Agricultural products provide the clearest example of the dynamics of supply and demand in competitive markets. A number of years ago, for example, a period of freezing weather killed a large number of orange trees in Florida. The sharp decline in the supply of oranges caused a large increase in orange juice prices, which encouraged people to drink other beverages, thus allocating the smaller supply of oranges. The higher price of orange juice also attracted Brazilian producers to the U.S. market, providing a large increase in the supply of frozen juice concentrate available to U.S. consumers. The higher prices also encouraged U.S. farmers to replant farther south in Florida, and after a few years U.S. production recovered. The combination of the short- term Brazilian and long-term U.S. response to the supply shortage brought prices back down.
The same response to a supply shock occurred in the coffee market in the 1970s. In July 1975, a widespread freeze killed a large portion of the coffee crop in Brazil, cutting the subsequent harvests in 1976 and 1977 from 23 million bags to 9.3 million bags. The response of the market was predictable: prices rose to extremely high levels, which encouraged people all over the world to begin drinking more tea. High coffee prices, however, also caused an increase in coffee plantings in C��te d'Ivoire, Uganda, and elsewhere in the tropical world, resulting in a large increase in production a few years later. Prices responded by falling. This pattern has been repeated hundreds of times over the history of agricultural markets and might even be viewed as unremarkable.
Supply and demand become more complex and often more fascinating when they fail, which usually occurs when, for some reason, prices cannot change. Price controls imposed by governments are the most common reason for the failure of markets to function. Some U.S. cities, for example, have decided that free-market rents for apartments are simply too high and have imposed controls on such rental charges. Maximum legal rents are set well below the rental prices that would be set by supply and demand alone -- with predictable results. Rent controls create a permanent excess demand for rental units, meaning that large numbers of people who would like to live within the city cannot find rental housing. Investors are discouraged from building new apartments or even from maintaining the units that they own. There is little or no private construction of rental units, and the existing housing stock deteriorates.
One might ask why such a system is politically popular. The answer is that it provides a great bargain for those who are fortunate enough to have a rental apartment in a decent building. There are always more tenants than landlords, and people who would like to rent but cannot do so are not legal residents of the city and cannot vote. Politics and economics often conflict, and politics frequently wins.
-- Robert M. Dunn, Jr.