Tuesday, April 5, 2011

D is for ... Demand

Demand is an important concept in economics; it is a measure of how many units of a commodity on a market are likely to be sold, or more prosaically a measure of desirability - of value - for that commodity. Demand is not a perfect correlate to desire: it may be that somebody wants something very much, for example, but simply cannot afford its market price. Demand is related to supply - the number of units of a commodity available at market - through something called Say's Law. It is named for the classical French economist Jean-Baptiste Say, although he no more discovered it than Marjorie Latimer discovered Latimeria chalumnae. Of such accidents of history is authority made.

Say's Law, in his original formulation if not the original French, simply asserts that "products purchase products." Living as we do in a capitalist society, we're accustomed to think that money purchases products - but, of course, we're also accustomed to think of our dollars, which are merely currency, as money. More on that another time. For now, I'll paraphrase Say in saying that the currency we exchange for some product only has value in being exchanged for other products; Say, for whom money was what Gresham would call "good money", didn't believe any sensible entrepreneur would hang onto money when he could exchange it for property before it depreciated. In our post-Keynesian world, we might have a different view, but we'd still have to allow that ultimately the value of any currency is as a medium of exchange, superior to barter only in that it does not require a "coincidence of wants" (for instance: if I have a cow I wish to barter for three pigs, I must find an owner of three pigs who wishes to barter for a cow. If we instead exchange for money, or currency at a pinch, the transaction becomes much easier to accomplish even though it now necessarily involves a middleman).

The more of some commodity there is on a market, ceteris paribus, the more likely it is to constitute a glut, an overabundance coupled with a falling-off in demand. If every man can simply draw breath to obtain air, nobody is going to pay a premium for the privilege. At the other end of the scale, where supply is scarce, demand for a commodity, ceteris paribus tends to increase. There is thus a dynamic of supply and demand; where the amount of goods demanded is roughly the same as the amount supplied, a price equilibrium exists. The nature of this price equilibrium varies with the forces of supply and demand in a free market, as this graph demonstrates:

The supply curve S, it can be seen, varies inversely with the demand curve D. Further, an increase in demand from D1 to D2, assuming constant supply, increases both the price and quantity of the commodity at market; a decrease from D2 to D1, assuming constant supply, decreases both. It should be apparent that variations in supply can likewise impact the price of a commodity on the market; the graph depicts an idealized situation in which the price is purely a function of supply and demand and neither producers nor consumers can artificially influence either factor. There are, in fact, numerous ways that real markets distort this picture. An obvious one occurs when one or more producers manage to "corner the market," or control so great a share of the market that they are able to manipulate supplies to maintain artificially high prices. One producer accomplishing this is said to enjoy a monopoly; several acting in concert form a cartel. OPEC is a cartel that controls the supply, and hence the price, of crude oil; the Federal Reserve is a cartel that controls the supply, and hence the price, of currency.

Although governments generally enact antitrust legislation to restrict the advantages of monopolies, there remain many such examples of cartels and monopolies that are allowed to remain, usually because it is politically expedient for them to do so - it can therefore fairly be stated that no genuinely free market, of the sort envisioned by Adam Smith when he extolled the "invisible hand" of the market, exists in society. Governments also constitute monopsonies - purchasers who "corner the market" from the other side, and can dictate prices to vendors because without them there is no market for the goods - in some sectors, for example the healthcare and defense industries. It can therefore be argued that governments, by involving themselves in the market either directly - as monopsonistic consumers, for example - or indirectly - in applying price controls such as minimum wages or agricultural subsidies, for example - distort the equilibrium between supply and demand, and create the kind of inequalities that, in an idealized market abiding by Say's Law, cannot arise. Certainly, inflation - the overproduction of money, leading, in accordance with Say's Law, to a loss in purchasing power of that money - is a direct result of manipulation by central banks like the Federal Reserve.

The relationship between price and demand embodies a property called "marginal utility" - this is, the added usefulness of a slight (or marginal) increase in supply of some commodity. The concept of marginal utility actually applies more broadly than conventional market scenarios: absolutely any rational decision to pursue any goal in the satisfaction of any need can be modeled with a marginal utility curve, making marginal utility a function of rational decision-making, and rational decision-making a function of barter. Ludwig von Mises termed this praxeology: the ambitious science of human action, specifically concerned with the factors influencing the decisions people make. Marginal utility theory replaced the Marxist labor theory of value, which viewed all profit necessarily as exploitation of labor (that is, profit becomes possible only if the laborer is paid less than his labor is worth; what merit this position has is chiefly in illustrating the departures from the ideal of Say's Law in the labor market).

I'll be returning to this otherwhen.

1 comment:

Heather Henry said...

Interesting! My friend and I had a conversation about bartering today. I personally like the idea of bartering because it means that you have to be productive and you also have to give before you can receive. I know for me, I feel like having money allows me to go out and buy things that probably aren't necessary, which leads to an overabundance of stuff, which becomes a burden and in the end, I donate it. If I bartered, I'd be more careful and live more simply.
Awesome post! Thanks!
Have a splendid day!