My last post dealt with what the “Carry Trade” is actually all about. We want to understand why it can move currencies, but before we can do that, I realized that we need to have a basic understanding of supply and demand.
If you are unfamiliar with supply and demand, the basic premises that we need to remember are:
- As demand rises beyond supply, so will price.
- As demand falls below supply, so will price.
The easiest way to understand this is to remember the foolishness that surrounded such products as Buzz Lightyear, Furby and Cabbage Patch dolls. They each had a price attached to them when they came on the market, but they became insanely popular. So people bid up the prices in order to get their hands on one.
Someone I know paid somewhere around $100 for a Furby for her daughter.
After the Christmas season, however, manufacturers were able to bring a larger supply to the market, which also coincided with a decrease in demand (no Christmas rush) and prices moved back to rationality. Someone who bought a Furby for $50 on December 10th may have been able to sell it for $100 on December 20th, but he/she would not have been able to get that price in February.
Think also of tickets for the mens hockey gold medal match at the recent Vancouver Olympics. Tickets were issued with prices of $350 – $775 depending on the seats. Here is a slightly different situation, in that there was a specifically limited supply. You couldn’t run around to different stores or hope that the manufacturer would be able to get out an extra shipment - there are only so many seats in the arena. As Canada and the U.S. progressed in the tournament, demand moved higher and higher to the point that $775 face value tickets could be had for prices of $5000, $10,000 or even $15,000!!!
The limited amount of seats in the venue as well as the success of Canada and the U.S. meant that prices could move this high. With a normal product if price moves too high, demand will fall off in light of more rational thinking. If there are only 13,000 seats available (about 19,000 seats are in the arena, but 30% were held for Olympic related guests) it’s pretty easy to find enough rich people to pay ridiculous prices.
Without really thinking about it, supply and demand is around us daily. It is responsible for the prices we pay for goods and services, the way kids trade sports cards, the reason service providers know they can raise prices, and the reason exchange rates move up and down.
And it is exchange rates that will interest us in the next post.