The Flaw of Supply and Demand

[anderxander]

The Flaw of Supply and Demand and it's implications for Bitcoin

The Law of Supply and Demand is usually presented in textbooks in association with a graph made up of two intersecting lines, but the graphs displayed are not identical. Some show straight lines with opposite slopes; some show curved lines, one being is some sort of inverse relationship to the other. One line represents supply, the other, demand, and the point of intersection, price. Readers are told to imagine moving one of the lines to the right or left and observe how the point of intersection changes. If the supply line is moved to the left (decreasing supply), the point of intersection (price) rises; if the supply line is moved to the right, (increasing supply), the point of intersection falls. Similar but opposite results are generated if the line of demand is similarly moved. Students are induced to conclude that as supply falls or demand rises, prices increase, and as supply rises or demand falls, prices fall. Essentially, that's all there is to this doctrine.

However, if one disassembles this doctrine, important things are revealed. The graphs sometimes show straight, sometimes curved lines. But any two intersecting lines produce the same result. The nature of the lines on the graphs is irrelevant. Since lines are made of sequences of data points, data is also irrelevant. Since the lines are arbitrary, no formula can be written that relates them to each other and, therefore, the doctrine doesn't allow anyone to make any calculations. That is, the price cannot be calculated by replacing the supply and demand variables with numbers. The supply cannot be calculated by replacing the price and demand variables with numbers, and the demand cannot be calculated by replacing the price and supply variables with numbers. Although the graph gives the impression that the relationship is mathematical, the doctrine has no mathematical applications.

I am surprised that no economist has found this curious, especially since mathematical modeling is so pervasive in today's orthodox theory. For instance, Dani Rodrik [http://rodrik.typepad.com/dani_rodriks_weblog/2009/03/the-sorry-state-of-macroeconomics.html] has written, "The economics profession doesn't take an argument seriously until the argument can be laid out with a well-specified model that respects accepted standards of modeling. . . ." But if a well-specified model that respects accepted standards of modeling is necessary for economics to take something seriously, the Law of Supply and Demand should have been jettisoned a long time ago.

Someone may object that I have not stated the doctrine precisely, and that's true. So let's examine its terms.

Supply seems to be the easiest to understand. Let's say it means the number of units of a product available for sale, although I'm not certain that this definition is accurate. But the concept of demand is another matter altogether. First of all, using the word demand in this context is a linguistic howler. When a robber walks into a bank, points a gun at a teller, and says, "Give me the money!", s/he is making a demand. Demands are expressed in imperatives. That's not what happens in the marketplace. So what can demand mean in this context? One possibility is the number of people who need a product, as for example, the number of people who need a specific drug to maintain their lives. Another is the number of people who want a product, as for instance, the number of children who want a specific toy for Christmas. Still another is the number of people who can afford to purchase the product. But none of these is part of the doctrine as precisely stated. The precise definition of demand is the number of people who are willing to purchase a product at a specific price. But this definition destroys the doctrine, because if price alone determines the demand, supply is no longer relevant even though the supply may influence the vendor's pricing. The doctrine becomes a mere empty tautology. Furthermore is willingness to buy synonymous with buys? Isn't it possible for a person to say, "I was willing to buy it, but I was too busy to get around to it"? But the real weasel word is price.

The Law of Supply and Demand is perhaps the most frequently cited economic principle by the American press; it is cited every time an oil company raises gasoline prices. But the precise definition of price in the doctrine is "equilibrium price" which is a purely theoretical concept. What relation it has to the actual price is a mystery.

When an oil company or an economist claims that the price of gasoline is rising because of increased demand, it/he/she is weaseling. The precise claim should be that the equilibrium price is rising because of increased demand, but that is never claimed, and even if it were, it would have no relevance unless the relationship between the equilibrium price and the actual price were specified. All equilibrium price means is the price at which the number of units for sale is equal to the number of units consumers buy. But equilibrium is a fantasy. If it is ever attained in reality, the attainment is purely accidental. So the Law of Supply and Demand plays no place in the marketplace.

It is true, of course, that retailers sometimes lower prices during "sales" to rid themselves of excess products. But they do not raise prices when the number of items available decreases. The products are sold at the fixed price until they are gone or are restocked. Even oil companies function this way at the retail level. After a supply of gasoline is delivered to a filling station, the price is set and even if a long line of automobiles forms at the station, the proprietor does not dash out and increase the price to get some of the people lined up to drive away. The same is true of toy makers at Christmas. Often one new toy becomes very popular with children whose parents attempt to buy it. But toy stores do not increase the price when they notice the unexpected demand; they merely sell the toy first come, first acquired until the toy is sold out. So the Law of Supply and Demand is a principle without a practice.

Pricing is not the only method of distributing products. In times of crisis, such as wartime, products are often merely rationed. Everyone who needs a product gets a share of those available. The manufacturer makes a profit and consumers get at least some of what they need. Another distribution method is the method described in the previous paragraph. Products are distributed to consumers first come. Again the manufacturers make a profit and those consumers who get to the retailer soon enough get what they want, those who do not get none. But what would happen if the Law of Supply and Demand were applied in the market place? The vendor would raise the price as the supply diminished, the consumers who managed to acquire the product would pay more for it than they would otherwise, and the other consumers would get none no matter how essential getting some was. This scenario is identical to the previous one except that the vendor makes a larger profit at the expense of the consumer. It is merely a method of transferring wealth from consumers to vendors without providing consumers with an additional benefit. In other words, it transfers wealth from the neediest to the neediless.

This, of course, raises an important question: Why would economists advocate a method of distribution that enriches vendors at the expense of consumers? Why would they advocate an economic principle that reduces the wealth of consumers to advantage vendors? Exactly for whom does the economy exist?

The Law of Supply and Demand is an empty, tautological doctrine that is not supported by observations of the marketplace and merely serves as an excuse used by some producers to increase prices to the detriment of consumers. It is not an economic law; it is an economic flaw It is not even a legitimate idea; it is a mere notion.

by Prof. John Kozy

http://www.globalresearch.ca/index.php?context=va&aid=13081

The model of prices being determined by supply and demand assumes perfect competition. But:
"economists have no adequate model of how individuals and firms adjust prices in a competitive model. If all participants are price-takers by definition, then the actor who adjusts prices to eliminate excess demand is not specified".[

Alan P. Kirman, "Whom or What Does the Representative Individual Represent?" Journal of Economic Perspectives, V. 6, N. 2 (Spring 1992): pp. 117-136

"If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an explanation expressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. Supply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a complex world. It does not - nor should it be expected to - give us in addition an accurate and complete description of any particular real world market."

Goodwin, N, Nelson, J; Ackerman, F & Weissskopf, T: Microeconomics in Context 2d ed.

[Alex Beckenham]

Who are you quoting?

[kjj]

ZOMG!  Economics isn't perfect!  Everyone run for the hills!

It is completely true that supply and demand in real life don't look like the idealized abstract charts in economics books.  Also, real atoms don't look like the little solar systems in physics books, and molecules don't look like the stick figures in chemistry books.

However, any supply that is not unlimited must be allocated in some way.  There are many possible ways to allocate a scarce good.  Here are just a few examples:  You can use a lottery.  You can use rationing.  You can use a queue.  You can use merit.

All of those tend to turn into allocation by corruption, by the way.  And they virtually guarantee that resources are not allocated to those who can best make use of them.

Which brings us to allocation by price.  Sure, the curves in real live aren't neat and clean, and no one really knows the exact level of supply, nor of demand.  And pricing isn't exact.  But everyone tries, and for the most part, we do a pretty good job of it.

Ask your parents about the gasoline lines in the 70s if you are wondering how well non-price allocation systems work.  The Law of Supply and Demand isn't perfect in the real world, but it is wildly better than every other method anyone has ever tried.

[benjamindees]

The "law" of supply and demand is kind of like the law of gravity.  It doesn't really tell us how things always are.  It tells us how things tend to be.  You can ignore the law of supply and demand;  it's not impossible.  But as a consequence you will run out of some scarce resource at the least opportune time.  Just as you can ignore the law of gravity, and feel free to jump off a cliff.

[kiba]

The "law" of supply and demand is kind of like the law of gravity.  It doesn't really tell us how things always are.  It tells us how things tend to be.  You can ignore the law of supply and demand;  it's not impossible.  But as a consequence you will run out of some scarce resource at the least opportune time.  Just as you can ignore the law of gravity, and feel free to jump off a cliff.

Some people survives falls thousand of feets in the air...but I wouldn't bet on surviving a fall thousand of feets in the air.

[Andris]

Ask your parents about the gasoline lines in the 70s if you are wondering how well non-price allocation systems work.  The Law of Supply and Demand isn't perfect in the real world, but it is wildly better than every other method anyone has ever tried.

And yet, during World War II, rationing did work. Only because the nation was behind the effort, of course. That should never be discounted as a factor.

This also only applies to goods where 'standing in line' actually makes any sort of sense as a distribution model. Do you want multiple competing organizations printing out gathered data only to people who will pay? It... works, but it's demonstrably not the optimal solution, compared to multiple open organizations giving out their data with them supported by society in some fashion (E.g. the open source movement).

Some people survives falls thousand of feets in the air...but I wouldn't bet on surviving a fall thousand of feets in the air.

Part of the point. Not all resources are scarce.

[anderxander]

Part of the point. Not all resources are scarce.

+2

And resources that are scarce can be produced, warehoused, and distributed in such a way, that for all practical purposes they are in abundance all the time.

[MacFall]

And yet, during World War II, rationing did work.

Only as compared to, say, destroying all resources before they could be consumed in a useful fashion. Mussolini also made the trains run on time.

Anything can be said to "work" if opportunity cost is ignored.

[MacFall]

In reply to the OP: any graphical representation of an economic law will be imperfect. But the law itself can be deduced from irrefutable axioms. One cannot attempt to refute the law of supply and demand without, ultimately, attempting to refute the action axiom - which is a performative contradiction.

[anderxander]

Supply and Demand being those axioms?

Maybe you should read the part where he refutes those axioms.

Axioms (unless redundant) cannot be derived by principles of deduction, nor are they demonstrable by mathematical proofs, simply because they are starting points; there is nothing else from which they logically follow (otherwise they would be classified as theorems).

Economic Definition of axiom.

erm axiom Definition: A basic precondition or assumption underlying a theory. Axioms are basic, unverifiable world view assumptions, including personal beliefs, political views, and cultural values, that form the foundation of a theory. These axioms can not be verified with real world data, and as such are largely accepted on faith. Belief in a supreme, omnipotent, omniscience being is one such axiom. The notion that people are basically good (or bad) is another.


The "Law" of Supply and Demand is a faith.

Why are we not using an economic system that uses real world data to make real world decisions?  

[MacFall]

That's only one definition of an axiom, and it's not the one being used.

Try to disprove the principle (from which the law of supply and demand logically follows) that people always act in accordance with what they believe, at the moment of action, will meet their most immediate achievable end. You can't do it without proving it in the process. So unless you can show that supply and demand do not logically follow from that principle (which it does), it's as solid a law as 2+2 equalling 4. Any supposed exception to it will be found, given sufficient data, not to be an exception at all.

[Andris]

Only as compared to, say, destroying all resources before they could be consumed in a useful fashion. Mussolini also made the trains run on time.

Anything can be said to "work" if opportunity cost is ignored.

It was the greatest three-year economic boom in US history. Ever. Sustained real GDP growth of ~17%, for a nation that was already the world's largest economy.

Ideal? Certainly not. It all went to armaments and logistics and things that only indirectly improved America's real wealth, but you can see that all that money ended up getting pumped into the private sector when the war was over. But the United States never saw that sort of sustained growth before or since.

[MacFall]

GDP doesn't measure wealth.

You can make GDP look good by routinely demolishing cities and rebuilding them without a war. War is just the excuse.

[DrSammyD]

Who gives a shit if GDP is high when your life is getting worse.

In other words.

http://www.youtube.com/watch?v=GTQnarzmTOc#t=3m06s

In order to believe the increase in GDP you have to believe that an average annual rate 13% growth over 4 years which is greater than any other in history took place when 16 million working men were put into the military, and they were replaced by inexperienced teenagers, women with little to no experience in those industries, and elderly men. And then when they returned, the economy's output would fall by 22% in 2 years.

What about this is plausible? Those statistics are bullshit. Here's why.

Most of the economy was under the command of government. They ordered producers to make things, and then gave those things prices decided by the government. When you add those arbitrary prices up, you get a massive arbitrary number. Thus the GDP data you cite is moronic to think actually represents growth, and not some faulty accounting trick.

[Andris]

GDP doesn't measure wealth.

You can make GDP look good by routinely demolishing cities and rebuilding them without a war. War is just the excuse.

This is funny. Austrians use the boom of the Long Depression to bolster their arguments despite the widespread suffering, but when a major government intervention unequivocally -ends- that suffering (alongside a boom), it doesn't count. Because the US was really suffering in the postware period compared to the prewar.

[MacFall]

Because the US was really suffering in the postware period compared to the prewar.

This is just plain bullshit.

Go break your own windows and see how rich you get. Leave mine alone, thanks.

[amincd]

Austrians use the boom of the Long Depression to bolster their arguments despite the widespread suffering, but when a major government intervention unequivocally -ends- that suffering (alongside a boom),

First of all, there was enormous increase in 1) wages and 2) life expectancy during the "Long Depression". The economy grew at its fastest rate in US history, and this was market driven growth, meaning it reflected an increase in what people actually demanded, not government-spending driven growth where the increase is in value as arbitrarily defined by government.

Second, there was great suffering during WW2, and a huge debt had to be accrued during that period. To claim that it ended suffering, when it was associated with forced labor (drafting of people into essential industries), rationing, a terrible war, and an enormous deficit that sapped the economy for years to come, is ridiculous.

[MacFall]

Not just ridiculous; it's frankly insane.

Also, I find it hilarious (in the archaic sense of the word) that supposed "liberals", those wonderful paragons of compassion and peace, think that wars are just dandy whenever it's one of their guys running them. The "Good War" is a progressive myth that was only recently adopted by neoconservatives, which are basically progressives who are more honest about their attitude towards foreign policy.

[luv2drnkbr]

That thing was so stupid I want to punch my monitor.  So many inconsistencies from a professor of logic and philosophy.  Wow.

[anderxander]

That thing was so stupid I want to punch my monitor.  So many inconsistencies from a professor of logic and philosophy.  Wow.

Please explain.