The World

[as I find it]

Supply and Demand: an Unhappy Marriage

I’ve been meaning for quite some time to write something about John Kenneth Galbraith, specifically an idea he put forward in The Affluent Society (1958). It’s an idea worth repeating, because it exposes an underlying assumption in contemporary debates about everything from government spending to school choice to health care. Roughly, Galbraith’s claim is that when supply and demand are not independent in an economy, (neo)classical economics fails to describe the behavior of that economy. This means, among other things, that the conclusion that unfettered trade will best serve to fulfill the wants and needs of consumers is either invalid or reduced to tautology.

Let’s unpack this a bit. “Neoclassical economics,” as I understand it here, describes economic behavior in terms of the following postulates:

  1. Resources are limited. Not every consumer can get everything she wants or needs at the same time. Thus, there is always demand.
  2. Individuals have rational preferences according to which they order their needs and wants, i.e., decide which to meet sooner, and which later. Thus, demand for any particular good or service is variable and may be higher or lower relative to other goods or services at a particular time.
  3. Producers supply goods and services that meet consumer demand in a way that maximizes their profit: they produce more of what is in greater demand because it has a higher price, and less of what is less in demand because it has a lower price, relative to the cost of production.

(Disclosure: I have never taken an economics class; I’ve only read a few books and articles. I hope, though, that this can be considered a fair summary.)

Therefore, the theory goes, by letting people choose what they want to buy and when they want to buy it, and given some medium for producers and consumers to exchange information about what they’re selling and buying (e.g., advertising, market research), the greatest number of people will have the greatest number of their wants and needs met. What consumers demand the most will be what producers make the most of, because it’s the most profitable; and when consumers’ demands are met, they are happier and better off. Assuming it is better for society to have more of its members’ needs met and to have its citizens happier, you have a ready-made case that society should promote and support this sort of uninhibited economic exchange — what we normally call “free trade” or “free market capitalism.”

Galbraith’s point is that the underlying assumption of this argument, and of the neoclassical theory used to defend it, is that supply and demand are independent in the sense that supply always follows demand. (Perhaps this is why economists always say “demand and supply,” instead of the more popular “supply and demand.”) Consumers form their ideas about what they most want and need ahead of time, and they share these ideas with producers through various forms of communication: by voicing them in focus groups, by filling out surveys, or by simply buying more of the products they want. Producers are constantly a step behind: they must determine which products are the most in demand, and then supply them to meet that demand. Producers do not play any role in the way consumers form their ideas about what they want and need; they merely fill in the demands as they come down the pipe. Supply is at the other end of a causal chain that begins with demand, and never the other way around. The two are independent in this very specific sense.

If supply (or the producers that create it) causes demand — if the presence of a product on the market causes consumers to form preferences where they previously had none — then the neoclassical description breaks down. First of all, resources become “unlimited” in one important sense: the supply of a product will always be ahead of the demand it is creating. Producers do not need to choose among the limited pre-existing quantities of consumer demand in order to maximize profit; they simply produce more, and demand for that production follows. (To be sure, other resources are still limited for both consumers and producers, so this cycle won’t go on forever.) Second, it becomes much more difficult to describes consumer preferences as “rational”: if the presence of a product or a slick marketing campaign can alter consumers’ pre-existing desires or create demand where there was none before, then consumer preferences are subject to external causes, which can be manipulated by producers or other entities. It’s hard to make the case that one’s preferences are the result of reasoned deliberation and careful consideration of one’s circumstances if those preferences are so easily manipulated. If I’m starving, it’s rational that I prefer a steak to an iPhone. I’m much less willing to say that my preference for an iPhone over a Treo is rational, because Apple’s commercials are just so much more fun to watch.

Third, and most importantly, the argument that fulfilling greater quantities of consumer demand is better for individuals and for society falls apart. When demand is independent of supply, you can make a fairly good case that more demand-fulfillment leads to more happiness and that more happiness is better for people. (At least, you can make a good case if you’re talking to a utilitarian.) This is because producers are filling a void in consumers’ lives: their products are meeting a pre-existing demand, something that consumers would prefer to have but could not until the product came along. Presumably, the fact that they wanted it but couldn’t have it caused them distress, and by supplying consumers with the product, producers both relieve that distress and give consumers the inherent satisfaction of using the product itself. Less distress, less pain, more happiness — I’ll buy it.

But when demand is not independent of supply, the process by which consumers’ needs and wants are fulfilled is the same as the process which creates those needs and wants. Arguing that this kind of demand-fulfillment is good for individuals and for society is a bit like arguing that it’s good for a man to dig a hole and then fill it in again because the labor will make him more righteous. When producers create preferences for their own products, they create the very pain and distress that they subsequently relieve. It would be peculiar to say that this process makes people happy — unless you define happiness as simply the fulfillment of demands, instead of in terms of a favorable balance between (say) pain and pleasure.

Of course, whether consumers form preferences on their own or whether they are influenced by profit-seeking producers, they will continue to buy the products that they demand. The neoclassical view probably gets this right: a free market is often the best way to ensure that the greatest demands are met for the greatest number of people. But whether or not this is a good thing is an open question. If supply and demand are not independent in the way that I’ve described, then meeting consumer demand is, in some cases, a zero-sum game (or worse) for happiness and societal good. That means that anyone who proclaims the benefits of a free market in such circumstances is either lying or using a very different definition of “good” than most people use, which can amount to the same thing.

Galbraith argues that in an “affluent society,” where supply and demand have been coupled tightly because there is more wealth than can be spent on basic needs alone, consumption will steadily increase even while badly-needed public services and infrastructure fall into neglect. His picture is frighteningly similar to the situation in which the United States finds itself today, where we continue to spend enormous amounts of money on things we don’t need and can’t afford, while our bridges and levees fall into disrepair, our schools and healthcare system fail to meet the needs of students and patients, and consumer debt has increased by 500 billion dollars to nearly $2.5 trillion in the last five years. We might benefit from a re-reading of Galbraith’s book.

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Written by whereofwecannotspeak

November 29, 2007 at 8:29 pm

Posted in Ideas, Language

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