The Limits of Supply and Demand / INTERTESSANTER ARTIKEL, engl.

verfasst von JÜKÜ, 10.04.2002, 21:13

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<font size="2"><font face="Verdana" color="#002864" size="5"><strong>The Limits of Supply and Demand</strong></font>
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<font size="4">by Frank Shostak</font>




[Posted April 10, 2002]




Within
this framework, neither consumers nor producers have anything to say as far as
the origin of a good?s price is concerned. The price is just given. In short,
both consumers and producers react to a given price. But who has given the price?
Where has the price come from? </font>




<font size="3">The law of supply and demand as presented by mainstream
economics doesn't originate from the facts of reality but rather from the
imaginary construction of economists. In short, none of the figures that
underpin the supply and demand curves have originated from the real world; they
are purely conjectural.</font>




<font size="3">The framework of supply-demand curves rests on the assumptions
of unchanged consumer preferences and income and unchanged prices of other goods.
In reality, however, consumer preferences are not frozen, and other things do
not remain constant. Obviously, then, no one could have possibly observed these
curves. According to Mises,"it is important to realize that we do not have
any knowledge or experience concerning the shape of such curves."<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn1" name="_ftnref1">[1]</a></font>




<font size="3">Yet, economists are heatedly debating the various properties
of these unseen curves and their implications regarding government policies. </font>




<font size="3">The supply-demand graphic is contrary to the fact that human
actions are conscious and purposeful. In the graphs, there are no entrepreneurs.
Instead, the shift of curves is in response to various factors that set prices.
For instance, it is held that a shift in the demand curve to the right for a
given supply will lift the price of a good. The price will also increase if, for
a given demand curve, the supply curve shifts to the left. In other words, the
supply-demand framework doesn?t deal with human beings but with automatons
that react to various factors.</font>




<font size="3">The whole idea that the price of a good is simply given
produces the impression that the price is an attribute of a good--i.e., that it
is part of the good itself. There is, however, no such thing as a price of a
good in general. The prices of goods are established in a particular transaction
at a particular place and at a given time. According to Ludwig von Mises,</font>



<font size="3">A market price is a real historical phenomenon, the
quantitative ratio at which at a definite place and at a definite date two
individuals exchanged definite quantities of two definite goods. It refers to
the special conditions of the concrete act of exchange. It is ultimately
determined by the value judgments of the individuals involved. It is not
derived from the general price structure or from the structure of the prices
of a special class of commodities or services. What is called the price
structure is an abstract notion derived from a multiplicity of individual
concrete prices. The market does not generate prices of land or motorcars in
general nor wage rates in general, but prices for a certain piece of land and
for a certain car and wage rates for a performance of a certain kind.<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn2" name="_ftnref2">[2]</a></font>



<font size="3">The value that an individual assigns to goods is the product
of his mind judging the facts of reality. Individuals assess the usefulness of a
good as a means to support their life and well-being. On this Carl Menger wrote,</font>



<font size="3">Value is thus nothing inherent in goods, no property of them,
nor an independent thing existing by itself. It is a judgment economizing men
make about the importance of the goods at their disposal for the maintenance
of their lives and well being. Hence value does not exist outside the
consciousness of men. It is therefore, also quite erroneous to call a good
that has value to economizing individuals a"value," or for
economists to speak of"values" as of independent real things, and
to objectify value in this way.<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn3" name="_ftnref3">[3]</a></font>



<font size="3">Similarly Mises wrote,</font>



<font size="3">It would be absurd to look upon a definite price as if it were
an isolated object in itself. A price is expressive of the position which
acting men attach to a thing under the present state of their efforts to
remove uneasiness.<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn4" name="_ftnref4">[4]</a></font>



<font size="3">Since prices are always in reference to a particular
transaction, and since each transaction is unique, it is erroneous to homogenize
these transactions by means of curves.</font>


<font size="2">
<h1>How prices are determined</h1>
</font>


<font size="3">Contrary to the mainstream view, prices are not just given;
they are set by somebody. This somebody is a producer. Whenever a producer sets
a price for his product, it is in his interest to secure a price where the
quantity that is produced can be sold at a profit. In setting this price, the
producer/entrepreneur will have to consider how much money consumers are likely
to spend on the product, the prices of various competitive products, and the
cost of production.</font>




<font size="3">Producers set the price, but consumers, by buying or
abstaining >from buying, are the final decision-makers as to whether the
price set will lead to a profit. Producers in this regard are at the total mercy
of consumers. If, at a set price, a producer cannot make a positive return
on his investment because not enough people are willing to buy his product, the
producer will be forced to lower the price to boost turnover. Obviously, by
adjusting the price of the good, the entrepreneur must also adjust his costs in
order to make a profit.</font>




<font size="3">Consequently, a producer will secure a profit when, at the set
price of a good, consumer buying will generate revenue that will exceed the cost
plus interest. Profit is an indication that both producers and consumers have
improved their well-being.</font>




<font size="3">In short, by investing a given amount of money, producers have
secured a greater amount of money. This, in turn, enables them to secure a
greater amount of goods and services, which in turn promotes their lives and
well-being. Likewise, consumers, by exchanging their money for goods that are on
their highest-priority lists, have raised their living standards.</font>




<font size="3">In actual fact, price-setting is never mechanistic and
automatic. It is up to the producer/entrepreneur to assess whether it is a good
or a bad idea to raise prices; after all, what matters for him is making a
profit. When a good makes a profit at a particular price, then it is a signal to
entrepreneurs that consumers are willing to support the product at the set price.
Prices, therefore, are an important factor in establishing how producers/entrepreneurs
employ their resources.</font>




<font size="3">Observe, then, that what determines the amount of goods
supplied is not some hypothetical demand schedule, but a producer's appraisal as
to whether, at a given place and a given time, consumers will approve of the
goods supplied. </font>




<font size="3">Also, no producer is engaged in hypothetical ideas regarding
the amount he will supply at varying prices. He has to be as accurate as
possible in setting the right price that will enable him to sell his supply at a
profit.</font>


<font size="2">
<h1>Further fallacies</h1>
</font>


<font size="3">In the supply-demand framework, an increase in the cost of
production will shift the supply curve to the left. For a given demand curve,
this will raise the price of a good. In short, in the supply-demand framework,
production cost is an important input in determining prices of goods.</font>




<font size="3">We have already seen, however, that it is consumer buying or
abstention from buying that is the sole determining factor for the prices of
goods. No individual buyer is preoccupied with the cost of producing a
particular good. The price that he will agree to pay for a good is in accordance
with his particular priorities at a given point in time. The cost of production
is of no relevance to him.</font>




<font size="3">Moreover, the cost-of-production theory runs into trouble when
attempting to explain prices of goods and services that have no cost because
they are not produced--goods that are simply there, like undeveloped land.
Likewise, the theory cannot explain the reason for the high prices of famous
paintings. On this Murray Rothbard wrote,</font>



<font size="3">Similarly, immaterial consumer services such as the prices of
entertainment, concerts, physicians, domestic servants, etc., can scarcely be
accounted for by costs embodied in a product.<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn5" name="_ftnref5">[5]</a></font>



<font size="3">Using the supply-demand framework for a particular good,
mainstream economists proceed further and introduce supply and demand curves for
the whole economy. They hold, for example, that if the economy is
underperforming, then what is needed is a bolstering of demand by means of
fiscal or monetary policies. For a given supply curve, they contend, this will
push the demand curve to the right, thereby lifting overall output. Needless to
say, the supply-demand framework provides the rationale for government and
central bank interference with businesses.</font>




<font size="3">This framework, however, says absolutely nothing about how the
increase in demand generates more output. Furthermore, it is silent regarding
the funding required in order to raise output. Also, we have seen that, in
reality, it is producers that initiate the introduction of new products. They
set in motion increases in goods and services, and not consumers as such.
Producers present new products, so to speak, to consumers who, in turn, by
buying or abstaining from buying, determine the fate of products. Hence there is
no such thing as an autonomous demand that somehow triggers supply. Moreover,
one cannot demand something before offering something in return.</font>




<font size="3">Supply-demand graphics also provide the justification for
various imaginary monopolistic theories, which in turn provide the rationale for
the government destruction of successful businesses. For instance, it is held
that a company that forces the price above the competitive price level is
engaged in monopolistic activities and therefore must be taken to task. </font>




<font size="3">Even if we were to accept this way of thinking as valid,
however, there is no way to establish whether the price of a good is above the
so-called competitive price level (monopoly price). By what criteria can one
decide what is competitive price? On this Rothbard wrote,"There is no way
to define 'monopoly price' because there is also no way of defining the 'competitive
price' to which the former must refer."<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftn6" name="_ftnref6">[6]</a></font>




<font size="3">In the supply-demand framework for the economy, economists
employ the quantity of output produced and its average price. However, neither
the average price nor the total output can be logically defined. Thus it is not
possible to establish an average for $10/shirt and $5/liter of wine. Likewise,
it is not possible to add 10 shirts and 20 potatoes to establish the total
output. Hence, the entire graphical framework of the supply and demand for the
economy rests on misleading premises.</font>




<font size="3">What?s more, the whole issue of so-called equilibrium is
misleading in the way the supply-demand framework presents it. Equilibrium, in
the context of conscious and purposeful behavior, has nothing to do with the
intersection of supply and demand curves. Equilibrium is established when an
individual?s ends are met. When a supplier is successful in selling his supply
at a price that yields profit, he is said to have reached equilibrium.</font>




<font size="3">Similarly, consumers who bought this supply have done so in
order to meet their goals. Therefore, government and central bank policies aimed
at shifting imaginary curves toward so-called equilibrium in fact prevent both
consumers and producers from attaining their goals and hence prevent true
equilibrium. </font>


<font size="2">
<h1>Conclusion</h1>
</font>


<font size="3" color="#FF0000">Despite its great appeal because of its
simplicity, the supply-demand graphic as employed by mainstream economics is a
tool that is detached from the facts of reality. The real-world economy is far
too complex to be faithfully rendered on simple graphs that take no account of
uncertainty, entrepreneurial speculation, and the ceaseless change of the market
economy. </font>




<font size="3" color="#FF0000">By no means is this framework harmless,
because government and the central bank decision-makers make use of this tool in
forming various policies. This is why they are continually surprised when the
real economy performs in a manner different from what their graphical analysis
would seem to predict.</font>


<font size="2">
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<hr align="left" width="33%" SIZE="1">
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Frank Shostak, Ph.D., is an adjunct scholar of the Mises Institute and a
frequent contributor to Mises.org. Send him <font color="#000080" size="2">MAIL</font>
and see his outstanding Mises.org <font color="#3571ca" size="2">Articles
Archive</font><font size="2">. Dr. Shostak expresses gratitude to Michael
Ryan for helpful comments during the writing of this article.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref1" name="_ftn1"><font size="2">[1]</font></a><font size="2">
Ludwig von Mises, <em>Human Action, </em>ch. 16 (2), Valuation and
Appraisement, p. 333.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref2" name="_ftn2"><font size="2">[2]</font></a><font size="2"> Ibid.
ch. 16 (13), Prices and Income, p. 393.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref3" name="_ftn3"><font size="2">[3]</font></a><font size="2"> Carl
Menger, <em>Principles of Economics</em> (New York, London: New York
University Press), pp. 120-21.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref4" name="_ftn4"><font size="2">[4]</font></a><font size="2"> Mises,
<em>Human Action, </em>chapter 16 (12), p. 392.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref5" name="_ftn5"><font size="2">[5]</font></a><font size="2"> Murray
N. Rothbard, <em>Economic Thought Before Adam Smith: An Austrian Perspective
on the History of Economic Thought, </em>vol. 1 (Edward Elgar), p. 452.</font>


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<a title href="http://www.mises.org/fullstory.asp?control=931&FS=The+Limits+of+Supply+and+Demand#_ftnref6" name="_ftn6"><font size="2">[6]</font></a><font size="2"> Murray
N. Rothbard<em>, Man, Economy, and State (</em>Nash Publishing), p.
607.</font>


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