3.3.2 Supply and Demand

(This is a current page, from the Patterns of Power Edition 3 book contents.  An archived copy of this page is held at http://www.patternsofpower.org/edition03/332.htm)

In a ‘market economy’, the prices of materials, goods and services and the volumes of business transacted are mainly governed by the economics of supply and demand.[1]  Suppliers will only provide materials, goods and services if they can charge high enough prices for them to make a profit – but people will only buy if the price is low enough to make the purchase worthwhile.  Equilibrium is reached at the price where the availability of supply matches the strength of demand.

Lower prices are not the only competitive weapon.  Companies can differentiate themselves by producing products and services that customers value more highly than those provided by competitors, for example, whether by innovative design or persuasive marketing.[2]  Whatever the competitive model though, customers have to be willing to buy what is produced.

The process of setting the market price is conducted by face-to-face negotiation, or haggling, in some parts of the world and for some types of purchase.  In shops in Western economies the price is set by the shopkeeper on the basis of trial and error: when a price has been set too high, and the shopkeeper has excess stock, the price has to be reduced to clear the shelves.  More recently, Internet auctions are being used to agree a price.  Whatever the actual steps taken to set the price, the overarching governance mechanism of an adequately regulated market is the matching of supply and demand: balancing the power of the buyer against the power of the supplier; they need each other, so neither has an unqualified advantage provided that each has other acceptable choices available.

In most countries consumers wield the strongest power in the Economic Dimension.  It can be argued that this is the purest form of democracy: people demonstrate what they want by being prepared to pay for it and, in a market economy, what has been called the ‘invisible hand’ guides the sources of supply to match themselves with the demand of their customers in a network of relationships.[3]  Businesses are dependent upon, and therefore have to submit to the power of, their customers.  Consumer power depends partly upon aggregation – a sufficient number of people who want similar goods and services – but otherwise is limited only by people’s disposable income.

But businesses also wield power in the reverse direction: they can stimulate demand by advertising.  People respond to a variety of factors: price, quality, service, brands, fashion, or a company’s ethics.  Corporate influence is widening to reach customers all over the world, helped by improvements in communications and the Internet.  As companies become larger they reap the benefits of scale: their fixed costs, such as product research, are spread over a greater sales volume and unit costs per item are therefore reduced.[4]  Smaller companies find it hard to compete.  The emergence of global demand has made some corporations extremely wealthy – and some have used their wealth to increase their political power by giving money to politicians (6.4.5).

These market forces – the power relations between businesses and their customers – are mostly beyond the control of governments.  The buyer and supplier need only to negotiate with each other.

Where there are multiple sources of supply, competition provides one of the purest forms of governance because suppliers cannot be excessively exploitative: any business which charges high prices in a free market risks being undercut by a competitor who is prepared to charge less.  Suppliers of unsatisfactory goods and services will fail as buyers choose to purchase elsewhere.

The result of lower prices is to leave money in the customer’s pocket, which can then be spent on other goods and services.  Competitive supply and demand thereby fuel economic growth.

© PatternsofPower.org, 2014

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[1] Samuelson and Nordhaus describe the operation of supply and demand in Economics, chap.  3, pp.  38-51.

[2] Michael E.  Porter, in his book On Competition, identifies five forces which govern competition – only two of which (the bargaining power of buyers and the power of suppliers) relate solely to price.  A summary was available in March 2018 at http://www.businessballs.com/portersfiveforcesofcompetition.htm.

[3] Adam Smith used the term ‘invisible hand’, as in An Inquiry into the Nature and Causes of the Wealth of Nations, IV.2.9, which was available in March 2018 at http://www.econlib.org/library/Smith/smWN.html.

Leonard Read elegantly described its operation in I, Pencil, from Four Essays, which is told from the point of view of the pencil.  It makes the point that the network of transactions to make a “simple” pencil is complex and many different companies are involved, so the pencil can confidently say of itself: “I am seemingly so simple.  Simple? Yet, not a single person on the face of this earth knows how to make me.”  This was available in March 2018 at www.econlib.org/library/Essays/rdPncl1.html.

[4] Samuelson and Nordhaus explain the link between higher sales volume and lower average costs, due to the sharing of fixed cost, in Economics, chapter 7, p.  107.