Supply and Demand

Economicsby Timothy Lane   12/16/13
When I attended Purdue University, School of Science students needed to complete 12-18 hours (generally 4-6 courses) of humanities and social sciences to qualify for a baccalaureate (in addition to the basic requirements in English and a foreign language). I ended up taking 12 courses – 6 in history, 4 in economics, and 1 each in sociology and English (a first-time course on science fiction my last semester there). The first economics course I took (ECON 215) handled microeconomics. I think this is something more people need, much earlier than college and not as an elective.

I have previously discussed the microeconomic concept of opportunity cost. In this article, I intend to discuss the importance of the concept of supply and demand. There are many political disputes today in which the liberal side ignores (if they’re even aware of them to begin with) this basic element.

Basically, if you increase supply faster than demand, the price will decline; conversely, if you raise demand faster than supply, the price will increase. (If these price changes are prevented by government action, they will disrupt the market.) Similarly, when prices rise, supply is likely to increase and demand will fall (though it’s theoretically that a cheap staple will be used more its price rises because people consume it instead of more expensive alternatives); and when prices fall, supply will decrease and demand will generally increase.

When it comes to agriculture policy, this is well known and accepted. The New Deal recognized this when it destroyed food supplies to increase far, incomes at a time of want, and later when they adopted farm parity as the basis for their policy under the Agricultural Adjustment acts (the first was rejected by the Supreme Court, but the virtually identical second version was successfully defended on the basis of regulating interstate commerce even though the farmer in the deciding case used the extra grain he produced solely as fodder for his own animals).

But when it comes to labor, no one seems to recognize the effects. Minimum wage laws artificially raise the price of labor and thus reduce the demand, but few liberals will admit this link. Increased Immigration greatly increases labor supply, which in a time of virtually stagnant demand for labor (as is the case today) means reduced compensation for labor. Again, this is hardly a new fallacy; the basic error goes back to Herbert Hoover, who tried to keep wages up when the Great Depression began (a policy that his successor continued). Naturally, unemployment exploded to then unimaginable levels.

We see similar errors with complaints about price-gouging, particularly during emergencies. Such price increases are certainly very unpleasant for the victims of natural disasters, but they also help lead to increased supply and lower demand, which will ultimately benefit those victims. There is a story that Daniel Patrick Moynihan, during his time as a domestic advisor to Nixon, once was expressing pleasure about a major interception of illegal drugs. He then noticed George Schultz (an economist who knew his stuff), and commented that no doubt this would lead to increased prices and ultimately more drugs brought in to replace them. Schultz acknowledged that Moynihan was learning. Sadly, all too often politicians don’t learn these lessons. (Moynihan himself later ignored them in his Senate career, preferring doctrinaire liberalism.)

Part of the problem is that most economic advisors are more familiar with macroeconomics (which deals with the economy as a whole and how to deal with it) rather than microeconomics. Indeed, economics used to be called “political economy,” and even if the terminology is different today, the problem remains. • (1192 views)

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7 Responses to Supply and Demand

  1. Brad Nelson Brad Nelson says:

    But when it comes to labor, no one seems to recognize the effects. Minimum wage laws artificially raise the price of labor and thus reduce the demand, but few liberals will admit this link.

    I think that definitely qualifies as an example of the most basic economic law of all: There is no free lunch.

    Thomas Sowell and Walter E. Williams have written many articles (and possibly a book or two) on how increasing the minimum wage is particularly harmful to blacks. Whatever the reason for the circumstances one starts with, not everyone is worth $8.00 or more per hour (or whatever the prevailing minimum wage is). This destroys jobs and eliminates the chance for many to start out on the bottom rung of the ladder and gain work experience and thus work their way up.

    I noticed an article the other day that mentioned that McDonald’s workers were asking for $15.00 an hour for a minimum wage. Hey, I have to admit that it would be great if there was a magic money tree that you could just pluck dollars off of so that everyone could be a millionaire with little or no effort. But there is not.

    But back to the first law of economics: There is no free lunch. A significant portion of Americans are economically illiterate. They have no clue how it works. They have little idea about wages being inherently tied to value. And the Communist influence (all this “living wage” baloney) has turned many Americans into beggars and soft thugs wherein the market operates (at least in their mind) by the principle of what you can get government to demand that people be paid.

    But the economy is geared to value (or should be), not what the government can try to dictate. Nor is (as in the Communist scheme of things) a job’s worth tied to mere labor (the pet paradigm of Communists and socialists). As valuable as school teachers may be, they do not deserve more just because someone says so. And although a ditch digger arguable works harder than Madonna, that digger shouldn’t necessarily be paid more because of it. In a Communist system where labor, not value, is king, maybe. But not a freedom-based one where the value of one’s labor is decided by other people (the market), not some economic dictator according to often wicked and cruel ideologies that masquerade as something nice.

    America must decide where it wants freedom or Communism. You can’t have both. And if we keep choosing the latter, we will no longer have prosperity either. America must start to see through the shysters in both parties who promise something for nothing which is an economic impossibility. But, politically, such promises are attractive to the uninformed or those who want to steal from others via government and call it something nice such as “social justice.”

    • faba calculo says:

      “Thomas Sowell and Walter E. Williams have written many articles (and possibly a book or two) on how increasing the minimum wage is particularly harmful to blacks.”

      Ironically, one of the groups least hurt by increases in the minimum wage appears to be black women. Black men, on the other hand, do get screwed first and worst.

    • Timothy Lane says:

      Price is not dependent on cost, but obviously (except perhaps to liberals) the price must be at least as high as the cost for a business to survive. I thought about discussing this aspect as well, but decided to focus specifically on supply and demand.

      • Brad Nelson Brad Nelson says:

        Well, I think supply-and-demand fits into the overall paradigm where it is prices (what people are willing to pay for something) that are the rational determinant in a market economy. And such price decisions are made via value judgments by customers.

        And, of course, prices are constrained at one end by what it costs to make the goods as well as by what the competition is charging for a similar product (or just another “disposal income” product which might be in an entirely different product category). One can’t just set any price that one wants, no more than one can just pull a wage out of the air ($15.00/hr) for a hamburger flipper. The foundation of prices as the rational basis for making transactions (as opposed to command economies driven by various political schemes) is what distinguishes a free (and productive) market from a creaky, old-style, Soviet one.

        The price system works. It’s not enough to say, “Well, there are still some who can’t afford an iPhone.” Well, boo-hoo. If you want an iPhone, get off your ass and earn one. Make yourself valuable to an employer and/or a customer. Gain a skill. Shop it around. But it’s just not enough to say “Some people are doing without.” Of course some people are doing without. We can’t have everything we want just by wishing for it. iPhones cannot be a “right” no matter how high you turn up the crocodile tears. They have to be produced and paid for. There is no magic to this, although government welfare and intrusions into the market can mask this fact. And there are plenty of politicians (most of them, if you ask me) whose interest it is to convince us that nothing would get produced unless government was involved.

        Basic ignorance of economics combined with the Communist/entitlement mindset is a recipe for disaster. And we voted one of these fools into office as president (and there are plenty in Congress as well, on both sides of the aisle, but primarily in the Democrat Party). We doom ourselves by this Communist “niceness” that is not good.

  2. faba calculo says:

    “Similarly, when prices rise, supply is likely to increase and demand will fall (though it’s theoretically that a cheap staple will be used more its price rises because people consume it instead of more expensive alternatives); and when prices fall, supply will decrease and demand will generally increase.”

    A small but important point: supply and demand don’t respond to changes in prices, quantity supplied and quantity demanded do that. That is to say, changes in price don’t move the supply (or demand) curves; it’s the movements of the supply and demand curve that determine prices. But changes in prices can affect where you are on the curve in question, thereby changing the the quantity demanded (or supplied).

    When it comes to labor, I think everyone acknowledges that a large enough increase in the minimum wage will show up as a measurable decline in the quantity of labor demanded. However, what every empirical study I’ve seen (and I’ve seen dozens and did my Master’s thesis on this topic as well) shows is that the increases we’ve seen passed in the last 30 years have had small effects relative to the size of the increase in income. That is, each 10% increase in the minimum wage seems to have brought about a 1% to 3% drop in the teen employment-to-population ratio. Thus, the gainers are gaining more than the losers are losing. In fact, with a high enough turnover (as companies such as fast food restaurants have very high turnover rates), it’s possible (note: I’m not saying it happens, just that there room enough for it to happen) that nearly all the teen workers gain both in the form of higher yearly incomes AND a reduction in hours on the job. It’s always seemed strange to me that economists spend so much time puzzling over why teen workers don’t oppose increases to the minimum wage when it hurts the demand for their labor. But if the workers are getting more money AND more leisure, and only the owner is being hurt, there’s not much mystery.

    I chose this topic as my thesis subject hoping, in no small part, to be able to demonstrate how much minimum wage increases hurt teen workers. But this was not the story that the numbers told. That, however, is NOT to say that I came to see increasing the minimum wage to be a good idea, since:
    1) It’s never a good idea to encourage Congress to talk about how generous we should be with other people’s money. Taxation is inevitable, but associating taking money from one small class to benefit another is, all else constant, not a good idea.
    2) The research I mentioned (of others and of myself) look at increasing vs. not increasing the minimum wage, not at what the world would have looked like if there had never been a minimum wage to begin with. Thus, the jobs that got swept away long ago when the minimum wage strongly priced them out of the market aren’t really in the tally when we consider raising or not raising the minimum wage in comparatively narrow bands.
    3) Such small increases in the minimum wage up (via legislation) and down (via inflation) may be what’s anticipated by employers who make staffing decisions according to the long-term averages. In this case, one would not expect small changes in the minimum wage to have any effect, though that would not mean that the minimum wage itself doesn’t play a significant negative role.

    • NAHALKIDES NAHALKIDES says:

      Don’t forget the other bad consequence of raising the minimum wage above market level: the transfer of income from consumers to minimum wage workers. In other words, when the minimum wage is raised, since there is no increase in the real value of the work performed, if market conditions permit the job to be retained then the increased labor cost must be passed on in the form of higher prices or reduced profits, both of which reduce the purchasing power of the dollar and reduce the standard of living for non-minimum wage workers. In fact, even minimum-wage workers could realize no net benefit since they themselves will have to pay higher prices for things like McDonald’s hamburgers.

      • faba calculo says:

        My guess is that it is the owner who gets screwed in profits. And that’s the problem (vis a vis ending the minimum wage): it would be a lot easier to turn people against it if it were workers rather than the “rich” owners getting hosed.

        Still, I’d have a very hard time seeing how minimum wage workers who keep their jobs could be made worse off than they had previously been in the way you describe. Typically, they get all (or at least a very large percentage) of their income from their minimum wage job, while they probably only spend a small fraction of their money in that way. So even if prices go up from the wage hike, they’re still going to come out well ahead.

        About the most likely way workers are getting hurt is in the jobs that aren’t being created due to the higher minimum wage. But proving that, and even more so quantifying it, is going to be hard to impossible, while it’s easy to show that those who retain their jobs are made better off and by how much.

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