Russ Roberts, economics professor at George Mason University, put up a link to an excellent supply and demand course supplement paper he wrote a few years ago, "How Markets Use Knowledge" on the Cafe Hayek blog where Roberts is a co-contributor with Don Boudreaux.
In fairly simple descriptive terms (except for the normal and expected supply and demand graph, which requires a little thought and patience to follow the concepts on the graph), Roberts utilizes a hypothetical example of graphite use in two industries.
Starting with the example of graphite tennis racquets and then introducing a new demand for graphite in the auto industry, Roberts shows how the higher demand changes the price and increases the production of graphite.
The most important take away from the article, for those readers that are unfamiliar with the mechanics of supply and demand, is that only part of the auto industry demand is met by increasing supply. The price increase makes suppliers go out, find, and produce more graphite but not enough to meet all the extra demand.
Part of the demand is also met by a decrease in graphite use in the tennis racquet industry. Tennis racquet manufacturers faced with higher graphite prices reduce their use of graphite through material substitution, through more efficient processes that use less graphite and maintain the same quality, or consumers buy fewer graphite racquets due to a higher price and switch to wood or switch to lower cost racquets that use less graphite.
Also, the auto industry gets most of the graphite it needs but not all and therefore is forced to find alternative materials or to improve its efficiency in the use of graphite.
Cafe Hayek is an excellent economics blog that should be read regularly.
Also see my other post, a video, in this series, "Basic Economics: Production And The Firm Video By Art Carden."
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