CRITIQUE OF THE SUPPLY & DEMAND THEORY

 

Directions: 1. Read the information below. 2. Answer the activity questions in your notebooks . Just note your answers (no need to write the questions).

 

The theory of supply and demand, in the United States, is seen as a law; that it is a proven fact that the economic world conforms to its set of principles.  This idea is so ingrained in our national thinking that no serious presidential candidate, Democrat or Republican, can afford to publicly doubt its accuracy.

 

REASONS FOR THE ORTHODOXY:

          1. The supply & demand theory is simple and makes sense: people act in their own self interest, and want the best quality at the lowest possible price.  The tension between competing producers, trying to meet the needs of the market, produces the highest quality goods at the lowest possible prices. If only government and special interest groups would stay out of the way and let the market work, those who wanted to could get rich. But, is the world this logical?

 

ASSUMPTIONS OF THE "INVISIBLE HAND" (the force of free-market economics that produces the benefits to society from the work of supply and demand)

 

1. ASSUMPTION ONE: No individual buyer or seller, nor any group of buyers or sellers, has the power to affect the market-wide level of prices, wages, or profits.

 

2. ASSUMPTION TWO: No economies of scale.  Small plants can produce as cheaply as large ones.

 

3. ASSUMPTION THREE: Perfect information about the present.  Buyers and sellers know everything there is to know about the goods being exchanged.  Also, each is aware of the wishes of every other potential buyer and seller in the market.

 

4. ASSUMPTION FOUR: perfect information about the future.  Contracts between buyers and sellers cover every possible future eventuality.

 

5. ASSUMPTION FIVE: You only get what you pay for.  Nobody can impose a cost on somebody else, nor obtain a benefit from them, without paying.

 

6. ASSUMPTION SIX: Self-interest.  In economic matters, each person cares only about his or her own level of well-being.

 

7. ASSUMPTION SEVEN: No joint production.  Each production process has only one product.

 

ACTIVITY

CRITIQUE OF THE FREE-MARKET ASSUMPTIONS: Match each with its assumption above.

 

______ A. Even in an age of specialization there are plenty of exceptions to this assumption.  For example, large service firms such as hospitals or universities produce a variety of different services using the same resources.

______ B. Our economy is dotted with centers of market power, from large corporations to unions.  Furthermore, employers have an edge in bargaining with workers because of the threat of unemployment.

______ C. Solidarity, jealousy, and even love for one's family violate this assumption.

______ D. In fields such as mass-production industry, transportation, communications, and agriculture, large producers enjoy a cost advantage, limiting competition.

______ E. In a free market, polluters can impose costs on the rest of us without paying.  Like when a hospital dumps syringes at sea.

______ F. The world is full of lemons, also people are not mind-readers so producers get stuck with surpluses and willing buyers are unable to find the products they want.

______ G. People may save money today in order to buy (demand) goods and services tomorrow.  The problem is predicting when.  This was a major cause of the Great Depression because of massive over-production.

                  

Source: Tilly, Chris. Dollars & Sense, "Shaking the Invisible Hand", 11/89.