Chapter 8
Supply and Demand Made
Easy
In this chapter, I lay out in simple terms the most powerful economic model
of them all---Supply and Demand!
This model is so simple that it can be captured
graphically as two lines crossing. Where the two lines cross tells you
very precisely the two most important things that are determined in market
economies---the prices at which things sell and the amounts of each good and
service that is sold.
If markets
are working properly---and by that I mean that property rights are being
enforced and all transactions are voluntary---then you get an even more
stunning result: the prices and amounts determined by the supply and demand
model not only match reality but are also socially optimal in the sense that
only units of output for which the total benefits outweigh the total costs
are produced!
Unfortunately,
this nice result is often screwed up by government interventions that
prevent supply and demand from working their magic. Here is some
further reading about the major ways in which governments screw things up:
price ceilings, which involve legislating a maximum price, and price floors,
which involve legislating a minimum price.
Links about Price Ceilings
Here is a nice article by
Roger Ream
detailing how price ceilings end up hurting the poor---despite the fact that
politicians typically promote such policies as ways to help the poor.
And here is an excellent little article by
Walter Block on rent control, which happens when a government imposes
maximum prices on the rents that landlords can charge tenants. And
also check out this more general article by
Hugh Rockoff which covers all kinds of price controls--both price
ceilings and price floors.
The
fundamental problem with price ceilings is that they prevent the market
price from adjusting to equalize supply and demand. But this does not
mean that somehow you have eliminated the need for the total demand to equal
the total supply. Quite the contrary, God put limits on the world and
ensured that you can't have more than there is to have---that is, the total
amount received by demanders (buyers) can't be any more than the total
amount offered by suppliers (sellers). So when there is a price
ceiling that prevents prices from adjusting to equalize demand and supply,
you get an alternative mechanism to equalize demand and supply---queuing, or
standing in lines (queues). Those willing to stand the longest get the
supply.
Here is a great post by
a guy named Naveen at the
Spontaneous Order blog about how price ceilings for Indian train tickets
screw everything up and lead to massive queues to allocate the limited
number or train seats since prices aren't allowed to equalize supply and
demand. Economists often refer to queuing as "non-price rationing"
since queuing is a non-price mechanism for rationing out the limited supply.
Free markets, by contrast, work through "price rationing."
Links about Price Floors and Minimum Wages
Agricultural price "supports" are among the most
visible price floors in most economies. As
Robert L. Thompson explains, they cause a whole lot of harm while
typically lining the pockets of agribusiness rather than the small farmers
that politicians claim they are trying to help.
Minimum wages are the other most obvious price floor.
They are floors on the wages that employers can pay workers.
Linda Gorman has some good things to say about the problems they cause.
If the working poor need help, better to give them government assistance
rather than impose a high minimum wage that might cause employers to fire
them. The key fact to remember is that the minimum wages only applies if
you have a job. If the minimum wage goes too high, then your
employer may find it more profitable to fire you and not pay you at all
rather than keep you on at the minimum wage. So the big problem is
that minimum wages laws tend to get poor people fired. Those lucky
enough to still have jobs will, it is true, get paid at least the minimum
wage. But those who get fired because they are worth less to their
employers than the minimum wage that employers must pay workers are
obviously made much, much worse off by the minimum wage law. Along those
lines, be sure to read what
Bruce Bartlett
has to say on the minimum wage. And the ever-enlightening Thomas
Sowell has several important things to say in these articles about the
minimum wage
here and
here.
Minimum wages tend to
get low productivity workers fired, as pointed out by
Burton
Folsom. And since minority workers are disproportionately low
productivity (due to poor schools and the legacy of oppression), minimum
wages also tend to wreak most of their havoc on minorities.
The chapter ends with a sidebar section detailing how
the free grain given as food aid to developing countries often bankrupts
local farmers who of course can't compete with the food aid which people can
get for free. Kenyan economist James Shikwati has some very strong
things to say about this practice as well as development aid in general in
this interview in Germany's
Der Spiegel (don't worry, the interview is in English).
