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Teaching students (and skeptics) about markets

It’s September.  Footballs are filling the air.  Pennant races are heating up.  And hundreds of economics professors in classrooms around the world will open their principles or intermediate micro classes with supply and demand.  We tell our students that the market sets the price of wheat or beer.  We use that language because it is useful and has stood the test of time.  Yet when we say the market “sets” the price, we unintentionally imply intentionality, a will or design on the part of the market that masks the underlying reality of emergent phenomena.  Or we will say that the “market solves that problem” when talking about a shortage or that the market tries to “avoid” a tax.

In some sense, this semantic shorthand is harmless.  We all know that markets don’t “do” anything.

We teach our students that prices are set by supply and demand.  But this logic is exactly backwards.  Supply and demand are concepts economists invented to help us understand prices.  The emergence of prices from the tendency of human beings to truck, barter and exchange caused the invention of supply and demand as a way for our brains to organize our thinking about the orderliness of prices and the behavior such order makes possible.

We all know that there are no supply and demand curves that cross somewhere resulting in a price.  They only cross on our blackboards, our whiteboards, our computer screens and our homework assignments. 

This essay I wrote for The Library of Economics and Liberty treats prices as an emergent phenomenon that spawn supply and demand rather than the other way around.  In one sense, this more "realistic" approach is unnecessary.  After all, if you want to analyze price controls, supply and demand is very powerful.  But one area where our mechanistic vision of supply and demand handicaps us is in talking to the general public.  When we say things like "the wages that Wal-Mart pays are set in the marketplace," we know what we mean.  But to a non-economist it’s a theoretical claim that has no content.  I think treating prices as an emergent phenomenon rather than an inevitable result of supply and demand might be a more effective way to communicate the concept of markets to the skeptic.