The Economics of Supply and Demand

I was meeting some friends on Saturday and somehow we got to talk about domain names. It was probably me who started the topic, as always, but anyway… The point is, my friends were not easy to convince that domain names were actually valuable assets and relatively safe investments (if you do the necessary research). When I told them the usual arguments like “Domains have gone up in value faster than any other commodity ever known to man” (Thanks, Rick!), “Generic domains drive lots of type-in traffic to its owners’ web sites”, “Direct navigation traffic converts better than search engine traffic” etc., they said there was certainly truth in these arguments, but still they were not really convinced that domains were an investment as good as I claimed. So, I thought, how could I convince them? What would be the best way to explain to them that domains will continue to appreciate in value for many years to come? The arguments mentioned above are all true, but maybe they were just the wrong arguments for that audience. (I should note that most of my friends went to business school.)

After thinking a little while, I had the idea to back my claims up with plain and simple economics. Here is a summary of what I told them, including graphs I quickly drew on napkins that evening (now “excelized” for you ;)):

Supply

First of all, we should observe that the domain market is different to other markets, because there is very limited supply. While in most markets products can be reproduced, every domain name is unique. To be clear, once one particular domain gets bought it might be off the market forever and the only way to get your hands on that domain name might then be to purchase the entire company that bought it.

Domain Name Supply

As shown in graph 1 above, the supply curve remains the same over time. This is because there has always been the same amount of generic domains to choose from, be it registered or available domains. Therefore, the supply curve has remained flat.

It is true that one can come up with less desired and longer domains that are still available for registration if the preferred domain has already been registered and isn’t for sale or the asking price is too high. But these would be, as said, less desirable domain names and, if we look at this argument more accurately, such a domain would still be one of the limited number of letter combinations that have always been there for people to register, buy and resell. After all, the supply of domains is limited.

Another counter argument might be that supply has been increased several times by the introduction of new top-level domains, but I’d like to concentrate on .com only, which has always been and will continue to be the most valuable domain extension. On a side note, one could even argue that new TLDs, which are all just minor choices, only added to the fast increase in value of DotCom domain names, but that’s another topic to debate.

Demand

In addition to supply remaining the same, demand for domain names is rising sharply. Every day there are more people using the Internet and there are also more buyers and investors entering the domain market. All of them compete for the very same number of domains.

Domain Name Demand

Other than the supply curve, the domain demand curve slopes upwards, as shown in graph 2, because demand has increased over time. In fact, both the need and the demand for domains have continually gone up and have never been as high as they are today. And still there is no end in sight.

Bringing Supply & Demand Together

The result we get when bringing these two curves together is pretty obvious: there is a demand surplus that will only increase over time, as can be seen in graph 3 below.

Domain Name Market: Demand Surplus

Domain Prices On The Rise

This increase in demand results in domain name prices that rise as time goes by.

Domain Name Market: Shift of the Demand Curve

Note that the demand curve slopes downward in graph 4, because we’re now looking at supply and demand in relation to the price of domains and no longer in relation to time. (The higher the price, the lower the demand.) But graph 4 also shows what will happen to the demand curve as time passes (with supply remaining the same): The demand curve shifts to the right.

The equilibrium price for a domain might have been Price=8 at the time we have the curve “Demand 0”. Let’s assume this equilibrium price is the average price at that both domain buyers and sellers are willing to trade a domain name.

Over time the demand curve shifts to the right, because supply doesn’t rise but Internet usage and the importance of both the Internet and domains do increase. So, we get a new demand curve “Demand 1” and a new equilibrium price (Price 2) at the intersection between the demand and supply curves at Price=10.

As you can see, there is no way but up for the average sale price of domains if you apply the economics of supply and demand to the domain name market.

All this is, of course, just a basic look at the rather complex domain name market and I only used relative numbers instead of hard facts in the graphs, but I hope anyway that this sketchy analysis succeeds in pointing out why supply and demand, as shown above, have had a huge impact on the positive development of domain market prices.

7 thoughts on “The Economics of Supply and Demand”

  1. Well-said. The uniqueness or we should perhaps say non-fungibility of domain names is what drives the argument. Is this what people are failing to comprehend about domain names? You can't back up your SUV without crashing into a Starbucks, but once flowers.com is taken, there can't be any more.

    I for one hope the general public doesn't figure that out any time soon. 😉

  2. Interesting post. However, their needs to be some correlation between the figures provided (i.e what does 6 or 8 represent in any of the charts?). Your point is well taken and should include a chart showing elasticity (substitutes). Nonetheless, nice!

    **ANSWER**

    Thanks for your comment, Steve. You're right about that, of course, but as I said in my post, I only used relative numbers instead of hard facts or realistic values, because I don't have any dependable data on hand. So what these numbers represent is simply that the value of domains "goes up"; I didn't factor in any elasticity. That's also because I didn't want to make a thorough industry analysis but I wanted to explain the effects of the powers of supply and demand on the domain name market in way as simple as possible.

    You're right, though, that it would be interesting to see a realstic and more accurate domain industry report based on proven average sale prices from the past up to the present with graphs showing the actual rise in value of .com domains. I have indeed played with the idea of writing such an extensive report for quite some time now, but so far I've just been too busy to get started with it and I'm still looking for a dependable source for the vast amount of domain sales data needed as well as a solution to get all that data into one database that makes it easy to sort and analyze the domains and sale prices. After all, the number of domain sale records to be analyzed would be well in excess of 100,000.

  3. So how did your business school graduate friends respond to the supply and demand graphs?

    **ANSWER**

    They remained skeptical. It takes longer for some people to recognize opportunities than for others; nothing wrong with that. We met to have fun and not to talk business anyway, so we moved on to another topic. 🙂

  4. Interesting write, but you can't just leave it to .com You can have a flower.com, flower.net, flower.me, etc. .Com is king of the hill now, but others are becoming increasingly popular and to eleviate the dwindling of supply. . . a dot eu is created or dot org Your theory neglects to take into consideration that other dots are increasing.

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