Category Archives: economics

Supply and demand: think again?

Some of the things we learn in economics classes may not be as simple as they seem.

            One of the basics taught in economics classes is that the price of a good is determined by supply and demand. There’s a curve showing how the supply varies with the price and another curve showing how the demand varies with the price. Where the two curves intersect determines the price.

            This seems plausible, but I must admit I never thought deeply about these curves. So I thought I’d try to figure out what the supply curve might look like for product I know something about: printed books.

            What happens to the supply of a book when the price goes up? Well, most books are sold at the same price until they go out of print: the price doesn’t go up at all. Sometimes remaining print copies are “remaindered”: they are sold off to discount booksellers at a rock-bottom price, maybe $1 each, and the discount booksellers mark them up a bit, maybe to $2 or $5, though they are still a bargain compared to the original retail price.

            When the book goes out of print, then it’s usually possible to buy used copies, for example via booksellers who sell through Amazon. If there’s still a demand, then some suppliers jack up the price. On the other hand, if the demand is great enough, the publisher may do another print run, so then the supply is suddenly increased.

            So what does the supply curve look like? Here’s what the textbooks say.

Whoops. The textbook curve doesn’t seem to fit what happens with printed books. Instead of supply increasing as the price increases, the price stays the same and then, if there’s still a demand for the book as supply dwindles, the price goes up.

Ryan on economics

            If this is as confusing to you as it was to me, then read Michael Ryan’s book The Truth about Economics. Ryan was a high tech executive who decided to become a school teacher in Texas and, after having to teach economics, became sceptical about some of the basics. To him, the claims in the standard textbooks used in the US didn’t make sense. So he wrote a book to explain, in simple terms, what’s going on.

            According to Ryan, the supply and demand curves in textbooks like Paul Samuelson’s Economics and Gregory Mankiw’s Principles of Economics simply don’t apply in many situations. The texts say that the curves apply when other things are equal. The trouble is that other things often aren’t equal.

            Even worse, Ryan shows that some of the data provided in the textbooks to show the operation of supply and demand are made up. Rather than using actual data from markets, the numbers in the texts are chosen to give the right answer, namely the answer that agrees with the theory. In other words, the authors work backwards from the theory to generate data that shows that the theory works.

            If your mind goes blank at the sight of a table of numbers or a graph, you will find Ryan’s book challenging. Actually, though, it is easier than most economics texts, not to mention econometrics research papers, because Ryan patiently explains what is going on.

            The Truth about Economics made me think for myself about supply and demand. I already knew about some of the abuses involving pharmaceutical drugs. Some companies exploit their patent-protected monopolies over drugs by raising prices unscrupulously, even though it costs no more to make the drug than before. When patients desperately need the drug, the demand is inelastic: it doesn’t change much even when the price goes up.

            Another example Ryan uses is buying a car. He notes that there are different price ranges. You might be in the market for a low-cost Nissan Versa or a top-of-the-range Porsche. Most buyers only want one car, and want it within a particular price range. The result is a very different sort of supply-and-demand diagram.  

          As well as markets for goods and services, there are also markets for labour. Ryan analyses what US textbooks say and is withering in his criticism. He presents arguments showing why raising the minimum wage makes almost no difference to unemployment rates. Instead, raising the minimum wage benefits workers at the expense of owners and managers. Ryan points to the ideological role of conventional economic theory, at least as presented in US textbooks. He quotes from standard texts to show the authors’ hostility to trade unions. This raises the suspicion that some facets of economics texts are more a glorification of capitalism than a neutral presentation.

            Could it be that generations of students have studiously learned about supply and demand curves and never questioned whether they actually described what happens in real markets? That is what Ryan claims. He presents ideas about groupthink to explain the economics profession’s continued commitment to a model based on questionable assumptions and for which there are so many counterexamples — such as book sales. As for students, Ryan believes most are too young and inexperienced to question textbooks, or they just suppress their rebellious thoughts.


Michael Ryan

            I’m not here to endorse Ryan’s critique. Instead, I recommend it as a way to encourage you to think for yourself about markets.

            Ryan argues that high-school students should be given the option of taking courses in financial literacy, learning the basics of bookkeeping and profit-and-loss statements. Financial literacy, he says, is far more relevant to the lives of students when they are in jobs and perhaps running their own businesses. However, Ryan is excessively optimistic to imagine that, based on his analysis, a movement will arise to introduce financial literacy courses throughout the US.

Learning about economics

You may have no interest in economics, but if you do, what’s the best way to learn about it? I’d say there are three things to look at.

            First are expositions of the dominant neoclassical perspective. Currently in the US the most popular textbook is Gregory Mankiw’s Principles of Economics, so you could start there, but just about any basic text would be fine.

            Second, to avoid simply accepting standard ideas without question, you can also look at critiques. Ryan’s The Truth about Economics is one possibility. Steve Keen’s Debunking Economics is a more advanced analysis.

            Contrary perspectives have been put forward for decades. Ryan quotes from early economists like H. L. Moore, who challenged Alfred Marshall’s dominant ideas about supply and demand. That was in the early 1900s.

            You can dip into the large literature on political economy, which is based on the idea that the economic system cannot be understood separately from the political system. John Kenneth Galbraith in a number of books, for example Economics and the Public Purpose, showed the value judgements built into orthodox economics.

Those with a mathematical bent can appreciate John Blatt’s 1983 book Dynamical Economic Systems in which he showed that the assumption of equilibrium in markets, an assumption that underlies a vast body of econometric theory, is untenable. Blatt also wrote a paper, “The utility of being hanged on the gallows,” that challenged the assumptions underlying utility theory, central to much work in economics.

            Third, it is illuminating to look at alternatives to standard economic theory. For example, you can read about local currencies, which provide a radically different way of thinking about markets.

A more radical alternative is the sharing economy based on an expansion of the commons, with production done collaboratively without pay, as with free software. Then there are models or visions of economic systems that avoid reliance on organised violence. Current market systems do not qualify because the power of the state is required to protect private property. I have found only four models or visions of economic systems that could operate without organised violence: Gandhian economics, anarchism, voluntaryism and demarchy.

            If you’re going to study standard views, critiques and alternatives, what’s the best order to approach them? My suggestion would be to look at all three in tandem, because each throws light on the others.

            It is not surprising that the discipline of economics is, to a considerable extent, a reflection and legitimation of the existing economic system. Challenges are needed to orthodox economic theory as part of challenges to the dominant economic system. That means there is still quite a lot worth investigating, indeed entire realms. Most likely, though, improved theory will depend on economic alternatives becoming a reality.

Brian Martin
bmartin@uow.edu.au