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S
upply and demand are among the fundamental building blocks of economic theory. The interplay between the amount of a product available on the market and the eagerness of consumers to buy that product creates the foundation of markets.The importance of supply and demand in economic relationships was studied as long ago as the Middle Ages. The medieval Scottish scholar Duns Scotus recognized that a price must be fair to the consumer but must also take into account the costs incurred in production and therefore be fair to the producer. Subsequent economists studied the effects of supply-side costs on eventual prices, and economists such as Adam Smith (p.61) and David Ricardo (p.84) linked the price of a product to the labor required in its production. This is called the classical labor theory of value.
In the 1860s new economic theories began to develop, challenging these ideas under the banner of the neoclassical school. This school of thought introduced the theory of marginal utility (pp.114–15), where the satisfaction
a consumer gains or loses from having more or less of a product affects both demand and price.
British economist Alfred Marshall joined the analysis of supply with the new neoclassical approach to demand. Marshall saw that supply and demand work in tandem to generate the market price. His work was important because he illustrated the varying dynamics of supply and demand
SUPPLY AND DEMAND
IN CONTEXT
FOCUS Theories of value KEY THINKER Alfred Marshall (1842–1924) BEFORE c.1300 Islamic scholar Ibn Taymiyyah publishes a study of the effects of supply and demand on prices.1691 English philosopher John Locke argues that commodity prices are directly influenced by the ratio of buyers to sellers. 1817 British economist David Ricardo argues that prices are influenced mainly by the cost of production.
1874 French economist Léon Walras studies the equilibrium (balance) in markets.
AFTER
1936 British economist John Maynard Keynes identifies economy-wide total demand and supply.
Alfred Marshall
Born in London, England, in 1842, Alfred Marshall grew up in the borough of Clapham before going to Cambridge University on a scholarship. There, he studied mathematics and thenmetaphysics, concentrating on ethics. His studies led him to see economics as a practical means of implementing his ethical beliefs.
In 1868, Marshall took up a lectureship specially created for him in moral science. His interest in this continued until a visit to the US in 1875 made him focus more on political economy. Marshall married Mary Paley, his
former student, in 1877 and became principal of University College, Bristol, UK. In 1885, he returned to Cambridge as professor of political economy, a post he held until his retirement in 1908. From about 1890 until his death in 1924, Marshall was considered the dominant figure in British economics.
Key works
1879 The Economics of Industry
(with Mary Paley Marshall)
1890 Principles of Economics 1919 Industry and Trade
0 PR IC E QUANTITY Quantity at equilibrium P ri c e a t eq ui li b ri um Su pp ly Equilibrium De ma n d
This graph, known as the Marshallian
Cross, shows the relationship between supply and demand. The point at which the supply and demand curves intersect gives the price.
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in short-term markets (such as those for perishable goods), as opposed to long-term ones (such as for gold). He applied mathematics to economic theories and produced the “Marshallian Cross:” a graph showing supply and demand as crossing lines. The point at which they intersect is the “equilibrium” price, which perfectly balances the needs of supply (the producer) and demand (the consumer).
The law of supply
The amount of products a firm chooses to produce is determined by the price at which it can sell them. If the assorted costs of production (labor, materials, machines, and premises) amount to more than the market is willing to pay for the product, production will be seen as unprofitable and be reduced or stopped. If, on the other hand, the market price for the item is substantially more than the costs of production, the company will seek to expand production to make as much profit as possible. The theory assumes that the firm has
no influence over the market price and must accept what the market offers.
For example if the costs of producing a computer amount to $200, production will be unprofitable if the market price of the computer drops under $200. Conversely, if the market price of the computer is $1,000, the firm producing it will seek to produce as many as possible to maximize profits. The law of supply can be visualized using a supply curve
(see opposite), where every point of the curve provides the answer to how many units a firm will be willing to sell at a particular price.
Furthermore, there must be a distinction between fixed and variable costs. The above example assumes that production can be increased with the unit cost of production remaining stable. However, this is not the case. If the computer factory can produce only 100 machines per day, yet there is demand for 110, the producer ❯❯
See also: The paradox of value 63 ■ The labor theory of value 106–07 ■ Economic equilibrium 118–23 ■ Utility and satisfaction 114–15 ■ Spending paradoxes 116–17 ■ Elasticity of demand 124–25 ■ The competitive market 126–29
INDUSTRIAL AND ECONOMIC REVOLUTIONS
Producers supply goods to the market to meet consumer demands.
If goods are not supplied in large enough quantities to
meet demand, prices rise.
… until the market settles at a price that balances
supply and demand. Supply is increased (producers make more)
to satisfy demand. However, at some
point, supply surpasses demand.
At this point, prices begin to fall…