Supply and Demand and some Left Myths


“An economist is a man who states the obvious in terms of the incomprehensible.”

Alfred A. Knopf

In order to clarify some myths that both Right and Left proffer, we need to review some basics of economic law. I know you know them, so I will be brief and hope not to bore you to death. The most basic economic law is also the most ignored: Alfred Marshall’s Supply and Demand. The law is very simple, at a given price, the consumers are willing to buy so many articles:

sdpic1.jpg

This is call elasticity. As the price increases, the consumer is willing to buy less; as the price decreases, the consumer is willing to buy more. The more sensitive is the consumer at price changes, the more inclined is the line. The second part of the law is that, at a given price, the producers are willing to manufacture so many articles:

sdpic2.jpg

I talk about manufacturing, but of course this is also applicable to agricultural products and services. The process is that these two forces interact to define the price: Where the supply meets the demand is called equilibrium point or market clearance:

sdpic3.jpg

We can expand on this model. First at all, the lines are not infinite. There is a minimum price that the producer will ask in order to start offering the article or service that will cover the costs and yield a profit. There is a maximum amount that the producer can offers due to installed capacity, so, the producer line is limited in those ways:

sdpic4.jpg

The implications are the same for the consumer, there is a maximum possible price to pay for a product (let’s say, the total income that the consumer has available) and a maximum quantity that the consumer will get, even if the product is free (for example, who wants 2,000 kilograms of potatoes for his small urban apartment):

sdpic5.jpg

To complicate more the model, the line is not a line, but a curve. Elasticity tell us how the quantity of a product, produced or purchased, changes according the price. Let says we want to buy shirts to go to work, and the price of a shirt is $20, at this level, we will buy 3 shirts. The value of the shirts market is $60.

<>If scarcity comes and the prices goes up at $40, we will buy only one shirt because we want to wait if a sales comes or the prices go down again, in this case, the value of the shirt market is $40. Now let’s says that instead of scarcity there was overproduction and the price of a shirt goes down to $10; it is so cheap that now we want a different shirt for every working day of the week and two for going out the weekend and buy seven. Now the value of the market is $70:

sdpic6.jpg
The curve is more rounded in the first set of prices and is smoother in the second, as the total price increase get closer to out maximum budget. Elasticity is not the same along the curve, the higher the price, the more sensitive (elastic) the market. This of course is not always the case, some goods, like diamonds, increase the demand as the price increases, but remember, I want to keep it brief.

A final complication is that at certain level of prices, the curves may not meet:sdpic7.jpg

In this case, if the producer wants to sell, it will have to be between the ranges of P1 and P2, but will never sell the quantities desired, which will lead him to leave the market.

This one, as any model, is based in certain assumptions, the most important of all is that exist perfect information:

  • All consumers and producers know all things.
  • About all products.
  • At all times.

We will come back alter to this, but if the assumptions hold true, then we have perfect markets, and this model shows us several things that happen in perfect markets condition, that takes away some of the myths that dwell on the Left:

  1. Prices are set in the market, not in an obscure room by conspirators.
  2. The public is willing to pay the price. No one is forcing the price in the market. There is no need for price control.
  3. The producers are willing to produce the quantity Q at the price P, so there is no need for subsides or special considerations for the producers.

So, I know it doesn’t sound very socialist from my part, but in my next post, I will talk about the myth that the Right uses in some of its arguments: The existence of perfect information and perfect market conditions.

Advertisements

3 Responses to Supply and Demand and some Left Myths

  1. Lance White says:

    Hi Alfred,

    Thanks for the succinct and well written article. I am trying to apply some of these concepts to an actual problem. There are some added dimensions to the situation we are looking at wich is a high running demand (stimulated by sales and marketing) with the inability to supply. Do you have any further models or insights into this impact. ie I feel there will be a fall off point as the product is requested.. The response is 1/3 supply ratio. There then is a higher price alternative with ample supply side.

    Any thoughts, references or charts would be well apreciated.

    Kind Regards,

    Lance

    Managing Director,
    Insyte Consulting P/L
    Mob: 0408 589 769

  2. […] <>Let’s go back to the supply’s graphic. We mention earlier that there is a minimum price that the producer will ask in order to start offering the article or service that will cover the costs and yield a profit and a maximum quantity the seller can offers due to installed capacity and other variants: […]

  3. […] three concepts which are very simple but also very powerful. You may want to go back to our little supply and demand post before moving on. If you know it already, let’s then move […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: