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Macro Explanations and the Law of Supply and Demand

In extra reading on February 20, 2010 by Jenny

Last year, I wrote a paper about how the law of supply and demand was explanatory.  Andre asked me to post my paper to the blog because it touched on many of the issues we’ve been discussing or will discuss in this class–macro vs. micro explanations, statistical explanations, and it gives the example from Garfinkel that we didn’t get a chance to look at last time.  The paper is certainly a work in progress; so I’d appreciate any constructive comments you have.

Tripping on LSD (PDF)

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3 Responses to “Macro Explanations and the Law of Supply and Demand”

  1. Lots of interesting ideas here, but the paper can be improved by getting some basic terminology and concepts right. For example, the “laws of supply and demand” isn’t a thing; rather there is the Law of Supply and the Law of Demand, two different things. There is also the concept of market equilibrium, which involves the interaction of the supply and demand functions, but this is distinct from the law of supply and the law of demand themselves.

    The Law of Supply states that for units of a homogeneous good, price and quantity demanded are positively related. The Law of Demand states that for units of a homogeneous good, price and quantity demanded are inversely related. (Or, more precisely, the law of demand states that to a higher price of a good, there corresponds a lower (or at any rate not a higher) quantity demanded.) So your statement at the bottom of p. 1 defines the Law of Demand, but doesn’t say anything about supply or equilibrium. (Moreover, these concepts do not apply only in perfectly competitive markets; the characteristics of the demand function are independent of market concentration, the elasticity of supply, etc.)

    Hence, throughout the paper it is unclear whether you’re talking about demand curves or market equilibria (resulting from the interaction of demand and supply curves). Also you use the terms “quantity demanded “and “demand” interchangeably (e.g., p. 9: “Consider the price of frozen pizza increasing by one dollar a pie. According to LSD, a significant price hike like this will mean that overall demand for frozen pizzas will decrease.” Saying the “demand will decrease,” in economist jargon, means that the entire demand function or demand curve shifts to the left. The Law of Demand states that the quantity demanded will fall, but there’s nothing here to suggest that the function would change.) Some clarification would really help your argument.

    You also seem to confuse individual and market (aggregate) demand curves. This is covered in any introductory microeocnomics textbook. In your pizza example, increasing the price will lower the market quantity demanded, though it may have no effect on an individual demander (e.g., if I just want one pie, and my maximum willingness to pay is $10 per pie, and the price rises from $5 to $6 per pie, then my behavior remains unchanged: I purchase one pie. As long as there are some buyers with reservation prices below $6, however, the market quantity demanded will fall.) I don’t see that this has anything to do with statistical explanation versus causal-force explanation. In the subsequent paragraph you seem to be making a pragmatic argument, namely that because individual demand functions are unobservable, all the economist can do is observe aggregate patterns of price and quantity to draw inferences about demand. But here you are missing what econometricians call the identification problem; we don’t observe price-quantity pairs along an aggregate demand curve (or an aggregate supply curve), but only the equilibrium prices and quantities. As these change from day to day, or as they vary across markets, we don’t know if the changes are tracing out the shape of a demand curve, a supply curve, or neither, because both demand and supply curves are potentially changing from observation to observation. The shape of a demand curve or supply curve can be deduced theoretically, or it can be estimated econometrically (using instrumental variables), but it cannot simply be observed.

    My major substantive disagreement is that neoclassical economists do not, by and large, accept the causal-force explanation of market pricing, despite the language they use in introductory textbooks. Most conceive of prices as the outcome of a system of simultaneous equations. (The exception is the “Austrian school,” which is sometimes described as “causal-realist” economics to distinguish it from the a-causal mainstream of neoclassical economics. On this see William Jaffe’s classic article “Menger, Jevons, and Walras De-Homogenized, 1976.”)

    More generally, there is a large literature in the history of economic thought and economic methodology that is worth consulting here. Check out the Journal of Economic Methodology or History of Political Economy, or one of the methodology textbooks by Mark Blaug, D. Wade Hands, Neil de Marchi, Bruce Caldwell, or others.

    Good luck with the revisions!

  2. Dr. Klein,

    Thanks so much for your comments! My paper will be much improved after I fix my confusions/conflations regarding demand vs. quantity demanded, individual vs. market (aggregate) demand curves, and the law of supply and the law of demand vs. market equilibrium. And I will definitely check out the journals and books you recommended.

    It is interesting that you write that “neoclassical economists do not, by and large, accept the causal-force explanation of market pricing […] Most conceive of prices as the outcome of a system of simultaneous equations.”

    This is interesting because philosophers, by and large, do accept causal-force (i.e. Newtonian) explanations of market-pricing. For instance, the person whose argument I criticized for assuming that pricing was determined in economics though the citation of causal forces, Harold Kincaid, is one of the foremost thinkers in philosophy of economics, recently editing the Oxford Handbook of Philosophy of Economics, among other things. This consensus amongst philosophers that forces explain market pricing suggests to me that the people who do philosophy of economics don’t understand how pricing works. Thus, there seems to be a great opportunity here to help philosophers get it right.

    Thanks for helping me do that.

    Jenny

  3. Or to help economists get it right! 🙂

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