Banner
    Economic Theory – Supply and Demand
    By Gerhard Adam | July 10th 2009 03:44 PM | 34 comments | Print | E-mail | Track Comments
    About Gerhard

    I'm not big on writing things about myself so a friend on this site (Brian Taylor) opted to put a few sentences together: Hopefully I'll be able...

    View Gerhard's Profile
    In economic theory, the law of supply and demand is considered one of the fundamental principles governing an economy. It is described as the state where as supply increases the price will tend to drop or vice versa, and as demand increases the price will tend to increase or vice versa. Basically this is a principle that most people intuitively grasp regarding the relationship of goods and services against the demand for those goods and services.

    When supply and demand are in balance, the economy is said to be in equilibrium between price and quantity.

    This is a very simple principle but is it actually a “law” and is it completely true?

    When we examine specific instances of goods and services against a particular demand, we see that this behavior seems to hold true and so where could there be a problem with this model?

    Let’s examine the supply side first. This is the component that provides the goods and services, so effectively this is the element that brings things to “market” for which the consumer or demand side reacts. One of the big items considered on the supply side is the cost of labor.



    “…as wages rise, the supply of goods and services is reduced, because wages are the input price of labor. Labor accounts for about two-thirds of all input costs, and thus wage increases create supply reductions …” (Introduction to Economic Analysis, McAfee)
    No doubt, this all makes sense and probably sounds like a statement of the obvious. However, let’s examine the demand side of this relationship. What is it? Where is it? How does it manifest?

    Here’s where we encounter the problem with this model. There is no independent demand side of the equation. Demand is based on the consumption of the goods and services provided by the supply side, but the means by which this demand is met requires trade in exchange for the item(s) involved. In modern times that trade is through the use of money (or credit).

    So the obvious question becomes, where does the consumer or “demand side” acquire its money? The answer is; from the supply side. In other words, despite the statement above which indicates that labor accounts for about two-thirds of the input costs, in reality, what is happening is that the supply side (labor cost) is subsidizing and creating the consumer or demand side of the equation. There is no independent demand side.

    The problem this creates is that when the supply side attempts to reduce its cost of products (by reducing the cost of labor), it is correspondingly reducing the money available to the demand side. In effect, it becomes a death spiral, while every attempt by the supply side to reduce its costs further, the demand side shrinks as the jobs and means of acting on the demand are reduced.

    The problem is that supply and demand aren’t independent variables interacting, they represent a symbiotic relationship where each is absolutely dependent on the other. Disruption of one automatically disrupts the other.

    This leads us to a second assumption in the “law of supply and demand” and that’s for the model to hold, it must be a closed system. So it is worth exploring what the bounds for such a closed system must be.

    Generally, it is sufficient to consider the system along national boundaries, since there is a common currency, common regulations, and a relatively fixed base of individuals the system is modeling. Without this constraint, the model no longer produces valid results, since they are skewed by irregularities (i.e. different rules in various circumstances).

    Suppose we consider a closed system as being the United States. We will ignore foreign trade, imports/exports, etc. for the time being. From this limited view, we would expect the law of supply and demand to function as predicted because in a closed system, the constraints that drive these metrics will work.

    If there is a shortage of skills, then employers must pay higher wages to attract individuals to work. If there is a surplus of goods, then prices will fall, all in keeping with the “law of supply and demand”.

    However, let’s consider what happens if we take labor out of the equation and allow the supply side to operate outside this system and obtain cheaper labor from a different source. Suddenly the demand side no longer has the “subsidy” needed in order to generate a demand, so as demand drops, the price of goods and services must drop to accommodate it. However, if demand drops to zero (i.e. no money), then there is no equilibrium point for the supply to drop to and the economy collapses. 

    In effect, by moving the labor costs outside the system, the rules have been skewed so that supply and demand no longer holds. While it may be considered valid on a larger system (i.e. the world), this is an impractical model since there are no consistent rules with which to model any of the actors. In other words, the supply/demand relationship has been subverted by moving outside the system and rendering one of the driving economic forces impotent.

    Continuing to use the example of the labor markets, while it is often stated that different groups compete with each other, this is an economic fallacy since they are not operating from the same system. Different governments, different laws, different standards of living, do not provide a means by which economic competition can be gauged, so what actually happens is that the supply/demand model is rendered inoperative.

    So in practical terms, the “law of supply and demand” needs to be restated to indicate that it reflects the relationship between supply (goods and services) and demand (consumers) within a closed system. It is the closed system that ensures that the cost of labor in producing supply is recycled into the demand side of the equation so that goods and services can be consumed.

    Please note that I’m not making any statements about how foreign trade should be conducted, nor am I discussing isolationist policies. I am simply describing the necessary conditions for the “law of supply and demand” to hold. Any variations from this will render this “law” moot.

    This situation will be exacerbated when we have supply and demand side players that can operate from different rules whereby one uses a global basis of operation while the other is confined to local operations. In the next post, I will explore the effects on a national economy by global players.

    Comments

    Steve Davis
    Nice work Gerhard.
    The silliness of the quote you gave is illustrated by the well known fact that Henry Ford knew that increases wages led to increased demand that led to increased supply. The authors must have known that, so what they wrote was propaganda.
    Gerhard Adam
    Thanks Steve.  I'm curious to see if I can find a way to mathematically describe these relationships.
    Mundus vult decipi
    kerrjac
    Nice article Gerhard, it's about time someone here talks economics.

    As I understand it, the "law" of supply&demand is a bit of a misnomer. It is more along the lines of a basic assumption (ie, regarding how supply & demand determine price).

    Building atop this premise, say that, according to someone's model a price for commodity X moved in an unexpected manner relative to supply & demand - maybe supply went up, demand stayed relatively the same, and yet the price increased. In that case, the model would have to be revised in order to account for the discrepancy. That is, the conclusion wouldn't so much be that supply & demand don't hold, but that the model was incorrect or failed to take something into account.

    Anyone can question the law of supply & demand, but since it is more of a premise than a law that would be rather hard, like questioning an axiom or definition. It would almost be like questioning the assumption that 2 sides of an equation have to equal each other. I suppose what one would have to do would be to assume that the law of supply & demand is indeed wrong, and then see where that takes them, rather like non-Euclidian geometry.
    Here’s where we encounter the problem with this model. There is no
    independent demand side of the equation. Demand is based on the
    consumption of the goods and services provided by the supply side, but
    the means by which this demand is met requires trade in exchange for
    the item(s) involved. In modern times that trade is through the use of
    money (or credit).


    So the obvious question becomes, where does the consumer or “demand
    side” acquire its money? The answer is; from the supply side. In other
    words, despite the statement above which indicates that labor accounts
    for about two-thirds of the input costs, in reality, what is happening
    is that the supply side (labor cost) is subsidizing and creating the
    consumer or demand side of the equation. There is no independent demand
    side.
    Well, I don't think that's entirely true. Try opening a website that sells soiled used baby diapers. You can raise or lower the price, but demand for your product will remain non-existant.

    let’s consider what happens if we take labor out of the equation and
    allow the supply side to operate outside this system and obtain cheaper
    labor from a different source. Suddenly the demand side no longer has
    the “subsidy” needed in order to generate a demand, so as demand drops,
    the price of goods and services must drop to accommodate it. However,
    if demand drops to zero (i.e. no money), then there is no equilibrium
    point for the supply to drop to and the economy collapses. 

    This maybe theoretically possible based on supply & demand alone, but it is hard to imagine how demand could really fall to absolute zero. The bottom line is that demand comes from real people; it exists all or semi-independently of money, and the demand that economists abstract in referring to the law of supply & demand is not entirely unrelated to what people usually mean when they refer to demand.

    This feeds back into your comment about the difference between a closed & open system. Even if you were able to only look w/in the US, you wouldn't exactly be dealing with a "closed" economic system. It's not hard to imagine a scenario - say a natural disaster - where demand suddenly shifts. (An economist who creates a model for price fluctuations of hurricane disaster supplies, and yet fails to account for the occurance of hurricanes, will be in a for a little shock when a hurricane hits.)

    Overall, economic growth occurs through increased productivity, innovation, output, etc. Wage increases may "lower supply", but if they genuinely represent increased productivity or better service, then they represent true progress above which there is no closed ceiling.
    Gerhard Adam
    This maybe theoretically possible based on supply&demand alone, but it is hard to imagine how demand could really fall to absolute zero. The bottom line is that demand comes from real people; it exists all or semi-independently of money, and the demand that economists abstract in referring to the law of supply & demand is not entirely unrelated to what people usually mean when they refer to demand.

    Not at all.  Demand is not "desire".  Since the equilibrium point between supply and demand establishes the price, then the only response the demand side can provide is to spend its money.  If there is no money, there is no demand (unless you can trade services). 

    Try opening a website that sells soiled used baby diapers. You can raise or lower the price, but demand for your product will remain non-existant.
    I'm not sure where you're going with this, but my point is that the supply side provides the means by which the demand side can "consume goods and services".  It wasn't meant to imply that there was a direct return to the supplier.  So in your example, if I want to sell soiled baby diapers and I hire an individual to build the web-site, then I have subsidized the demand side (by giving money to this individual).  It doesn't mean that that person will become a consumer of my product, but rather than I have increased the resources available to the demand side of the equation. 

    However, to even do that, I must have a source of income with which to buy diapers, food, support children, have a computer, etc. etc. etc.  So at some point, I have a job that is providing my income that allows me to consume all these products (I'm ignoring credit options).  If I then choose to take some of that income and create a web-site to become a supplier I will be subject to the same supply/demand issues as any business.  If I cannot sell my product, then I must somehow subsidize my business (presumably with my job) to keep it going as it operates at a loss. 

    The point remains.  If an individual has no income, then they cannot participate in the demand side of the equation.  Similarly, if there is no demand, then the supply becomes irrelevant.

    That is, the conclusion wouldn't so much be that supply & demand don't hold, but that the model was incorrect or failed to take something into account.
    As such the model is incorrect for those circumstances.  This is similar to the role of relativity against Newton's laws.  However, we don't have the equivalent of "relativity" in economics, so therefore the model is incomplete or it doesn't hold.

    Mundus vult decipi
    kerrjac
    The point of the diapers example is to show that people do not blindly consume whatever is supplied to them. That is, you can supply something, but people do not have to demand it. 
    Not at all.  Demand is not "desire".  Since the equilibrium point between supply and demand establishes the price, then the only response the demand side can provide is to spend its money.  If there is no money, there is no demand (unless you can trade services). 
    Demand isn't desire, but they overlap greatly. In contrast to your argument that the term "selfish gene" is skewing a common social term for scientific purposes, the economic notion of "demand" really does mirror the social one.

    Demand can be satisfied by spending $, but other factors - aside from supply&money - affect demand. See for example http://en.wikipedia.org/wiki/Demand_curve#Shift_of_a_demand_curve. Barter is one example of an alternative way to fill demand, but there are infinite more subtle shifts that occur before getting that extreme. In response to rising food prices, many people have started home-gardens. Since prescription drugs are expensive, many turn to herbal remedies. The demand for such complementary products is not independent of each other. That is, demand for an expensive prescription drug will go down if an equally effective herbal remedy becomes available. Moreover, price can feed back into things independently of demand. If prescription drugs become even more expensive b/c the FDA raises their standards (or b/c a storm wipes out a clinical testing facility), then  demand for herbal remedies will likely increase. To the degree that an herbal remedy may prove as effective as its Rx counterpart, this may continue. If people simply cannot live w/o the drug, then demand for other unessential miscellaneous goods - such as eating out - may drop. All of this may become irrelevant if condition that these drugs are treating decreases in prevalence for some reason.

    Yes, if you have no money, you cannot buy things. But you still have demands&unmet needs. And to the degree that your needs remain unmet, it will behoove you to either make money or fulfill your needs in some other fashion. 

    The point is that you can't simply define supply, demand,&price by each other. Sure they're inter-related, but other factors - be them human, cultural, ecological, random - are driving all of these variables&the nature of their relationships. What is postulated in the law of supply&demand is that supply & demand will be related in order to determine price, along with the direction of the relationship. We then need to figure out the nature, strength, and related factors that drive the relationships.

    If you were somehow able to perfectly quantify supply, demand, price, & maybe income, & keep them so that they can only change relative to each other, then you may have your closed system. But if you suck out the human element, then what's the point? You can try closing the borders to just look at America, but it's the human element that makes it impossible to create a truely closed economic system. Demand for silent B&W films has plummeted since the '20s, and the market for Frank Sinatra vinyl's is not what it used to be. There's no economic explanation for this, and there need not be one either, as the cause behind some trends is just common sense.

    Gerhard Adam
    I'm not talking about setting public policy, I'm talking about whether the "law of supply and demand" fulfills it's role as a viable model to explain what happens.  The idea of the closed system, is a major consideration in interpreting how supply and demand operate.  It's not to say that it can't operate in different ways, but then the model must be modified to accommodate an open system and what the ramifications of that might be.  The whole point of noting that supply/demand is a closed system, is that it is the only way in which the relationship being described holds.  When supply is reduced, the only reason that prices go up is because it is explicitly assumed that there is no alternate supply someplace.  If there is, then the model is not accurate.  This is precisely what is happening in labor markets when businesses don't want to pay the price of workers and go to other countries where labor costs are lower.  They have skirted around the supply/demand by going to an alternate market.  Whether that's good or bad is a policy decision.  The fact that it occurs, needs to be accounted for in the model and generally it's not.

    One of the key points was simply that supply and demand are not independent variables, but rather that demand is subsidized by supply.  Every solution you've described that doesn't use money requires time and work by the individual (which cannot be spent engaged in other work).

    If economics is supposed to be based on principles that hold predictive power, then they must be defined properly or else we only have anecdotal information and inference.  For labor to be characterized solely as a cost of producing "supply", clearly misses the point that it is a recycled resource that will be essential in providing the "demand" side of the equation.
    Mundus vult decipi
    kerrjac
    The whole point of noting that supply/demand is a closed system, is
    that it is the only way in which the relationship being described
    holds.  When supply is reduced, the only reason that prices go up is
    because it is explicitly assumed that there is no alternate supply
    someplace.  If there is, then the model is not accurate.

    From a basic scientific perspective - not talking policy or product price determination - if supply for product x goes down&then its price also goes down as well, then one would have to infer that demand for product x decreased as well relative to supply. This inference comes from the law of supply&demand. & from it you try to find what caused the decrease in demand.

    If models weren't able to account for instances in which supply & price both go up or down, then we would be in trouble. What they assume is that the law of supply & demand holds, & that additional factors caused the phenomena.

    It's similar to the assumption that if you run a regression error variance equals variance that is not accounted for. The next step supposedly is to find variables that further attempt to eliminate the error variance. So in applying an economic model, if supply decreases much more relative to demand, but then the price decreases a lot as well, the assumption is that supply & demand are not well defined in the model. They need to be tweaked, similar to a regression model that doesn't account for much variance.

    As with any regression, a model that gives poor predictions is simply a bad model, it is not proof that regression does not work. Questioning the law of supply & demand in this instance is like questioning the general linear model. It's possible, but it's a different kind of argument, which I'd imagine might play out more like a geometric proof than a criticism of any given model.
    Gerhard Adam
    I never stated that supply and demand doesn't work, but rather that the model as it currently exists addresses a closed system only.  To accommodate a broader range of circumstances would require that multiple economies be considered instead of assuming that there is a single global economy which exhibits uniform behavior.
    Mundus vult decipi
    Hi Gerhard,

    I like your articles a great deal. They make a lot of common sense. Thank you. I wonder though, don't you have the following reversed?

    "[The law of supply and demand] is described as the state where as supply increases the price will tend to drop or vice versa, and as demand increases the price will tend to increase or vice versa."

    Maybe I'm wrong. But I think you're suggesting a negative slope for supply and a positive slope for demand. This is backwards, isn't it? My understanding of the theory is, as price increases buyers tend to demand less. Conversely, as price increases sellers tend to supply more. Right?

    http://en.wikipedia.org/wiki/Demand_curve#Characteristics

    I don't think this disputes your conclusions at all. But I do think you have the roles of supply and demand reversed. I'd love to cite your work in my own writing. I've also referred others to your articles. But in good conscience, I can't cite you until you fix this. So could you please?

    Hope this helps. Thanks again.

    David

    Gerhard Adam
    Thank you for the kind remarks.  I think we're both saying the same thing, so let me see if I can explain.

    If prices increase, then the demand will be reduced as you say.  In this case the pressure is being applied by the "supply side" by raising prices resulting in fewer people having the incentive to buy at that price. 

    As the demand increases than prices will tend to rise because of a reduced supply.  In other words too much demand chasing too few goods.   Similarly the reverse of that is when supply increases to produce a glut of product, then the price must go down to increase the incentive for consumers to buy up the excess inventory.

    There is no question that these two elements are inextricably linked and you can certainly have one action trigger a corresponding response from the other. 

    Let me know if that explanation helps regarding why I said it the way I did.  If you think it's still incorrect, then let me know and let's see how we can resolve the apparent discrepancy.
    Mundus vult decipi
    Thank you, Gerhard. Here's a bit from your response:

    "As the demand increases than prices will tend to rise because of a reduced supply. In other words too much demand chasing too few goods. Similarly the reverse of that is when supply increases to produce a glut of product, then the price must go down to increase the incentive for consumers to buy up the excess inventory."

    Right. These are alleged market responses to either excess supply or excess demand. However, I think the "law of supply and demand" generally stems from an assumption of no excess or "glut". Of course these conditions generally fail. But equilibrium and perfect competition are at least two general assumptions of the theory. In other words, "The equilibrium is a state of rest where there is no pressure for change. At any other price either buyers or sellers are dissatisfied and act to change the quantity demanded or supplied."

    There is an excellent discussion of all this and more in a booklet I found recently called, "The Economics of Health Care".

    http://www.ohe.org/lib/liDownload/288/ohe.pdf?CFID=905603&CFTOKEN=23251183

    It's really good stuff. I hope you'll take a look. Let me know what you think. Meanwhile...

    "There is no question that these two elements are inextricably linked and you can certainly have one action trigger a corresponding response from the other."

    I couldn't agree more, and I love your explanation of the symbiotic relationship between supply and demand. In fact, Wikipedia also says: "According to many analysts, such economic instability stems from a central contradiction: Wages are both a cost of production and an essential source of effective demand (needs or desires backed with purchasing power)."

    http://en.wikipedia.org/wiki/Economic_democracy#Deficiency_of_effective_...

    Despite any sort of "theory", this is how the "law of supply and demand" works in the real world.

    Thanks again for responding, Gerhard.

    David

    Gerhard Adam
    You're absolutely right.  The "Law of Supply and Demand" is an equilibrium law which is attempting to explain the various paths either "supply" or "demand" may take based on the perceived imbalance in that state of equilibrium.

    In effect it's like describing the oscillation of a pendulum where we can say that it approaches it's middle point, overshoots, and then corrects in the opposite direction (OK ... admittedly not a good example).  Perhaps a better example would be a weight balance scale.  As we add weight to one side or another it will tend to oscillate around its equilibrium point until we hit the perfect balance.  However a change in the opposite scale suddenly causes another reaction to which we need to respond.

    Such is my interpretation of these "supply" and "demand" states so that any description of prices rising or falling can only be interpreted in light of the direction needed to achieve equilibrium.

    I will look over the links you provided.  So thanks again for your comments.

    Mundus vult decipi
    Gerhard Adam
    I'm reviewing the link regarding health care and a question comes to mind that I'd like to ask you to respond to.

    Since business and economics is about goods/services and ultimately creating the incentive for individuals to compete for their own best interests.  Why is health and people's welfare considered an item suitable for profitability considerations?  I don't mean the question in a rhetorical sense, because the most obvious concern will center around the choices such a business will be forced to make when it cannot economically deliver the service AND when there is no choice on the demand side.

    It would seem to me, that an essential ingredient to achieve anything resembling a free market, is also the free choice to engage.  I don't think economic theory is really prepared to suggest that such choices should necessarily involve life and death.

    Anyway ... curious about your thoughts
    Mundus vult decipi
    Hi Gerhard,

    "Why is health and people's welfare considered an item suitable for profitability considerations?"

    In short, it's not. The booklet I referred you to begins by outlining market theory, but it doesn't necessarily end on that note. I certainly don't support marketing health care as a commodity. In fact, for all the reasons outlined in that booklet, the market FAILS absolutely with regard to health care. See especially the part about the price elasticity of demand.

    More later on all of the above. I look forward to discussing it further. But I'm about out of time for today. Thanks for the talk, Gerhard. See you next time.

    David

    Gerhard Adam
    Sorry, I didn't clarify.  I didn't mean to suggest anything of the sort.  It was simply an idle speculative question and had nothing to do with the booklet you linked to.

    More of a "thinking out loud" ....
    Mundus vult decipi
    Hi Gerhard,

    You say:

    "It would seem to me, that an essential ingredient to achieve anything resembling a free market, is also the free choice to engage. I don't think economic theory is really prepared to suggest that such choices should necessarily involve life and death."

    I wholeheartedly agree. Health care is not a "free market". It's a "command market", if it's any sort of "market" at all. The sellers are price makers, not price takers. Buyers have little choice but to "engage" at one time or another. Moreover, Barack Obama apparently wants to force as many US citizens as possible to "engage" in maximizing shareholder value for insurance corporations in the name of "universal health care". As an advocate of a single payer system, I'm having some serious trouble with that, and I would appreciate any views you'd care to share on the matter.

    I realize this isn't an easy issue to discuss, though you do have a great talent for brevity. Unfortunately, I don't. I'm still working on it. So rather than take up a lot of space here, I would invite you to look at the discussion at the following URL:

    http://edschultz.invisionzone.com/index.php?showtopic=49487&st=0

    Justin (J_dogg82) started the discussion on April 25 2009. I entered it only about a week ago. My display name there is "larone". It's two pages long (so far), so be sure to look at the second page. That's where most of my comments appear. I just left some new ones today.

    Once you read through all of that, I'd be very interested to discuss it further with you here. In fact, from your very common sense perspective, I'd be very interested in any ideas you might have about what Martin Luther King termed, "constructive coercive power".

    Thanks again, Gerhard.

    David

    Gerhard Adam
    I'll definitely take you up on that.  Unfortunately it may be a day or so before I can respond, I'll definitely check into it.
    Mundus vult decipi
    Gerhard Adam
    I've posted a new article called "Economics - Profitability" which may not address everything you've discussed, but I thought might serve as a platform to extend that discussion.
    Mundus vult decipi
    Gerhard Adam
    I found a few other comments for you to check out and see if this helps clarify my statements.

    When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted outward. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. More people wanting coffee is an example. In the diagram, this raises the equilibrium price from P1 to the higher P2.

    Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2—an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as the quantity demanded extends at the new lower prices.

    http://en.wikipedia.org/wiki/Supply_and_demand
    Mundus vult decipi
    Yes, I see. Our difference here, is between an "expansion" of demand versus an "increase" in demand. I'm referring to the former while you are referring to the latter.

    The "expansion" of demand that I'm talking about is described in the previous section of the same Wikipedia article called "Demand Schedule". *Expansion* of demand refers to any movement along the demand curve, while *increase* in demand refers to a demand curve shift -- in other words, moving the whole demand curve either outward or inward.

    So technically, your introduction is correct, though I'm sure I still don't understand. In fact, I'm probably more confused now than ever. But since your introduction specifically says "the law of supply and demand", I decided to look that up. Wikipedia isn't much help in that department, but the following link seems pretty helpful:

    http://www-personal.umich.edu/~alandear/glossary/l.html

    Law of Demand: The observation that when price rises, quantity demanded falls. This is not necessary in theory, but it is very rarely violated in practice, including in demands for imports and exports, as well as demand for foreign exchange (barring effects on expectations).

    Law of supply and demand: This says, most simply, that prices depend on supply and demand. More precisely, price is determined so as to equate quantities supplied and demanded. Even more precisely, a price tends to rise when demand exceeds supply, and vice versa.

    The former (law of demand) is what I was talking about. But actually, the latter (law of supply and demand) makes the most sense to me, as it describes the relationship between supply and demand in establishing price: "a price tends to rise when demand exceeds supply, and vice versa."

    In any case, as I said earlier, I don't think any of the above disputes your conclusions about the symbiotic relationship between supply and demand. Very well said. Thanks again.

    I'll probably be back later with some answers and more questions for you about health care, if you don't mind. Bye for now.

    Gerhard Adam
    I appreciate your comments.  In fact, one particular point you mentioned regarding prices that I should probably have clarified, is that price isn't actually the driving force, but value as it relates to price.

    In other words, while prices may vary among many products, it will be the perceived or real value to the "demand" side that will determine the response.  This may seem like a minor adjustment, but it demonstrates a more subtle relationship than that everything is simply price-driven.
    Mundus vult decipi
    Hey Gerhard and David,
    As i read through u both hav pretty impressive knowledge abt economics.. can you help me with a task...only points or guidance shall do too.. Using supply and demand economic theory explain why price of cars has changed over the last year. Obliged!

    Fred Phillips
    Here is a diagram from Paul A. Samuelson's classic textbook Economics (8th ed., McGraw-Hill, NY, 1970, p. 42):


    The words in the dark circles are, respectively, "Prices on Goods Markets" and "Prices on Factor Markets (Wages, rents, interest)."

    When as an undergrad I first read his book, one of the biggest aha's I got from it was, "Oh! The money goes around in a circle!"

    Note  Samuelson's capitalized "warning": The diagram's parts interact.

    Interaction means feedback (as a circle diagram suggests), and feedback means nonlinearity. Yet in their formal analyses, Samuelson and other economists treat demand and supply as linearly independent. Why? Best as I can figure, just because the math is easier, more elegant, and equilibria can be conveniently characterized. And also, I'll concede, because in more stable times, linear equilibria described the world tolerably well.

    We have recently seen how badly they fail in unstable times.

    Anyway, I think this distinction speaks to Gerhard's point and to several of the comments.
    Fred Phillips
    Sorry, a p.s.:

    Demand is definitely desire plus ability to pay.

    Even more realistically, we admit nonlinearity and say:


    demand = ability to pay + intention to buy if supply is present.
    Gerhard Adam
    Thanks very much.  I really appreciate the diagram.
    Mundus vult decipi
    Fred Phillips
    "Stable times" is a phrase that usually refers to mid-century, especially the period 1950-70. Technological change was slow, the US was the world's only major manufacturer, employment was generally high (among males), industry was closely regulated and nobody complained about it, America felt a sense of common purpose, and the Cold War stayed mostly cold. This was in contrast to earlier in the 20th century, when the telegraph, aviation, and new weaponry were changing the structure of industries, and later in the century, when LBJ tried to prosecute a hot war in Vietnam without raising taxes, Nixon "opened" China and repudiated the Bretton Woods currency agreement, Reagan deregulated everything, Europe and Japan hit their industrial stride, Americans were either Gordon Gekko or wanted to be, Clinton never saw a free trade agreement he didn't like, and some goofballs were inventing the Internet - all of which set industrial structure into a tizzy again.
    MikeCrow
    I think we also need to consider off-shore demand as well as off-shore supply(labor). You're right if there's no exports. But as foreign labor gets money they also create demand(priming the pumps). Even if we don't supply most of the goods, labor money will create demand, and as demand increases, more of their labor output will be consumed internally, raising wages, Japan is a good example of this.

    IMO this is the best solution to helping the people in 3rd world countries, foreign aid is a money pit, but transitioning economies is a tightrope act. There's a saying that trading partners don't generally shoot at each other. So there's more at stake than just business.

    But I'm optimistic, we're still the world leaders in creative solutions, creating whole new products from which demand will arise. The US can occupy the high ground, owning/creating the best new stuff.

    Lastly, the industrial revolution was also a major transition in economies, with lots of disruptions, yet many more people ended up with jobs(with less poverty and more wealth) than we had before.
    Never is a long time.
    Gerhard Adam
    The US can occupy the high ground, owning/creating the best new stuff.
    I think this isn't accurate, and far too optimistic.  Too many people assume that expertise is somehow intrinsic in the U.S. without recognizing that the same jobs they are sending off-shore were originally used to train new people to acquire the experience to become "experts".  Without that learning path, the U.S. is no position to own nor create "the best new stuff".

    There's no question that major transitions are disruptive and won't always produce good outcomes for everyone, but the U.S. is on a dangerous path in thinking that it can retain a leadership role without actually producing anything.  It has become fashionable to think that manipulating money is sufficient to justify making more money.  While this may work for a small segment of the population, it is an unrealistic way to fashion an economy.

    In addition, whether we like it or not, we have to stop chanting the "but it's cheaper" mantra as if that resolves everything.  We are simply in denial if we believe that abusing workers in other countries will solve anything. 

    In general, I am considering offshore demand and supply, but it isn't relevant until it comes back "on-shore".  That's the point.  An economy cannot grow without actual input and output, and if that's all being given to others, then we shouldn't be shocked when their economies grow while ours dwindles.  We still believe that somehow we're entitled to a booming economy instead of recognizing that it isn't in the "natural order of things" that it should always be so, and we have to actually make intelligent decisions if we expect certain outcomes.
    Mundus vult decipi
    MikeCrow
    Most of the tech space manufactures their product off-shore, and they seem to be doing okay with coming up with new ideas. But as I said there is a rope to walk.

    When I suggest this, I don't even include the financial world, let alone think we can get along just moving money around. I work in the product world.

    Cheaper isn't the mantra, but it is really hard to compete against a comparable product that costs 50% more, IMO it's better to off-shore labor than go out of business. Plus IMO we're not competing against foreign labor, we're competing with automation. I don't think there will be much of a need for humans to build things in what 30-50 years maybe? Bringing labor back on shore might not be the panacea you and the President think it will be, sooner or later those kinds of jobs will disappear.

    Imagine a world where Star Trek's matter replicator(or something much like it) exists, how many manufacturing jobs do you think we'll have then? And I see no way to derail the automation train that's coming.

    Lastly, we should want their economies to grow(it'll be good for us), though we do need to be cautious it doesn't come entirely at our expense.
    Never is a long time.
    Gerhard Adam
    We are heading for a train wreck.  We cannot continue to grow a population, while simultaneously creating an economy that requires fewer people, and simultaneously again, producing even fewer individuals (across the whole population) that are qualified to work in more advanced technologies and have the requisite skills.

     
    Mundus vult decipi
    MikeCrow
    What choice do we have but to make the best of the cards in our hand?

    Better or worse we've taught the Chinese to make all of our high tech(same as we did with the Japanese BTW), trained the Indian's and Chinese our sciences. They both have more high IQ people than we have citizens. We have to out play them.

    On the other hand adults have always felt the young weren't ready to take their place and the world was about to end, but it didn't. Most of the overseas tech software engineers I've worked with required detailed directions to find their way. We still have skills they don't, yet.

    I think we have a path to a bright future, but there are a lot of moving parts and we could drop too many of them to make it happen.

    But it's not a forgone conclusion.
    Never is a long time.
    Gerhard Adam
    But it's not a forgone conclusion.
    No, it's not a forgone conclusion.  The only problem with that sentiment is that it is a phrase that is invariably invoked when one hopes that luck is on their side.    That's my concern ... the people in this country simply assume that things will turn out for the best, despite overwhelming evidence from history of countless societies that collapsed because they didn't bother to apply themselves any more.  They simply took their favored position for granted.

    So while it's not a forgone conclusion .... it's still extremely likely if we don't recognize it as a possible outcome and begin taking steps to avoid it.  Simply uttering more nonsensical patriotic platitudes isn't going to do it. 
    Mundus vult decipi
    MikeCrow
    True, But people don't apply themselves when all they have to do is sit on their ass and wait for the government to feed them and keep them in good health.
    Even when you pay to send them to school they take stuff like Art History, because they like pretty pictures. God forbid they take something hard like math.
    Never is a long time.
    Gerhard Adam
    There's some degree of truth in what you say, but it goes well beyond that.  When the people that are supposed to be in charge are clearly interested only in their own well-being and that of their cronies, then all bets are off.  There's no question that those with an advantage are seeking ever greater advantages without regard for what it will do to the society they inhabit.  As a result, its become chic to argue that society is the albatross around the neck of progress.

    I know, that many would interpret my comments as one asking the government to fix things, but in fairness, it is the government that broke it to begin with, along with all the corporate lobbyists that have ensured that their own interests have been served.  After all, if corporations are people, then why don't people have the same rights as corporations?  I have no problem with the government staying out of the economy, provided that the government all stays out of helping corporations [and ensures that the law is equally enforced, and accessible, between private citizens and corporations].

    Things are simply too far skewed in favor of those that already have advantages.  It would be different if there were actual opportunities, but when those same interests are actively engaged in orienting the government against the people its supposed to represent, then there will be problems.

    While many people like to argue that the public feels "entitled", the reality is that there are no greater entitlements than to those that are already privileged.  Those with the means are already doing everything in their power to avoid carrying their "fair share" and yet they whine about how unfair the system is towards them.  There's something fundamentally wrong when a multi-millionaire is paying a lower tax rate than the guy that washes his car.  For years, we've heard about how unfair taxes are .... well, it's true, and it's becoming clear that they are unfair to those that actually work for a living, versus those that are living off the benefits of lobbyists.

    What's wrong with this picture?
    http://www.forbes.com/sites/chrisbarth/2011/12/14/29-companies-that-paid-millions-for-lobbying-and-didnt-pay-taxes/
    Mundus vult decipi