The Hidden Rule behind the Laws of Supply and Demand
October 1, 2018
The laws of supply and demand are some of the most fundamental economic concepts. They are essentially the centerpiece of market theory, and explain the fundamentals of the rules of market exchange. But what if these rules, these laws, were based on something deeper, more fundamental, and connected to the external world. In other words, the laws rules, and behaviors of markets may simply be a consequence of a rule that operates just as well outside the scope of markets, economics, and monetary exchange altogether.
So what is this fundamental rule? The rule thata underlies and explains the fundamental economic behavior of supply and demand is this:
It is rational to maximize how efficiently energy and resources are used.
This principle may directly underlie, and even supersede the fundamental economic laws. Furthermore, viewing economic laws as direct extensions of this principle may actually be a more effective way to describe why they work. This is the theory that will be presented in this article.
It is fundamentally rational to want to get as much use as possible out of the energy that you spend, or the work that you do. This rule is, of course not limited to markets, or economics. This rule is valid completely outside of a market, in a situation without any kind of monetary transaction. For example, imagine that you are picking apples in an apple orchard. It is rational to want to pick apples in such a way that you get the most a
mount of apples for the least amount of energy spent picking them. It is rational, for example to carry a basket with you and place apples in the basket as you go, rather than leaving the basket far away from the tree and having to carry each apple from the basket to the tree. This is a basic, common sense kind of rationality that stems directly from the innate desire to use your own energy efficiently. In choosing how to pick the apples no money is exchanged; no market is involved.
The economic laws of supply and demand can be explained as a direct extension of this more fundamental rule that works just as well to explain the way you might rationally choose to pick apples.
To understand how this works, we will have to think about money in a certain way. As a symbolic representation of energy and resources. This perspective is needed to understand exactly why and how the laws of supply and demand can be described by efficiency. Why does it make sense to think of money as a symbol for energy?
Consider the situation of employment, where a certain amount of work is exchanged for a corresponding amount of money. The basic deal of employment is that you spend some energy working, and you are given money in return. This money then effectively acts as a symbol representing the work you did, or the energy you spent. Let’s say you work 8 hours picking apples and are paid for it. This money, say $100, is effectively acting as a symbol of the work that you did. You can then exchange the symbol of the energy you spent, or the work you did, for work someone else did. When you go to the store and pick oranges, you are effectively exchanging the work you did picking apples, for the work someone else did picking oranges. The money you have, and the market you shop at effectively act as tools to facilitate this exchange of work, or exchange of energy. Through the symbols of the money, and the market, you exchange your apple-picking work for the results of someone else’s orange picking work. Treating money in this way, as symbolic energy, or symbolic resources, can be used to clearly explain how money effectively behaves in the real world. It behaves as a tool to facilitate the exchange of work (energy) , for resources.
Now how does this relate to the laws of supply and demand? The basic rules of supply and demand go like this:
As the price of a good rises, less people will want to buy it. Demand falls. As the price of a good falls, more people will want to buy it. Demand rises. Demand is inversely proportional to price. This can be shown easily in graphical format as a downward slope.
A seller, on the other hand, will want to sell more of a product if that product costs more. Therefore, if the price increases, the seller will supply more product. The supply therefore increases with price, which appears as an upward sloping graph.
The buyer prefers a low price, but the seller wants a high price, so the two forces will oppose each other to bring the price to an equilibrium price. This is the price where thes forces are the same, and the amount of product consumers are willing to buy is equal to the amount sellers are willing to sell. At this happy point all the product that is made by the seller is actually sold.
These rules, or laws, seems to make sense, but why exactly do they work? What is the underlying reason behind these rules? These rules can actually be explained in a more fundamental way by using money as a symbolic stand-in for energy.
When the price of a good rises, the good essentially costs more of a person’s energy, or more of a person’s work. Remember, it is rational for people to want to get as much as possible using the least amount of their own energy. If you make $10 an hour of work, a steak that costs $20 takes effectively 2 hours of your labor to acquire. The same steak that costs $10 effectively takes 1 hour of labor to acquire. It is more rational to buy the steak at $10, because less of your work, less of your energy spent, gets you more resources. It is more efficient, and therefore more rational to buy the same product at a lower price than at a higher price.
Now consider the seller’s perspective. Why would a seller want to make more of a product that costs more? Why would this be rational?
A seller must spend a certain amount of time, energy, resources, and their own money (capital) to produce a good. When the seller sells the good, they get energy back, symbolically, in the form of the revenue they receive. The process is only efficient for the seller, of course, if he makes more revenue on the product than he spent producing it. If a seller spends $10 per shirt, and sells them for $9 each, the process loses money, and therefore all the energy the seller spends does not get him any extra energy in return. The process is objectively inefficient for the seller. It is therefore irrational for him to spend the energy buying and selling shirts. If, on the other hand, the seller buys each shirt for $10, and sells them for $30, then he gets a large additional amount of revenue, or a large additional amount of energy, in return. There is a $20 profit for each shirt sold. Because of this, it is more rational for him to spend the energy required to buy and sell shirts when he makes a large profit. The more the shirts sell for, the more symbolic energy he gets in return. It therefore becomes quite literally more efficient, and thus more rational to make more shirts if they sell for more money. Acting to maximize how efficiently he uses his own energy and resources causes the seller to naturally seek to increase the amount of money he makes. Making more profit means receiving more symbolic energy per amount of actual energy, or work, spent, and is therefore more efficient.
The law of supply and demand is explained directly by the buyer and seller both acting rationally to maximize how efficiently they use their own energy and resources.
Both parties act to get the most energy and resources from effort that they spend. The buyer wants to get the most resources for the work he did. The seller wants to get the most money for the energy and resources he spent making the goods to sell.
These forces work against each other, as the buyer prefers a lower price, and the seller a higher price. The price will, ideally, reach an equilibrium, which is a price at which all the goods are bought / sold.
The ideal outcome of this process is that, if the real equilibrium is reached, all the goods that are made will be sold to the buyer. There will be no excess goods, and all the goods will therefore, ideally, be used efficiently.
This results hypothetically in the efficient use of the energy and resources of all parties simultaneously, including the buyer, the seller, and the goods themselves. The ideal outcome of all this is the fulfillment of the fundamental, external rule, that it is rational to maximize how efficiently all energy and resources are used.
BREAKING THE LAWS
There are important, notable cases where the laws of supply and demand will not work this way. Because this rule is based on the rationality of maximizing efficiency, it is broken in cases where it is not rational to maximize efficiency.
Consider goods like medicine, or insulin. Goods required for survival. It is rational to buy these goods regardless of their price because death is the consequence of not doing so. This is a case where a more fundamental rule is operating than efficiency. The rule that it is rational to do what is necessary to remain alive. In these cases, it is never rational not to buy the good, because that would result in death.
With these kinds of goods, demand will, of course, not be directly related to price. Instead, demand will stay the same as price rises, because the buyer will pay whatever is necessary to remain alive. Eventually, demand will fall when people simply do not have enough money to buy the critical good and die.
For this reason, goods that are necessary for survival should not operate directly by the law of supply and demand, because a different, more fundamental kind of rationality is at play.
This results in the phenomenon called inelastic demand, where the quantity of goods demanded does not change directly with price.
On a graph, this looks like a straight line, where the quantity demanded does not change no matter the price..
In the same kind of way, a seller may be physically limited by his own energy and resources to the amount of goods he can produce. Even if the goods become more profitable, he cannot make more because he simply doesn’t have enough resources. For example, a t-shirt printer may only physically be able to print 30 t-shirts per day, no matter how quickly he works. This limitation will cause inelastic supply, where the seller produces the same amount regardless of how high the price gets.
The rules, or “laws” at play will therefore vary depending on the kind of dominant rationality that is active in the decision-making process of the buyers and sellers. The law of supply and demand will only make sense in the traditional way if both the buyers and sellers are free to act to maximize their own efficiency, and not out of desperation, or limitation.
The economic laws at play are dependent upon the kind of dominant rationality being used.
There are several benefits to thinking about supply and demand, and economics in general, as an abstraction of energy exchange. First, the market, or the exchange of money, goods, and services is seen as continuous with the exchange of energy and resources outside of a market. The rule that it is efficient to maximize efficiency can explain market actions but works just as well to explain actions outside markets. In this way, thinking about monetary exchange as a symbolic abstraction of energetic exchange allows markets to be considered as continuous with the rest of the world, subject to rules outside the economic domain.
In other words, the rule that it is rational to efficiently use energy and resources is a rule that is more fundamental, and more important, than the rules of economics, and therefore works both inside and outside a market system.
This philosophy places the rational, efficient use of energy and resources as a higher priority, as more important than, money, markets, and profits.
Markets, instead of being tools to achieve profits, become tools to achieve the efficient use of energy and resources. This becomes their most important function.
There are cases where, if considered solely inside the economic system, resource distribution may seem perfectly efficient, however if considered in the full sense is inefficient.
For example, lets say a product is sold at a price that is very low, and the demand becomes incredibly high. Say, exercise balls are sold at an incredible discount. Many, many people buy a ball, because it is relatively efficient for them to do so, even if they do not actually need it. In this case every single item that was produced was sold, demand equaled supply, so economically it was an efficient allocation of resources.
Look at the picture, however, outside the scope of a market. These exercise balls took energy and resources to make, and many people bought them that will never use them. Real energy, and real resources went into making these balls, and because they are not used, they do not have any kind of tangible use, or tangible benefit in the real world. Therefore, the allocation of these balls was not actually effective, or efficient. If the unused and unneeded balls were never made, and never sold, then the resources used to make them would have never been wasted. In this way efficient allocation of resources in as described in the economic world may not actually be efficient in the real world.
The world of markets and economics represents only a portion of the entire picture of energy and resource exchange.
The second major benefit to thinking about supply and demand in this way, is that it places the primary value, and major emphasis on energy and the resources used, not on money. It is not the suppliers profit which is truly the important thing, it is the efficient use of the supplier’s energy and resources which is ultimately important. This perspective considers money not as the primary motivator of action, not as the thing with primary value and importance in and of itself, but instead as a symbol representing the real energy and resources spent by both the buyer and the seller. The money is a tool to aid in exchange of value, not something with value in and of itself. In other words, the thing that actually holds tangible value is the energy and resources of both the buyers and sellers. Money does not tangibly hold value, it is used as a tool for exchange that symbolizes value. This perspective is arguably a more rational way to consider money.
This leads to the interesting perspective that it is not ultimately profit which is most important thing. Instead, it is the efficiency use of energy and resources across all parties which is of primary importance. The drive for profit isn’t primary, it is a secondary consequence of the drive to maximize efficient use of energy and resources. In fact, maximizing profit may not actually be rational if it results in the inefficient allocation of real energy and real resources in the broader world outside of the economy, and outside of the market. In other words, the total efficient use of energy and resources is MORE important than the profit of ANY individual entity. I hypothesize that this is actually more rational, and will result in the creation of more value than holding up profit as the primary objective, as long as value is considered to be held in the energy and resources of the world, and not in money.