Understanding excess supply
Over at Econospeak is a fascinating conversation of arcane economic thinking:
Peter Dorman at Econospeak states:
I have just taught the theory of the supply curve at the principles level for the umpteenth time, and my conscience is in open rebellion. This business with the horizontal demand curve and setting supply equal to marginal costs is simply rubbish; it denies some of the most important, and obvious, facts about how capitalism actually works.
At the level of an individual firm, the theory obscures what ought to be the starting point for analysis—that in a capitalist economy the normal state of affairs is that firms set production at a level that requires them to chase consumers any way they can, and that the usual result is that some offerings go unsold. Across the entire economy the level of activity is nearly always demand-constrained, not supply-constrained.
Consider the relationship between buyers and sellers at the level of individual enterprises. From observers like Alec Nove and Janos Kornai, we have come to recognize that the prevalence of buyers’ markets is what distinguishes capitalism; in the state-managed systems of pre-1989 socialism, the seller was king. This suggests that excess supply is the most likely state of affairs, excess demand the least likely. An exact equality between demand and supply at the market-determined price is essentially impossible.
Nick Rowe at Worthwhile Canadian Initiative responds thusly:
Just to be clear, I totally agree with your first 3 paragraphs. It bugs me too. But my solution is different from yours.
Update: Nick sends Angry Bear an update to refine and illustrate his point here.
I have been following that discussion. The problem comes down to that lack of symmetry in real goods prodction, the distribution tends to be a directed flow. There are two governing norms the equations of mass and the equations of price. The equations of price are based upon the equations of mass for the production of bank seposits, but those equations of mass are much more symmetric then the equations of mass for shoelaces. Bank deposits migrate up and down the production chain much better than shoelaces.
Hence, when writing equations for bank deposits, symmetric flow in the network allows standard calculus. The lack of symmetry in heavier goods prohibits the use of standard calculus. The agents, you and I, use equations of mass, we manage positive definite queues. The economist can use the symmetric approximation, as long as he recognizes the approximation fails when unexpected shortages loom.
Hi Rdan: I’ve just done a new post, with a picture, to try to explain it more clearly: http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/11/excess-supply-under-monopolistic-competition.html
Just been reading 2nd chapter of Steve Keen’s Debunking Economics. The downward sloping supply curve was debunked by Sraffa in the 1920’s. It’s really a special case, only applies in certain industries with diminishing returns, such as petroleum(?) The usual case is flat, and all suppliers strive to gain as much market as they can and become monopoly if possible, for max profit. Also, most goods are unique, so suppliers seek niches. S&D economics has little connection with actual capitalism.
And what happens if no company adds capacity to meet demand?
Lead time goes out to abnormal lengths and customers wait patiently in line for the product or part. This is what has been experienced in mosfet production today. The ST, Intels, NXP, NEC, etc. have not added capacity to meet increased demand and have increased prices besides lead times from 12 to 26+ weeks. Neither has any new players entered the market place to offset the constrained capacity.
This has been going on for a year now with expectations of the same to occur in this globally manufacturing product for the upcoming year. Manufacturers “appear” to be limiting the amount of their product reaching the market place and have enjoyed full utilization of capacity with increased prices. I suspect oil refinering has pretty much accomplished the same.
New players are not so apt to come in at a lower price as much as join the mix with similar pricing and perhaps less lead time until capacity is 100% utilized.