Supply and Demand- script for a video that may never be madeJune 9, 2012
[I have been considering revising some of my proposed plans for the Law of Value series. Below is a script I wrote a while ago for Law of Value 11: Supply and Demand. I am considering skipping this video and moving directly to the video on price. The reason: this script is mostly a take-down of neoclassical supply and demand curves and doesn't say that much about the law of value. But I feel that there are still some good points in this script, worth sharing with readers.]
People sometimes think the labor theory of value is an alternative theory of price to the notion of supply and demand. This is not so. All of the classical economists who subscribed to a labor theory of value discussed supply and demand. Yet they did not think that supply and demand, by themselves, were enough to account for value and price. Most of us today have a vague notion of supply and demand (from some high school economics course we slept through) that relates to the neoclassical picture of supply and demand curves intersecting to select an equilibrium price. It certainly is a nice, simple image that elegantly conveys its ideas of balance, rationality and equilibrium, but when we look at a little closer we will see that this image doesn’t actually represent reality or help explain much of anything about reality. This video will both explain the relation of supply and demand to the Law of Value and deconstruct the neoclassical notion of supply and demand curves and equilibrium price.
What is the relation of the law of value to supply and demand?
It’s actually quite simple: There is a finite amount of labor in society. Yet the possibilities that we could apply this labor to are endless. Do we spend our labor curing cancer or building bombs? Writing string quartets or digging for oil? Social demand, the total demand of society, decides how much of each commodity is needed. The productivity of labor in each industry limits the total amount of supply we have to meet these demands. But there isn’t a committee that makes this decision. This decision is made through the price mechanism. Prices of commodities reflect a definite amount of labor that went into their creation. Commodities acquire their value in production prior to exchange. The more labor that goes into something the more value it has. When the supply of a toothbrushes exceeds demand for toothbrushes this means that too much labor has gone into making toothbrushes. Toothbrush prices are depressed below their value and this triggers a change in toothbrush production: labor must be withdrawn from toothbrush factories and applied elsewhere. If demand for toothbrushes is higher than the supply this will raise toothbrush prices above their values. This triggers an inflow of labor. Behind this fluctuation of supply and demand lies the actual value of a commodity. That value is the amount of labor time that went into making the commodity.
Even though the fluctuation of price moves above or below the value this doesn’t mean that value is erased. What happens is that the maker of toothbrushes receives more or less value in exchange then they produce. There is a value transfer in exchange. If there is an excess demand for toothbrushes this causes the social value of toothbrushes to rise above their individual value. The labor that went into making toothbrushes counts as more social labor than it actually represents. This causes a reapportioning of labor in society.
This fluctuation is essential to the law of value. Value only exists through the blind fluctuations of the market.
The traditional demand and supply curves have problems. Let’s examine them.
Neoclassical demand curves make the market seem rational, just, and equal. Consumers appear to be choosing to buy at a price that maximizes their personal utilities and producers selling at a price that maximizes their profits. This equilibrium price appears as a state of balance and harmony. All deviations away from equilibrium are just temporary, unimportant fluctuations. Attempts to interfere with this equilibrium, to disturb the status quo, will always make society worse off. This is the ideological backdrop to the neoclassical picture of supply, demand and price. (Simon Clarke argues that the development of marginal utility theory happened at a time of growing social movements that called on states to regulate labor conditions, markets, etc. Economists were looking for ways of measuring the effect of government actions on market processes. Hence the evolution of a theory of self-equilibrating markets. See Clarke “Marx, Marginalism and Sociology”)
The thing is, equilibrium prices are the most rational form of allocation for capitalists seeking to maximize profits. But they are not so for workers. We notice that workers and labor are left entirely out of the curves. For the neoclassicist these curves just represent utility, subjective desire. There is no role for the productive process or class. As we’ll see later, this lack of a theory of production makes the neoclassical concept of price circular and meaningless.
Equilibrium prices also don’t exist. The economy is never in equilibrium and never will be. It is constantly moving, changing, growing and contracting. Disequilibrium, often violent, is the norm. The regularity of economic crisis should be enough to prove that disequilibrium isn’t a freak accident of external interference in the market, but something internal to the the market itself. (Booms are also an instance of disequilibrium. The economy doesn’t stay still in a boom. It expands.)
The Demand Curve- a joke
This is a neoclassical demand curve. It tells us that as prices rise people will buy less and less of something. As prices fall they will buy more. That seems logical enough. The curve is derived from a table of preference rankings based on the idea of marginal utility: The more you buy of something the less value you put on the next unit. So if you’ve already bought 10 bananas the 11th one has less value to you. The 12th even less, and the 13th even less than that. Let’s say I’m willing to buy 10 bananas but not 11. The value I put on the 10th banana, the banana at the margin of my preference scale, is the price I will pay for bananas. This is what the demand curve shows, that the more bananas I buy the less value they have to me. This too seems to make sense at first… if we set aside the fact that people don’t ever buy bananas one at a time.
But what about capitalists? Workers are not the only people that buy things. Capitalists’ demand is a huge part of the economy. During the boom phase of an economy capitalists’ demand increases the more they buy. The more inputs they buy, the more profit they make, the more production expands, the more their demand for inputs grows. They do the opposite of what is predicted by marginal utility.
Let’s say the equilibrium price for a banana is 10 cents. What does 10 cents mean? Neoclassical economics has no answer to this question. It just says that 10 cents is the equilibrium price in which everyone’s utility is maximized. The price of health care is so high that millions of Americans can’t afford it. For neoclassical economics this is an equilibrium price. They say those of us without health care have maximized our utility because we value the money we didn’t spend over the value of health care. But most of us don’t have that money in the first place. Clearly this is a meaningless concept of equilibrium and price. When prices rise rich people continue to buy the same amount of stuff. Some even buy more because of the status associated with expensive things (fur coats, fancy cars). When prices rise poor people buy less.
So we see that the diminishing demand for bananas isn’t just a function of having a diminishing utility for bananas. It’s a function of how much money we have to spend. And this is a function of income- a concept that relates directly to production. The income of workers corresponds to a definite amount of work at a definite wage. The income of capitalists corresponds to a definite amount of value appropriated from the working class. And both of these relate back to labor. Without a theory of labor and the value it creates in a capitalist economy the idea of demand is meaningless.
Without this reference to labor the neoclassical theory of price becomes circular. Again, what does it mean to say that bananas are 10 cents? It means nothing at all unless we realize that the price of bananas reflects the relation of bananas to all other commodities. If bananas are 10 cents, apples are 12 cents, and oranges are 25 cents, then we can see the meaning of price. Price reflects quantitative relations between commodities. If the price of bananas rises to 10 dollars a banana people will buy apples and oranges instead. This will change the price of apples and oranges. But if the price of all fruit is rising this will effect the demand for bananas differently. We can only understand price and value in this relational way, as a relation of the value of one thing to another. Yet the demand curve can only be drawn by holding the prices of all other commodities as constant. If we are drawing a demand curve for bananas we must assume that prices are held constant for other replacement goods like apples and oranges. But this means that we must take for granted that which we are trying to explain. We must assume price in order to explain it. There is no way to escape from this circularity without referring to something outside of price. This something is labor.
….. when picking on neoclassical economics it can be hard to find a stopping point. But there’s one more thing about the demand curve that has to be mentioned.
Neoclassical economics draws the demand and supply curves as mirror images of one another in this way conflating the motives of consumers and capitalists. This allows economists to claim that just as capitalists seek to sell at a price which maximizes their profits consumers buy at a price that maximizes their utility, giving them a “consumer surplus”. Yet unlike capitalist profit, which is a real objective magnitude measured in money, this consumer surplus can’t be found anywhere in the real world. It exists only in the minds of economists. A surplus of money is a clearly objective phenomenon. Psychological satisfaction is not an objective thing. It can’t be measured in any numerical amounts, and there clearly can be no such thing as a surplus of subjective satisfaction over an objective amount of money spent. That’s like having a surplus of love over bananas. Such logical mistakes abound in marginal utility, reducing its theories to circularity and meaninglessness.
Since the supply of a commodity is determined by the amount of labor that goes into making it and the productivity of that labor we’d think that labor would be at the center of the neoclassical conception of supply. Yet, somehow it is able to completely remove this from the analysis.
Here’s a neoclassical supply curve. It’s the opposite of the demand curve. It predicts that as prices per unit rise capitalists will produce more of a commodity thus making more profit. Yet as production increases the cost of production can also increase. Therefore at a certain point the returns on additional production start to shrink.
This all seems to make sense. But because the supply curve focuses on individual unit prices and not total price it misses out on something very important. The most important strategy for capitalists to increase profits is to increase the efficiency of production. This allows them to sell more commodities at a lower price, increasing profits by out-competing rivals. If we were to draw a curve based on this fact, supply would actually rise with shrinking prices, just like the demand curve! But of course neoclassical economics wants to abstract away from the way that changes in labor productivity alter the value of commodities.
Because of its obsession with equilibrium the supply curve also assumes equal productivity throughout an industry. But as we’ve seen capitalists are constantly competing to lower the socially necessary labor time. This means that they are constantly investing in new equipment to increase efficiency. Investments in long-term fixed capital like factories create all sorts of inequality between different firms in terms of the level of productivity. So rather than one level of productivity throughout an industry we have several.
We could think of this as a series of smaller supply curves. At the left of each curve is a price below which a firm can’t make a profit at all and will go of business. To the right is a supply which is beyond the firms capacity to produce, at which additional production will be too costly. Demand determines which one of these firms will set the market price. If demand equals supply then the average productivity, the socially necessary labor time will be the price. But if demand is above supply then the least efficient firm will set the price and the other firms will receive a super-profit. If demand is below supply then only the most efficient firm can make a profit. The others will be forced out of business.
Rather then demand creating price, demand is selecting from amongst pre-existing prices based on the productivity of labor. This is the actual way in which demand and supply interact.
Equilibrium: If it ever happened it would be meaningless
Neoclassical economics assumes that the intersection of demand and supply creates an equilibrium price. This equilibrium is so powerful that any deviation from it is unimportant. Yet, in reality, demand and supply never meet. There is always a constant shifting between the two. For the neoclassicist these fluctuations are fluctuations around a center of gravity called equilibrium. Equilibrium is the average and this is why the fluctuations are unimportant. But what is ignored is that this “center of gravity” is constantly moving. As demand and supply fluctuate they change where the center is and this is why they never settle on equilibrium. Rather than tending toward equilibrium, the economy is in a constant state of disequilibrium as the interaction of supply and demand constantly change the productivity of labor.
If supply and demand ever did meet they would cancel each other out and be meaningless. If the economy was in a perfect state of equilibrium with supply and demand for all commodities in perfect balance this would tell us nothing about why some commodities are worth more than others. Fluctuations in supply and demand can tell us why the same commodity has a different price at different times, but supply and demand can not explain the relation of one equilibrium price to another.
What creates supply and demand?
By now that should be obvious. Supply is created by labor. Now, labor is not the only “factor of production”, yet it is the only one that we have control over as a society, and thus the one that can be the basis of social value. (This is why animals don’t create value. They may do work and create products but they don’t produce value because value is a social relation between people, not a measure of physical products. Animals don’t enter the market looking to buy commodities. Nor do robots- yet.) The sun, water and land are crucial for agricultural production. Yet these factors are pre-existing gifts of nature. If we are to try to exert control over them so that we can ration them differently through irrigation, improvements in fertility, or greenhouses, these improvements will require labor.
Demand is also created by labor. Demand is a certain amount of value in the market in the form of wages and profits looking to buy things. And those things we buy are also conditioned by the structure of production. Capitalists’ demand is given by what sort of inputs are needed for production. Workers’ demand are based on the level of productivity in society: what sort of commodities are available and at what cost. We can do better than the neoclassical idea of demand as some sort of magically independent force that shapes the direction of society. Demand itself is shaped by the structure of society.
If we were to take all of these problems with the neoclassical conception of demand and supply we could boil them all down to one thing: they try to explain demand and supply with utility instead of value. By relying on the subjective dimension neoclassical economics deprives itself of the ability to describe actually existing social relations and mires itself in endless circularity, always needing to assume prices in order to explain them. Because production is left out of the picture the motives of capitalists and workers are conflated, subsumed under the vague heading of ‘consumer choice’. Temporal motion and change are excluded from the picture giving capitalist social relations a timeless, universal character.
But neoclassical economics must do this in order to avoid discussing the organization of production in a capitalist society. It must paint the existing order of things as the natural result of people’s free choices and desires rather than of an unequal social order based on private ownership of the means of production and the exploitation of wage labor. In short, it must abandon the concept of value. This is what classifies it as ideology and renders it meaningless.
When we add labor back into the picture we get a very different picture of things. We see that behind both demand and supply there exists a labor process and that this labor process is a dynamic one, constantly in disequilibrium. We can still use the idea of demand and supply curves but they come out looking very different than the neoclassical curves.
Anti-Samuelson by Marc Linder - a thorough critique, in two volumes, of Paul Samuelson’s classic neoclassical econ textbook.
‘Demand, Supply and Market Prices’ by Paulo Giussani from the book “Marx and Non-Equilibrium Economics”
‘Non-Equilibrium Market Prices’ by Guglielmo Carchedi, also from “Marx and Non-Equilibrium Economics”
(Marx and Non-Equilibrium Economics is one of those prohibitively expensive academic books, the fault of the publisher’s not the writers. Let me know if you are interested in the above essays and I can look into making them available…)