VII. Demand and Supply

A. Classical Demand and Supply

1. Expenditure and quantity sold; price as the ratio of the demand to the supply.

2. Makes clear the relationship between the direction of price changes and the direction of demand and supply changes. Valuable in “macroeconomics,” where competitive factors cancel out.

B. Contemporary Demand and Supply.

1. Schedules or curves: the set of quantities buyers are prepared to buy or sellers to sell at varying prices, arranged in descending (ascending) order, all other things equal.

2.  For a hypothetical demand and supply schedule, see Figure 5–1 on p. 153 of Capitalism

3. Reproduce the diagram based on the data in columns 1–3 of Table 5–1 on p. 152 of Capitalism.

4. The law of demand: other things equal, the quantity demanded increases as the price decreases, and decreases as the price increases; to sell a larger quantity requires a lower price, while a smaller quantity for sale will bring a higher price.

5. Reasons for the law of demand:

a. Marginal utility must be above the price; a drop in price puts the price below the marginal utility of additional units and so makes their purchase advantageous. Marginal utility and price “sandwiching.”

b. Substitution effect.

c. Income effect.

6. Change in quantity demanded versus change in demand—see the column Quantity Demanded II in Table 5–1. Derive the diagram in Figure 5–1.

7. Reasons for changes in demand: changes in: quantity of money, income, prices of substitutes or complements, knowledge, tastes and preferences; development of new substitutes or of substitutes for complements.

C. Elasticity of Demand

1. Meaning: the percentage change in the quantity demanded divided by the percentage change in price.

2. The total revenue test.

3. Examples of elastic, inelastic, and unit elastic demand.

a. Elastic: close substitutes, luxury goods.

b. Inelastic: poor substitutes, necessities.

c. Unit elastic: aggregate spending.

4. Applications of concept of elasticity: employment effects of machinery, the profitability of charging a different price where there is little or no competition.

5. The elasticity of demand for a particular company under freedom of competition almost always much greater than for the industry as a whole.

6. Income and cross elasticity.

7. Elasticity changes even over the length of the same demand curve.

8. No constancy of elasticities.

D. Supply Curves

1. Basic case is vertical supply curve—reflecting a given quantity that sellers are prepared to sell at best price they can obtain.

2. Reasons for supply curves sloping up and to the right.

a. The marginal utility of sellers—actually not a significant reason.

b. Riding up other demand curves (case of broader fixed supply—e.g., wheat, gasoline in different partial markets).

3. Partial equilibrium and the confusion between cost of production and supply and demand as the determinant of price.

a. Upward sloping supply curve typically thought to reflect law of diminishing returns. Most prominent in agriculture and mining. And here not usually relevant in the short run, in which supplies of agricultural commodities are simply given.

b. Horizontal supply curve (the most common case, prevailing throughout manufacturing and retailing) actually represents determination of price by sellers, based on consideration of costs of production. Equilibrium price only apparently determined by the intersection of the supply and demand curves here.

c. Economies of scale and a downward sloping supply curve—again, price actually based on consideration of cost of production.

d. Ricardo and Böhm-Bawerk on the comparative influence of the buyers and sellers in determining prices—each correct in a different context.

E. Some Errors to Avoid

1. Why it is incorrect to try to derive S and D curves by observing prices and quantities bought and sold over time: all we observe are intersection points of any number of possible S and D curves; with any price change, at least one of them must be different; the curves highly volatile; no reason to assume even one of them the same one over time.

2. The existence of a rising price accompanied by a rising quantity demanded does not invalidate the downward slope of the demand curve: a change in the curve present.

VIII. The Uniformity-of-Profit Principle

A. Statement and Explanation of the Principle

1. The rate of profit (return) on capital invested tends toward uniformity in all branches of industry.

The rate of profit contrasted with a profit margin.

2. Uniformity-of-profit principle based on the fact that capital is withdrawn from areas of low profitability or losses and invested in areas of higher profitability, the effect of which is to reduce the initially high profit rates and raise up the initially low profit rates.

B. Significance of the Uniformity-of-Profit Principle

1. The harmonious balancing of the different branches of industry; incentives and means for the counteraction, delimitation, and prevention of mistakes in production.

2. The power of the consumers to shift the course of production—“consumer sovereignty.”

3. The need of businessmen to introduce continuous improvements in production ahead of others in order to earn an above average rate of profit; how the concern with profits expands production in the economy—the significance of cost cuts; why prices rise, even though the uniformity-of-profit principle operates to make them fall.

C. Applications of the Uniformity-of-Profit Principle

1. The repeal of farm subsidies, rent controls, and price controls on oil and natural gas.

2. Differential tax rates—e.g., the depletion allowance on oil and its abolition.

3. Rents and prices in minority neighborhoods.

IX. The Tendency Toward a Geographical Uniformity of Prices

A. Statement and Explanation of the Principle

1. The price of a good capable of transportation tends to be the same throughout the world, plus or minus costs of transportation (and tariffs, if any).

2. Basis in the fact that it pays to buy in the cheaper market and sell in the dearer market, which has the effect of raising the price in the former and lowering it in the latter.

B. Significance and Applications of the Principle

1. Why local crop failures don't cause famines.

2. The Arab oil embargo against the U. S.

3. The export of Alaskan oil to Japan.

X. The Tendency Toward a Uniformity of Prices Over Time

A. Statement and Explanation of the Principle

1. The price of a good in the present tends to equal its expected price in the future, or, more precisely, the expected price of a good in the future tends to exceed its price in the present by no more than the costs of storage and an allowance for the going rate of return on capital for the period of storage.

2. Basis in the fact that buying and holding to take advantage of a higher price acts to raise the price in the present and, by making larger supplies available in the future, reduce the price in the future.

B. Significance and Applications of the Principle

1. The mitigation of scarcities.

2. The productive role of commodity speculation.

XI. The Tendency Toward a Uniformity of Wage Rates for Labor of the Same Degree of Ability

1. Basis of the principle in the movement of workers from lower paying to higher paying fields and effect of more (less) workers on wages in a field; accomplished mainly by movement in supply of young workers entering the labor force.

2. Corollary tendency toward unequal wage rates for labor of different degrees of ability.

3. Premiums and discounts in wages accompanying non-monetary disadvantages and advantages of employment.

4. Consumer control over the relative size of the various occupations.

5. Seeking the highest paying job means trying to do what the consumers most want you to do

XII. Prices and Costs of Production

1. The tendency for price of products to be governed by their costs of production

a. Indirect determination by cost through variations in supply.

b. Direct determination by cost through the decisions of sellers in setting their prices: the need to hold down the profits of competitors and potential competitors.

2. Analysis of cost of production into prices times quantities of factors of production; prices of factors of production at each stage largely determined by supply and demand—e.g., wage rates. Role of supply and demand becomes cumulatively greater, the further back in the production process one goes—e.g., autos to steel making to iron mining. Explanation of price by cost, therefore, ultimately comes down to explanation based on supply and demand operating in markets for labor and other factors of production in given supply.

3. Full explanation of prices based on cost and of all other prices depends on explanation of prices by supply and demand.