The first week, the topic is the Law of Supply and Demand.
The law of supply and demand has three parts:
1. Excess supply leads to lower prices
2. High demand leads to high prices
3. Markets tend toward the point where supply=demand
Now, these three parts are not absolute. A market may take a while - even years - to correct itself. But eventually, things will revert towards the point where there is neither excess supply nor excess demand.
In the following graph, D1 and D2 represent demand curves, and S represents supply. The graph shows several key concepts:
1. Demand decreases as price increases (no thanks, I don't want that $600 iPhone, I'll wait until its $300)
2. Demand increases as price decreases (buy one get one free!)
3. Price increases as supply decreases (think rare artifacts or pop stars' famous items, like Madonna's bra or Michael's sequined glove)
4. Price decreases as supply increases (think mass produced Walmart products made in China)
Now, I'm not just spewing theoretical rhetoric for the heck of it. There is a very critical, practical application for this. When people forget the law of supply and demand, or pretend it doesn't exist, things get out of whack and you get a "bubble".
Take the housing bubble for example. Because of the proliferation of irresponsible credit lending, people forgot that houses were becoming unaffordable. They thought that prices always rise, so they could continue to buy and sell at higher and higher prices. To me, this just seems illogical. Couple this with a massive increase in supply (due to housing construction), and you have an unsustainable problem. Remember the fourth concept from above: Price decreases as supply increases. When supply is increasing and prices are increasing, you get further and further away from the equilibrium point where supply = demand.
So let this be a reminder/warning. If someone says "this market is different" or "old economic theories don't apply anymore!", just nod, smile, and ignore them completely. Bubbles form when people buy things out of emotional excess rather than sound, logical thinking. If you think "this is crazy!", you're probably right. Don't try to time the market, either. There were plenty of people who recognized that we were in a bubble, wanted to make as much money as possible while it was happening, but didn't get out in time and lost tons of money. Don't be one of them!
