The mystery of supply and demand

by Russ Roberts on September 24, 2009

in Complexity & Emergence, Education, Uncategorized

The paradox of markets is this: there is no single price even for apparently homogenous products, yet transactions by others, buying and selling similar goods, affect the price I pay or can charge. An extreme version of this is that every house is unique, yet as a seller of a house, I am not free to charge whatever I want. The price I ultimately receive when I sell my house may have something to do with my bargaining skills and my charm. But I am greatly constrained by what “similar” houses are selling for in “similar” neighborhoods. Supply and demand is the most powerful way to capture that relationship between transactions, even though it presumes, unrealistically, that there is a single price for a particular good.

Here is my essay on this issues.
And here is my attempt to take the insights of Hayek and put them into a supply and demand framework. For me, this helped me understand Hayek and enriched supply and demand.

Teachers and students of Principles or Intermediate Micro should feel free to use both of these pieces.

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Anonymous September 24, 2009 at 12:42 pm

Isn’t this similar to the insight of monopolistic competition? That supply and demand operate in predictable ways even if a given house is very unique, because of it’s similarity to other unique houses.I never understood why anyone ever thought economics was a dismal science. It’s full of these beautiful “ah ha” moments about how powerful markets are. I had a similar one at the grocery store last night, actually. Among other things we were buying apples (a large bag of them) and mushrooms (much smaller bag – portabellos). As the cashier rung it up, the large bag of apples came up as cheaper than the much smaller bag of mushrooms. I was jarred out of whatever else I was thinking of and thought about markets just then and said to myself “if someone just asked me to price everything in the produce section I would have no idea how to do it and I certainly wouldn’t have necessarily given the apples an edge over these two mushrooms”. What’s fun about economics is what I imagine living in a cabin in the mountains would be like. You go around your daily life fully aware of how beautiful your habitat is… but every once in a while it really dawns on you and you’ve just gotta sit back and appreciate it.

tw September 24, 2009 at 1:59 pm

Russ,

I think you should forward all of your supply and demand analysis to the staff of The Economist. At least that’s my reaction after reading their article on the value of an education.

Here’s how it begins: “THE law of supply and demand tells you that increasing the quantity of something tends to reduce its price. But not, it seems, in higher education. That is the puzzle…”

Didn’t anybody at the staff of The Economist take Econ 101 and learn the important phrase “holding everything else constant”??? How can this publication, of all publications for goodness’ sake, make this blatant a mistake with basic economic tenets?

Clearly there are other factors that are shifting that account for the price continuing to rise. I certainly appreciate your clear description of how multiple variables are always changing/in flux, and how that doesn’t violate supply & demand laws.

Al Abbott September 24, 2009 at 2:23 pm

The market does this “adjudication” with another highly beneficial aspect. The graphite industry, the automakers, and the tennis racquet makers do not become politicized, do not have to lobby the czar for favorable treatment, do not become subject to the whims of politics, do not have price controls or other such regulation restricting their behavior.

Current September 24, 2009 at 2:29 pm

There was recently a very interesting discussion of this on the Austrian Economists blog:

http://austrianeconomists.typepad.com/weblog/2009/09/what-does-the-price-system-communicate.html

Even some Austrian Economists think Hayek was wrong about this. I think the truth is more complicated than both sides recognise.

The Other Eric September 24, 2009 at 2:31 pm

Russ, have you and Don ever thought of approaching the Annenberg or other funding sources about doing a series for PBS or the History Channel? There are shows on such important topics as how to organize a closet and understanding your dog, why not do a 13 part series on the topics you cover here? It might not be as sexy as Top Model, but it would be good stuff. You could expand the blog to include video posts on stuff that doesn’t make the final cut.

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