Further FallaciesIn the supply-demand framework, an increase in the cost of production will shift the supply curve to the left. For a given demand curve, this will raise the price of a good. In the supply-demand framework, production cost is an important input in determining the prices of goods.
We have already seen, however, that it is consumer buying or abstention from buying that is the sole determining factor for the prices of goods. No individual buyer is preoccupied with the cost of producing a particular good. The price that he will agree to pay for a good is in accordance with his particular priorities at a given point in time. The cost of production is of no relevance to him.
Moreover, the cost-of-production theory runs into trouble when attempting to explain prices of goods and services that have no cost because they are not produced--goods that are simply there, like undeveloped land. Likewise, the theory cannot explain the reason for the high prices of famous paintings. On this Murray Rothbard wrote,
Similarly, immaterial consumer services such as the prices of entertainment, concerts, physicians, domestic servants, etc., can scarcely be accounted for by costs embodied in a product.[size=0.9em]5
Using the supply-demand framework for a particular good, mainstream economists proceed further and introduce supply and demand curves for the whole economy. They hold, for example, that if the economy is under performing then what is needed is a bolstering of demand by means of fiscal or monetary policies. For a given supply curve, they contend, this will push the demand curve to the right, thereby lifting overall output. Needless to say, the supply-demand framework provides the rationale for government and central bank interference with businesses.
This framework, however, says absolutely nothing about how the increase in demand generates more output. Furthermore, it is silent regarding the funding required in order to raise output. Also, in reality, it is producers that initiate the introduction of new products. They set in motion increases in goods and services, and not consumers as such. Producers present new products, so to speak, to consumers who, in turn, by buying or abstaining from buying, determine the fate of products. Hence there is no such thing as an autonomous demand that somehow triggers supply.
Supply-demand graphics also provide the justification for various imaginary monopolistic theories, which in turn provide the rationale for the government destruction of successful businesses. For instance, it is held that a company that forces the price above the competitive price level is engaged in monopolistic activities and therefore must be taken to task.
Even if we were to accept this way of thinking as valid there is no way to establish whether the price of a good is above the so-called competitive price level (monopoly price). By what criteria can one decide what a competitive price is? On this Rothbard wrote,
There is no way to define 'monopoly price' because there is also no way of defining the competitive price' to which the former must refer.[size=0.9em]6
In the supply-demand framework for the economy, economists employ the quantity of output produced and its average price. However, neither the average price nor the total output can be logically defined. It is not possible to establish an average price for a $10 shirt and $50 litre of wine. Likewise, it is not possible to add ten shirts and one liter of wine to establish the total output. Hence, the entire graphical framework of the supply and demand for the economy rests on misleading premises.
What’s more, the whole issue of so-called equilibrium is misleading in the way the supply-demand framework presents it. Equilibrium, in the context of conscious and purposeful behavior, has nothing to do with the intersection of supply and demand curves. Equilibrium is established when an individual’s ends are met. When a supplier is successful in selling his supply at a price that yields profit, he is said to have reached equilibrium.
Similarly, consumers who bought the supply have done so in order to meet their goals. Therefore, government and central bank policies aimed at shifting imaginary curves toward so-called equilibrium in fact prevent both consumers and producers from attaining their goals and hence prevent true equilibrium.
ConclusionDespite its great appeal because of its simplicity, the supply-demand graphic as employed by mainstream economics is a tool that is detached from the facts of reality. The real-world economy is far too complex to be faithfully rendered by simple graphs that take no account of uncertainty, entrepreneurial speculation, and the ceaseless change of the market economy.
By no means is this framework harmless, because government and central bank decision-makers make use of this tool in forming various policies. This is why they are continually surprised when the real economy performs in a manner different from what their graphical analysis would seem to predict.
FrankShostak's consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. Contact: email.
- 1.Ludwig von Mises, Human Action chapter 16(2), "Valuation and Appraisement," p. 333.
- 2.Ludwig von Mises Human Action chapter 16(13), "Prices and Income," p. 393.
- 3.Carl Menger, Principles of Economics (New York, London:New York University Press), pp. 120-21.
- 4.Mises, Human Action, chapter 16(12), p. 392.
- 5.Murray N. Rothbard, Economic Thought Before Adam Smith: An Austrian Perspective on the History of Economic Thought, vol.1 (Edward Elgar), p. 452.
- 6.Murray N. Rothbard, Man, Economy, and State, (Nash Publishing), p. 607.
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