Supply & Demand in Economics 101

[Pooh]

In the Global Warming and Weather Discussion, "The Politics of 'AGW' ", we looked at the strong similarity between the Soviet Union's "Turnover Tax" and the various political schemes for taxing carbon emissions.

In that Topic, Supply-Demand is used (in Reply #9) to illustrate the Turnover Tax. I committed to post a brief review of Supply-Demand concepts as a refresher. Here it is.

The topic is linked here if you care to refer to it.
(Right-click, New Tab to keep your place here.)
solarcycle24com.proboards106.com/index.cgi?board=globalwarming&action=display&thread=192

[Pooh]

What is this?

"The Politics of 'AGW' " considers the effects of carbon “tax”, “cap” or “credit” solutions to whatever AGW problem may exist. That Topic illustrated the effects of such taxes, using Supply-Demand concepts. This Topic offers a recap of Supply-Demand approach, just in case yours might be a bit rusty. Mine was.

These notes recap the basics in Samuelson (and Nordhaus), in Samuelson, Economics, 12th edition, Chapter 4. It was necessary to reproduce, in Excel, the graphs from their text, because page scans were really murky. Supply–Demand is generally high school level. Credit for development of the argument belongs to Samuelson and Nordhaus; omissions and botches are mine.

In a free market economy, customers are at liberty to decide what to buy (and at what price), and suppliers are at liberty to decide what to produce (and at what price). Per Samuelson, money acts as a “vote” on the desirability of the supplier’s product or service at a particular price.

As an analytical approach, Supply – Demand Curves treat changes (shifts) in only one thing at a time.

10/31/08: See excellent reply by Kiwistonewall in Reply #7

[Pooh]

Demand Curve (Samuelson, Fig 4-1, pg 61-63) The Demand Curve represents how much (Quantity) of something will be bought at various Prices. It slopes from the upper left to the lower right. In general, as Price increases, people buy less; so the Quantity sold (Demanded) will be less. People may substitute a lower priced product for their higher-priced first choice. Or, they may not buy at all. As Price decreases, people buy more; so the Quantity sold (Demanded) will be more. People may buy more of the product, or upgrade from a lower-priced product.

Supply Curve (Samuelson, Fig 4-2, pg 63-64) The Supply Curve represents how much (Quantity) will be produced and offered for sale at various Prices. It slopes from the lower left to the upper right. Since people make or provide things to make a living for themselves, the Price must at least cover the cost of production plus that “living” (or Profit). If people can’t make a living, they won’t provide it. At lower prices, overall Supply will decrease. If suppliers make a really fantastic living at it, other folks will try their hand at supplying it. They may go into business, or change the things they produce. At higher prices, overall Supply (Quantity) will increase.

[Pooh]

Equilibrium Defined: Where Supply Equals Demand (after Samuelson, Fig 4-3, pg 65) In a free economy, when the Price is right, the Supply will sell out. This position of balance between Supply and Demand (Quantities) is called the “Equilibrium Point”. At the Equilibrium Point, the Quantity Supplied and the Quantity Demanded are equal, at the same Price. (Remember, this is a concept.) Note that if either Supply or Demand changes, the Equilibrium Point shifts also. How? See below.

[Pooh]

Supply Curve Shift (after Samuelson, Fig 4-4a, pg 67) The Supply Curve is not static; it shifts to show the same supply at a lower price with technical and process efficiencies (e.g., personal computers), or a lower supply at a higher price (e.g., refinery shutdown). As Supply increases (shown as a shift to the right of the blue supply curve), the gray circles to the right represent higher Supply at lower Prices along the green Demand curve. As Supply decreases (shown as a shift to the left of the blue Supply curve), the gray circles to the left represent the lower available Supply at higher Prices. For example, as speculators and unqualified homebuyers tried to sell their houses, the supply of houses for sale increased, prices dropped, and builders stopped building.

Demand Curve Shift (after Samuelson, Fig 4-4b, pg 67) The Demand Curve is also not static; it shifts because of more potential customers, increased (real) incomes, marketing and preferences. As Demand increases (shown as a shift to the right of the green Demand curve), the gray circles to the right represent higher Demand resulting in higher Prices along the blue Supply curve. As Demand decreases (shown as a shift to the left of the green Demand curve), the gray circles to the left indicate that lower Demand results in lower Prices. For example, when the price of oil reached record levels (and with it, the price of fuel), people drove less and purchased less fuel. (Granted, crude oil is not an entirely free market: OPEC is a cartel, and new supply is restricted by Congressional dictate. Nor was real estate: demand was politically increased by pressure to make mortgages available regardless of income.)

Corrected ambiguity 10/30/08

[Pooh]

Why Equilibrium? Supply and Demand balance in a free economy (Samuelson, Fig 4-3, pg 65) If the Supply (Quantity) of something is greater than the Demand for it at that Price (e.g., a Surplus), then the Price will usually move down. On the other hand, if the Demand (Quantity) is greater than the Supply (e.g., a Shortage), then the Price usually moves up. Note (above, reply #3) that if either Supply or Demand shifts, the Equilibrium Point shifts also. (Page 67)

[Pooh]

Reference: Samuelson, Paul Anthony. Economics (12th ed). New York: McGraw-Hill, 1985.

[kiwistonewall]

Yes the old supply demand curve based on the assumptions that humans will make free rational decisions! It is also based on the assumption of informed decisions. It's close enough to reality, in the same way that Newtonian Physics is close to reality when things don't go too fast (relativity) or get too small (Quantum mechanics)

Classical economics is a theoretical model that can be used to make approximate judgments on how things work. Probably true for calm, ordered markets like sugar & wheat etc.

But in the current share market (where there is demand & supply of shares) we have wild fluctuations rather than an ordered market.
It also doesn't work well when the market is very thin - one seller (monopoly) or one buyer. Nor does it work well when the means of exchange isn't stable (massive inflation/deflation) or in any situation of massive disruption.

So it is fine to explain some situations, but don't get into the error of thinking that the supply demand curve is other than a theoretical construct. Otherwise you fall into the same pattern of thinking as the AGWers and their models.

[Pooh]

Oct 30, 2008 8:29:21 GMT kiwistonewall said:

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Yes the old supply demand curve based on the assumptions that humans will make free rational decisions! It is also based on the assumption of informed decisions. It's close enough to reality, in the same way that Newtonian Physics is close to reality when things don't go too fast (relativity) or get too small (Quantum mechanics)

Classical economics is a theoretical model that can be used to make approximate judgments on how things work. Probably true for calm, ordered markets like sugar & wheat etc.

But in the current share market (where there is demand & supply of shares) we have wild fluctuations rather than an ordered market.
It also doesn't work well when the market is very thin - one seller (monopoly) or one buyer. Nor does it work well when the means of exchange isn't stable (massive inflation/deflation) or in any situation of massive disruption.

So it is fine to explain some situations, but don't get into the error of thinking that the supply demand curve is other than a theoretical construct. Otherwise you fall into the same pattern of thinking as the AGWers and their models.
[/quote]

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Three points:
A. You are absolutely right! ;D and that's the point of the discussion (rant) in The Politics of “AGW”, post #1.
B. I didn't sufficiently qualify the explanation of my intent here in Supply & Demand in Economics 101, post #1. But you identified many qualifications I should have included, but did not for the sake of brevity (resulting in over-simplification). I did say one thing at a time, but chaos is not one of them.
C. Among your home runs:

• Wheat. Right on! That was Samuelson's example, too.
  
• Free, rational decisions. Exactly! In a Command Economy there is no decision other than put up or shut up.
  
• Monopoly. In a Command Economy, the State is the biggest monopoly on the block.
  
• Rational decisions, informed decisions,
  
• Theoretical. I called it analytical. Interesting: both USSR used the approach and modeling, and Lehman Brothers (below) used computer models. Both collapsed.
  
• (in)stability, massive disruption and the share market. You may agree that an informed and rational Price decision can not be made without estimates of value and risk. Well, over here, our politicians and mortgage brokers decided to give "affordable" home mortgages to people who could not pay. Two levels of financial mixmasters churned this drek with other goods, and sold them to banks and financial institutions, including FreddieMac and FannieMay. These "securities" were counted as reserves, which affected how much they could lend out. Since no one could tell what the "securities" were worth, the credit markets came down with a bad case of constipation; too much drek in the mix.

Fortunately, Lehman Brothers had large commitments in this fiasco, and also had high hopes of cleaning up in the carbon credit market. They even had James Hansen as an scientific advisor and perhaps some relationship with Al Gore and his GIM. (Both mortgages and carbon credits sought to make gold out of thin air.)

Justice was served as Lehman Brothers foundered, leaving nothing but a large slick. ;D I do regret what happened to the workabees there. And elsewhere. It's a crime (I hope).

[donmartin]

quaere: Is it possible the efficiency of the internet contributes to what seems to be dramatic economic events?

[kiwistonewall]

Modern communications yes.
The Internet as a communications medium Yes.
But the World Wide Web is the source of mis-information as much as information. (And the two are different, but often confused.)
The Internet is the tracks, and the WWW is a train running on the tracks, and is much newer than the tracks themselves.!

With modern software, we can have computerised sell orders. It is much quicker to do everything, which leads to more gut reactions, instant decisions.

In the past, you usually had a day or too to think things over.

So fast yes. Efficient? No.