Scarcity Principle

See: Scarcity.

Firms sell stuff. Consumers buy stuff. But...who decides the prices?

The firms do. They will set prices (and quantity) to the profit-maximizing level. If the firm isn’t a monopoly, that’ll probably be a decent amount of the good at a decent price. Where supply and demand cross, we have our equilibrium price and quantity of a good.

But what happens when there’s a limited supply of that good? Say, parking near the stadium on game day, or bananas during a banana shortage? This is where the scarcity principle enters the game.

The scarcity principle refers to the economic situation of high demand and low supply. What we’d expect to see if firms were to raise their prices up, up, up...until a new equilibrium of supply and demand is achieved. As the price goes up, demand goes down; you’re not going to pay fifty bucks for parking when it usually costs two. You can’t justify the cost-benefit analysis based on your income. Forget it.

Unless fifty bucks is nothing to you...then you’re a part of the remaining demanders. That’s the thing about the scarcity principle: it “works” in the economic sense of finding a new equilibrium, but it reduces access to goods only to those who can afford it. While this might be all right for parking and bananas, it’s more of a social crisis when it’s water, food, housing...the basics of living.

Firms can use the scarcity principle to justify high prices on luxury goods, or limited edition goods. "Get it now, while it lasts!"

Farming subsidies to farmers is an interesting case of the government protecting farmers from the scarcity principle. To keep farmers happy, the government gives farmers subsidies. This causes farmers to make too much supply compared to the demand. Thus, the government must additionally buy up the excess. Without the subsidies, there wouldn’t be that artificially high demand. Some farms would go out of business, and farm goods would become more scarce, leading to higher prices. If demand increased enough, more farmers could enter the market.