufficient to clear the market. It will cover the supplier's costs and give her/him a reasonable profit. When this happens, we say the market is in balance, or to use the economic term, in equilibrium.

But that does not mean the market will stay in equilibrium. People might begin to dislike camote (sweet potato) and therefore stop buying them. Or there might be a technological improvement in the growing of rice which lowered the cost of production and therefore the price of rice. In this case people would tend to substitute by buying more rice and fewer camote (sweet potato).

Or there might be a fall in income, in which case people would have to buy less of everything, including camote (sweet potato) -- or a rise in income, in which case they could buy more of everything, including camote (sweet potato). Any one of these things, a change in taste, a change in the price of other goods, or a change in income, will change the demand for camote (sweet potato). In turn such a change will affect the supply and price of camote (sweet potato), and the market forces will seek a new equilibrium. In doing so, a change in the allocation of resources will be brought about.

In the extreme case, if people just stopped liking camote (sweet potato), growers will ultimately stop producing them. And the resources which had gone into their production -- the land on which they grew, the time and skill of the grower, the transport worker, the road she/he drove on, the vehicle she/he drove, and the time and skill of the seller would be used for other purposes.

If the seller, the transport worker, and the grower are operating their own business, and if they are skilled entrepreneurs they will perceive quite early that the demand for camote is changing and will begin shifting their resources to other uses in order to lose as little as possible. In deciding what to produce instead, the entrepreneur would be attracted by the good then selling at the highest price, because this would offer her/him the best chance of making the most profit. Let us say this good happened to be uvi (yam).

If more people wanted to buy uvi (yam) than there were uvi (yam) for sale, then uvi (yam) would be in short supply. In helping to meet this demand the entrepreneur would be shifting resources to increase the supply of uvi (yam) to meet the wishes of the PUBLIC as expressed in their price decisions. As long as the supply of uvi (yam) is relatively short and the price relatively high, she/he would gain an extra reward in the form of additional profit for shifting into uvi (yam) production. As the supply and demand for uvi (yam) come into equilibrium, the entrepreneur would make a normal profit and the resources would be used to everyone's satisfaction.

In the less extreme case of the demand for camote (sweet potato) decreasing, but not stopping entirely, the same kind of shift would occur but it would affect only part of the resources used to produce camote (sweet potato).

Each one of us makes many decisions every day. This is another part of the reason why we all depend on one another for our economic well-being. This is also why the way you spend your money helps to determine how the resources of your country will be used, what kind of jobs will be available, and how much you can earn.

Interdependence becomes even more important when we think of increasing real wealth -- making the circle grow bigger or flow faster.

The economic process is both simple and complex. Any single movement brought about by the law of supply and demand is simple. The process becomes complex because the effects of any single movement ray out through the market like ripples in a pond when a pebble is thrown. Many pebbles are always being thrown; the pond is never still and the ripples criss-cross and flow into one another. We must observe very carefully therefore, if we want to find out what is happening in the economic process and why.

In making these observations and building up an understanding of the economic process, it is important to remember that while effect follows cause as surely as night follows day, our actions are the causes. If we wish to improve the effects, then we must improve our actions.

We must always assemble all the relevant facts and carefully examine the connections between them before jumping to conclusions about what is happening and why. A better knowledge of connections in the economic process will help you to make better economic decisions. If you find out what skills are in demand and train for them, you can always earn a good living. If you do your job efficiently, you keep the cost of production down. This makes you a valuable worker and gives you better chance of earning more money. A better knowledge of these connections also helps you as consumer. If you spend your money wisely, making sure you buy what you really want (instead of just following the crowd) and always look for the best price, you will get the best value for your money.

Elasticity of Demand

The way in which supply and demand works is called "law" because it always changes prices in the same way. If the price of a good or service rises, less of it is bought, while if it falls, more of it is bought. If the price of a good or service rises, more of it is supplied, while if it falls, less of it is supplied. But this does not tell us how much more or how much less is bought or supplied. "How much" depends on the stretch or elasticity of the market.

Each good and service has its own elasticity, and the elasticity of each good and service is different for different price ranges. For example, the elasticity of demand for bread is different from the elasticity of demand for shoes. And the elasticity of demand for bread when the price of bread ranges from 5 pesos to 10 pesos, is different from the elasticity of demand for bread when the price ranges from 6 pesos to 12 pesos.

In order to understand the meaning of elasticity, let us consider two extreme cases which never happen in real life. If there were a good or service which had perfect elasticity of demand this would mean that if the price of that good rose just the least bit, even a fraction of a centavo, that good would not be bought at all. If there were a good or service which had perfect inelasticity of demand, which is exactly the opposite of perfect elasticity of demand, this would mean that no matter how much the price of that good or service rose, exactly the same quantity would still be bought.

In real life, the demand for good or service is either relatively elastic, relatively inelastic, or that good has unitary elasticity of demand.

If the demand for a good or service is relatively elastic, then if the price of that good rises just a little the quantity bought will fall quite a lot. The reverse is also true. If the price falls just a little, a lot more of the good will be bought. The market for this good or service has a lot of "stretch" in it. On the other hand, if the demand for a good or service is relatively inelastic, then if the price rises just a little the quantity bought will also fall just a little. The reverse is also true. If the price falls just a little then just a little more of it will be bought. There is not much "stretch" in the market for this good.

If the demand for a good or service is relatively elastic, any price increase will result in so large a drop in sales that the seller will make less money. But if the demand for a good or service is relatively inelastic, the seller could be better off even with a slight drop in sales.

It can also happen that an increase in price and a drop in sales will leave the seller in the same position as before. This is called unitary elasticity of demand.

Relative inelasticity of demand may indicate that buyers do not feel strongly enough about a change in price to let their views be known in the most effective way -- by a noticeable drop in sales. The demand for alcohol and cigarettes, for example, is relatively inelastic.

Most buyers grumble when price goes up, but it is the elasticity of demand which indicates what they are doing about it. Prices are not like the weather -- something we can only complain about but not do anything about. Woman/man makes prices. They are her/his decisions about how much buying power a good or service is worth to her/him.

Elasticity of Supply

Elasticity of supply indicates how far the supplier can respond to changes in price, and this, depends on her/his costs.

It corresponds to elasticity of demand. If the supply of a good is relatively elastic, then if the price rises just a little, the quantity supplied will increase quite a lot. But if the price falls just a little, the quantity supplied will fall quite a lot.

If the supply of good is relatively inelastic, then if the price rises just a little, the quantity supplied will also increase just a little. And if the price falls just a little, the quantity supplied will also fall just a little.

If the supply of good is relatively elastic, this indicates that the factors necessary to produce it are still fairly easy to obtain at a good price; but if the price is relatively inelastic, then the opposite is the case.

It is the consumer's right to pay a high price to get something she/he wants. Everyone must decide for herself/himself what mixture of goods and services to buy with her/his income and how much to save. Everyone knows that if she/he buys some expensive things she/he must do without other things or save less.

But buying what you want carefully and buying what you want carelessly are two different things. If the consumer buys carelessly, she/he is saying to the producer: "Don't charge costs plus a reasonable profit. Charge what the market will bear."

It is worth remembering that our system of producing wealth is organized on the principle that producers and sellers are out to make as much profit as they can. But helping to keep the buying power in money is the responsibility of every individual member of society.