THE LAW OF SUPPLY AND DEMAND
Part II

A series of essays based on portions of Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by M. Northrup Buechner

In my previous posting on this subject, I noted that both the proponents and opponents of the law of supply and demand agree that it is a restraint on the power of the state. “Exactly what is this law on whose import both its friends and its enemies agree?” I asked. What does the law of supply and demand say? This is the first step in my answer.

When the layman or noneconomist invokes the law, he thinks the law means that prices are set by supply and demand, and he thinks of supply and demand as facts of economic reality. So far, this is correct. It is because supply and demand are facts of the economy that the law cannot be violated with impunity. In this respect, supply and demand do not differ from any other facts. Pretty much everyone understands that facts cannot be ignored or rejected without negative consequences.

Economists’ interpretation of the law of supply and demand differs from that of the noneconomist. Economists interpret the law to mean that the market price of every good (for example, toasters) is set so that the quantity demanded always equals the quantity supplied. Thus, every consumer is able to buy all the toasters he wants to buy and every producer is able to sell all the toasters he wants to sell. The problem with this interpretation is that, while it is true of toasters, it is not true of many things.

The most important exception is the market for workers and employees. Clearly, the wage for every kind and type of worker is not set so that every worker can find a job the way he can buy a toaster. Workers routinely spend weeks, months and sometimes years looking for jobs. Hotel rooms are another exception; hotels do not sell every room every night. Also, there are always houses for sale in the market for new and used housing. and there is always commercial office space available to rent in that market. The standard estimate of the average vacancy rate in rental apartments is five percent. In all these cases, it is unusual for the quantity supplied ever to equal the quantity demanded.

Now consider these common cases: Retail establishments, such as drugstores, shoe stores, grocery stores, clothing stores, and so forth, typically have large stocks of goods on their shelves, which is the supply they offer for sale. Each month, that supply consists of the store’s inventory at the beginning of the month plus whatever additions the store makes to inventory during the month—the total of which greatly exceeds monthly sales (the demand). Retail service outlets, such as nail salons, restaurants, barber shops, and so forth, usually have the ability to serve many more customers than they do. By their nature, retail businesses almost always have an excess of supply over demand.

Finally, utilities such as electric power and phone companies, always maintain excess capacity in order to meet peak load demand.

In light of these facts, I reject the interpretation of the law of supply and demand as meaning that the supply is always equal to the demand. But if the supply is not always equal to the demand, what does the law of supply and demand mean? I will take that up in Part III of this series.