A series of essays based on Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by the author.

I know that some of my readers have noticed that in this analysis of the Law of Supply and Demand, I have so far failed to define “supply” or “demand.” This is because the meanings of supply and demand that I depend on are common sense meanings—meanings that I think the reader will have assumed while reading the discussion so far. By contrast, the meanings of supply and demand that dominate modern economics would never be reached on a common sense basis and are held by no one other than economists

A short detour to indicate the meanings of supply and demand in modern economics will yield two benefits. First, my readers will be in a better position to grasp my definitions of supply and demand in contrast to their accepted meanings in economics. Second, the economic model of perfect competition described below is the implicit basis for the critique of my views that I projected in my last post (see the next to last paragraph below).

For about the last one hundred years, economists have defined supply as the quantity supplied at every price and demand as the quantity demanded at every price. The phrase “at every price” turns supply and demand into curves defined by mathematical equations that can be solved for a price. Many economists take this solution as a theory of price. But defined as curves, neither supply nor demand exist in the economy.

Modern economists agree that a supply curve makes sense only when the price is given to the businessman. This occurs only in the model they call perfect competition (millions of firms producing the same product). Farm markets are usually pointed to as the real world counterparts of perfect competition because boards of trade such as CBOT (the Chicago Board of Trade) give farmers the prices for which they can sell their products, and farmers are the only businesses in the economy who do not set their own price. (Such markets have nothing in common with the neighborhood “farm markets” found in many cities.)

Further, economists agree that demand curves cannot be defined when firms compete. The only industries in the economy with no competitors are government monopolies such as public utilities (gas, water, electricity) and, again, farmers. Farmers do not compete because millions of them produce identical products (such as winter wheat) for which they are all given the same price. Since each farmer can sell all he wants at the market price, there is no competition for sales. Since the products are identical, there is no competition for quality.

Thus, demand curves and supply curves are meaningful only for agricultural markets, and the Law of Supply and Demand, conceived as intersecting curves, applies only to farmers (which does not mean that the modern conception of the law is valid even here). In the standard measure of total economic output, agricultural output accounts for about one percent. Thus modern economists have succeeded in restricting the Law of Supply and Demand to one percent of the economy, while they have no theory of price for the rest of the economy. A disgrace is the mildest word that can be used to describe this performance.

The assumption of millions of producers on the supply side facing millions of consumers on the demand side with the price somehow set by no one is the perfectly competitive model, and the assumption underlying Part V of this series.

In my next blog, we will see how demand and supply can be defined to make the Law of Supply and Demand applicable to one hundred percent of the economy.