Sunday, November 22, 2009

The Layman's Version of Supply and Demand

The layman's version of supply and demand answers the question, "what can they possibly be thinking?"

It is just commons sense. Price is how much the buyer pays the seller. A higher price means that the buyer pays more to the seller, and so the buyer is worse off and the seller is better off. A lower price, on the other hand, means that the buyer pays less to the seller, and so the buyer is better off and the seller is worse off.

The most important question is determining the fair or reasonable price. That is the price that takes the unit cost of production and adds a fair or reasonable profit.

There are two important questions regarding quantity. One quantity is the amount people need. The other quantity is the productive capacity of the firms. Hopefully, firms will have a productive capacity that matches the needs of the public.

First, the layman's demand curve. It's just common sense.

The key characteristic of this demand curve is Qn, the amount of the good that is needed by households. Of course, everyone knows that if the price gets too high, no one can afford it and none can be sold. That is Pm, which is what market will bear. It is just common sense.
Now for the layman's supply curve.

The key characteristic of the layman's supply curve is Qp, the productive capacity of the firms. However, everyone knows that if firms cannot cover their production costs, they will all fail and produce nothing. So the supply curve shows Pc, which is the unit cost of production. It is simple, common sense.
Like the economists' version of supply and demand, the two curves are put together.

This particular diagram shows equilibrium, the fortuitous situation where firms are able to produce what households need and charge a fair price. The vertical segments of the supply and demand curves overlap. The price is between the unit cost of production and what the market will bear. The price happens to be at the fair or reasonable level, where the markup or unit profit is at the fair or reasonable level.

Market ideologues believe that a so-called invisible hand will result in this happy scenario. How likely is that given the large bargaining range between what the market will bear and the unit cost of production? What is the chance that big business and thousands of households will have equal bargaining power?

This diagram shows a situation where firms produce the amount people need but also the vast bargaining range. The diagram below shows the typical situation, especially likely when pro-business (Republican) politicians are in power, and firms charge Pg, the greedy price.

This is why it is essential to have a strong government willing to protect the little guy (Democrats).
P.S. The economists version of supply and demand has quite different implications. Remember this?

P.P.S. Look for future posts about the layman's version of labor markets, price ceilings, and price floors. It is just common sense.


  1. Strawmen are of course remarkably easy to beat up.

  2. David:

    Sadly, I don't believe it is a strawman, but rather the "economic analysis" typical of many people.

  3. And one we need to understand, if we seek to explain to non-economists why we see the world differently.

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