People keep saying supply and demand is a broken theory, but I'm not sure how to interpret that.
When oil prices fall some producers seem to shut off their pumps. When restaurants raise their prices the people I know tend to cook at home more.
Do you think those are weird outliers, and increasing prices should spur increasing purchases as a general rule? Do you think consumer and producer behaviors have no relationship with price whatsoever?
I have a hard time imagining what those worlds would look like, so I expect your critique is far more nuanced.
But if it is a nuanced critique, then it seems we all agree on the general principles in broad strokes, and we don't need to throw out supply and demand after all.
The biggest problem is with the supply curve, really. Economics tends to pretend that more supply requires a higher price. In reality, more supply very often leads to a lower price due to economies of scale.
This is a fundamental problem because it means that even if you assume fixed supply and demand curves (which is very dubious), there can be more than one equilibrium. That in itself pretty much invalidates most of the standard subsequent analysis.
The other big problem is that it assumes too much that all economic actors are price takers. In reality, prices are largely administered via cost-plus pricing, and advertisement and related tricks are used extensively to subvert the basic principles of supply and demand.
Another problem specific to macroeconomics is that it largely ignored the effect of demand. Increased demand very often leads to an increase in production rather than an increase of prices, a fact that was largely ignored in decades of supply-centred thinking. This has led to bad policies in response to the global financial crisis, for example.
I agree though that it makes no sense to throw out supply and demand as concepts entirely.
Newaccount456 has already covered your confusion over the difference between a movement of and a shift along the supply curve adequately. That entirely covers the more than one equilibrium point because even in Econ 101 they tell you the curves shift. Of course there are multiple equilibria. Increasing, decreasing and constant economies of scale will be in every intro textbook.
Re: Price taking or perfect competition, that’s just one of the basic models of price determination. Monopoly, monopsony, oligopoly and monopolistic competition are all treated in introductory courses too and if you got as far as an intermediate course they’d cover the Bertrand, Cournot and Stackleberg models of oligopolistic competition and how they contrast with perfect competition and monopoly. Even introductory microeconomics will cover the three basic methods of price determination verbally.
Your penultimate paragraph also relies on not being able to distinguish between a movement of a demand curve and a shift along an existing one.
> Newaccount456 has already covered your confusion over the difference between a movement of and a shift along the supply curve adequately.
I think you're wrong, nobody is confused about shift of the curves. The problem really is, there can be multiple equilibriums even if the curves stay the same.
It is kind of difficult to see and understand why, because the traditional supply/demand theory and diagrams obscure this heavily. But if you look at the problem differently (see my other reference to Blatt), and start taking into account several products at the same time, you will see why.
This is exactly it. The single equilibrium hinges on the assumption about the monotonicity and slopes of supply and demand. But these assumptions are simply wrong, and so multiple equilibria are possible even with a single market. Multiple markets of course make the problem worse.
> Economics tends to pretend that more supply requires a higher price.
No it doesn't. Shifts along the supply curve are due to changes in price, but other factors can shift the entire supply curve to the right or left. This is like day 1 of Economics 101.
A supply curve indicates simply what a firm is willing to produce for a given price, everything else being equal. It is purely a conceptional tool, as reality corresponds to only one point on that line.
That point, jointly derived with demand, is the logical (even mechanical) consistent solution to these two assumptions - both supply and demand are sensitive and dependent on price.
Economies of scale relate to costs. They may, for example, be modeled by decreasing marginal costs.
If, for example, economies of scale increase, and costs are reduced, the supply curve will shift outward.
This then leads to a lower price. That is 100% conventional econ 101.
On the other hand, the supply curve, however it may look, already includes the economies of scale that presently exist - the whole dependence of supply and quantity. Economies of scale are, as such, compatible with standard supply curves, but nothing keeps you from using more complicated cost setups.
The point is just that a supply curve, just as a demand curve, is one functional (or relational) dependence at a given time. Any changes will shift these curves, as the underlying tradeoffs change.
Supply and demand curves are functions of price, however they only represent, not encode, the underlying behavior. It is absolutely standard to have pricing power in the market. The supply curve is then, of course, no longer a simple uni-dimensional affair. You can, however, still draw it as a function of other prices (for example).
Supply curves are not the underlying behavioral assumption, they are a useful representation thereof.
I'd argue, for example, that Cost+Markup is the most standard way, in economics, to model a firm's pricing behavior, such as in oligopoly models.
The valuable insight from economics, which generalizes the simple demand and supply curves, is that this Markup is not arbitrarily set, but depends both on demand and on other suppliers.
Without these simple mental models, many people come to wrong conclusions about what happens in markets!
> Without these simple mental models, many people come to wrong conclusions about what happens in markets!
It seems like that happens with or without the simple mental models. Put five economists in a room and you'll get five opinions.
I'd argue that one purpose the mathematical models do serve is to shut down disagreements from non-economists. Where there's a difference in opinion, the economist can (fallaciously) argue that "if you don't have a model, you don't have a point".
See some of the discussion around MMT for a practical example.
In contrast, I challenge you to put five economists into a room and ask a question about, say, auction theory. Do you still think you get five opinions?
> See some of the discussion around MMT for a practical example.
MMT is Macro, and Macro is bad. Any of it. The reason is that the assumptions of any Macro model, including MMT, are so excruciatingly far from reality that "formal theory" is difficult to do.
We have formal theory such that five economists who disagree know exactly where they disagree - on which assumption or axiom.
A theory that does not formulate out its assumptions or scope conditions, which sadly includes a lot of "heterodox models", can not be criticized at all. It may be right, it may be wrong, but we can find to common basis on which we agree or disagree.
> We have formal theory such that five economists who disagree know exactly where they disagree - on which assumption or axiom.
In practice economic debate usually degenerates into mud-slinging because there isn't a universal arbiter of what constitutes a good model. I don't think the saltwater-freshwater debate was particularly precise or reasoned.
> People keep saying supply and demand is a broken theory, but I'm not sure how to interpret that.
It is broken, especially in macroeconomics. On micro level, it is less problematic, although the main criticism of atq2119 in this thread is correct. The things wrong with it are roughly the supply and demand curves, the idea of equilibrium (assumption of its existence and uniqueness) and the approach that is inherently one-sided - one market at a time.
> When oil prices fall some producers seem to shut off their pumps. When restaurants raise their prices the people I know tend to cook at home more.
This is a strawman. These actually do not follow from the supply and demand itself, but rather from indifference curves (although utility theory has its problems too). Unfortunately, the theory of supply and demand doesn't treat multiple different products very well (even in substitution).
> I have a hard time imagining what those worlds would look like, so I expect your critique is far more nuanced.
I understand. You don't know the alternative, so you cannot imagine a different world.
If you want a good overview of the criticism, read Steve Keen's Debunking Economics. He has two chapters devoted to problems of the supply and demand theory.
And if you want see alternative, which is completely superior (gives intuitively similar results and more, requires less parameters and is easier to extend), I suggest the treatment in Blatt: Dynamic Economic Systems, first part. (This was also suggested to me courtesy of Steve Keen, but boy, it is good. Keen is not to everybody's taste, but everyone in economics should read Blatt. He is the most forgotten of all forgotten economists. Although I think the approach is not his own, I think it goes back to von Neumann, but I don't know how it is called.)
> then it seems we all agree on the general principles in broad strokes, and we don't need to throw out supply and demand after all
I disagree, we need to throw it out, because there is a much better alternative approach. See above.
I've watched the former chief economist of Goldman Sachs argue with his right-hand man about whether the big drop in crude prices in 2014 was due to supply or demand. If they can't figure it out, what hope do the rest of us have?
In almost all cases, neither supply nor demand are observable. They change through time - but we don't have a good model for how they change. The curves are nonlinear, and there's feedback between changes in supply and changes in demand.
Finally, in macroeconomics, even the theory is incoherent. The Sonnenschein-Mantel-Debreu theorem says that the aggregate demand curve can take any shape - it need not be 'downward sloping'.
When oil prices fall some producers seem to shut off their pumps. When restaurants raise their prices the people I know tend to cook at home more.
Do you think those are weird outliers, and increasing prices should spur increasing purchases as a general rule? Do you think consumer and producer behaviors have no relationship with price whatsoever?
I have a hard time imagining what those worlds would look like, so I expect your critique is far more nuanced.
But if it is a nuanced critique, then it seems we all agree on the general principles in broad strokes, and we don't need to throw out supply and demand after all.