Is supply and demand a myth?

[RandFan]

I'm having a debate with Art Vandelay in this thread over in the Science forum. The OP takes Marilyn Vos Savant to task for declaring "the cost of a product has nothing to do with its selling price."

I conceded that profit is dependent on cost but that the price is determined by market forces.

RandFan
The price is determined by what the market will be bear.

Art Vandelay
No, not really. That's a common misconception.

There are not many voices over there and I was wondering if anyone else has a POV. Hey, I could be wrong.

FWIW Art makes the following argument.

There are 10 million people in the world that like widgets, and all of them would get one if they were free. However, every increase of one dollar in the price reduces the customer base by one million. I have a monopoly on widgets, so if I sell them for price P, (10-P)million widgets will be bought. If each one costs me C to make, then I make (P-C) on each, for a total of (P-C)(10-P)million. Taking the derivative with respect to P, I get 10-P-P+C. Setting that to zero, P=(C+10)/2. So if my costs are 2, I should sell for 6. If my costs are 4, I should sell for 7. Assuming a rational monopoly, price will depend on cost.

It seems counter intuitive to me to use a monopoly to prove that the concept of supply and demand is a misconception? Am I missing something here?

 

[Kevin_Lowe]

From what I can see, it looks like Marilyn's original statement was overly strong (if it was correctly reported, which is in doubt), and that Art made some blunders in an attempt to show off a limited knowledge of academic economic theory.

Art's quoted example is bogus because it assumes a monopoly, because it assumes no fixed or inelastic costs at all (both of which you pointed out), and because it assumes a smoothly downward sloping demand curve which is an economic fantasy.

The truth, which is stunningly obvious, is that the total cost of production can influence sale price but does not determine it.

 

[Kerberos]

I'm having a debate with Art Vandelay in this thread over in the Science forum. The OP takes Marilyn Vos Savant to task for declaring "the cost of a product has nothing to do with its selling price."

I conceded that profit is dependent on cost but that the price is determined by market forces.

There are not many voices over there and I was wondering if anyone else has a POV. Hey, I could be wrong.

FWIW Art makes the following argument.

It seems counter intuitive to me to use a monopoly to prove that the concept of supply and demand is a misconception? Am I missing something here?

Supply and demand sets the price. In theory at least the truth is as always more complicated, but not by much. This is true in both monopolies and oligopolies and under perfect competition. Of course in the long run the production price determines supply so it's really a false dilema.

 

[The Central Scrutinizer]

It seems counter intuitive to me to use a monopoly to prove that the concept of supply and demand is a misconception? Am I missing something here?

No, you are not. When you have a monopoly, the supply / demand curve goes out the window.

 

[Kerberos]

No, you are not. When you have a monopoly, the supply / demand curve goes out the window.

No it doesn't the suply curve just isn't identical to the marginal cost of production curve any more.

 

[Mid]

No it doesn't the suply curve just isn't identical to the marginal cost of production curve any more.

No in a monopoly the quantity supplied is determined by the marginal cost and marginal revenue, however the price you charge at is dependent on the demand curve. Given that it's perfectly possible to have 2 different demand curves that give marginal revenue curves that cut the marginal cost curve at the same point then you can't have a unique relationship between price and quantity supplied and therefore no supply curve.

Of course all this is in the short run, whether you can keep a monopoly in the long run is another matter.

 

[shanek]

I'm having a debate with Art Vandelay in this thread over in the Science forum. The OP takes Marilyn Vos Savant to task for declaring "the cost of a product has nothing to do with its selling price."

I'm gonna agree with Art here. The supply curve, while not driven solely by costs, is heavily influenced by them. If the cost of production increases, then manufacturers cannot provide as great a quantity at every price level, pushing the supply curve to the left. That has the effect of raising the equilibrium price while lowering the equilibrium quantity.

I conceded that profit is dependent on cost but that the price is determined by market forces.

But cost is one of those forces.

It seems counter intuitive to me to use a monopoly to prove that the concept of supply and demand is a misconception? Am I missing something here?

Supply and demand still works in a monopoly situation, yes.

 

[RandFan]

I'm gonna agree with Art here. The supply curve, while not driven solely by costs, is heavily influenced by them. If the cost of production increases, then manufacturers cannot provide as great a quantity at every price level, pushing the supply curve to the left. That has the effect of raising the equilibrium price while lowering the equilibrium quantity.

But cost is one of those forces.

You are the last one I would have thought make this argument but that is fine. I have never said that cost is entirely irrelevant and conceded that it is a force the very start. Though to be sure I down played its importance. My only point has been that at the end of the day you can't sell a product for more than someone is willing to pay for it. Right? If oil is scarce and a lot of people want oil then the price of crude oil will go up independant of the cost to get the oil to market. If there is a glut of oil on the market and people are cutting back their consumption because the price of oil was high then the price of oil will fall regardless of cost, right? Further if no one wants my widgets at above cost then I will be willing to sell them for less to cut my costs (liquidation). And how much will I sell them for? As much as I can get. This is often refered to as "what the market will bear" which Art says is a misconception. Do you agree that "what the market will bear" is a misconception?

 

[shanek]

My only point has been that at the end of the day you can't sell a product for more than someone is willing to pay for it. Right?

Right, but some people are willing to pay more than others. If your costs go up, you can still sell the product, just not as many as you could at the lower price.

If oil is scarce and a lot of people want oil then the price of crude oil will go up independant of the cost to get the oil to market.

Also true. There are many other factors involved.

 

[CFLarsen]

No it doesn't the suply curve just isn't identical to the marginal cost of production curve any more.

In a monopoly, the supplier can determine the price. Right?

 

[Mid]

You are the last one I would have thought make this argument but that is fine. I have never said that cost is entirely irrelevant and conceded that it is a force the very start. Though to be sure I down played its importance. My only point has been that at the end of the day you can't sell a product for more than someone is willing to pay for it. Right? If oil is scarce and a lot of people want oil then the price of crude oil will go up independant of the cost to get the oil to market. If there is a glut of oil on the market and people are cutting back their consumption because the price of oil was high then the price of oil will fall regardless of cost, right? Further if no one wants my widgets at above cost then I will be willing to sell them for less to cut my costs (liquidation). And how much will I sell them for? As much as I can get. This is often refered to as "what the market will bear" which Art says is a misconception. Do you agree that "what the market will bear" is a misconception?

Whose right and whose wrong all depends on the type of assumptions you are making about the market, and the time line you're looking at. If we move away from the assumption of perfect competition then a number of different factors as well as cost comes into play, such as behaviour of your competitors etc.

 

[Kerberos]

No in a monopoly the quantity supplied is determined by the marginal cost and marginal revenue, however the price you charge at is dependent on the demand curve. Given that it's perfectly possible to have 2 different demand curves that give marginal revenue curves that cut the marginal cost curve at the same point then you can't have a unique relationship between price and quantity supplied and therefore no supply curve.

Of course all this is in the short run, whether you can keep a monopoly in the long run is another matter.

ETA: Nah you're right, no supply curve for a monopoly, I guess it's been to long since I took economics.

 

[Kerberos]

In a monopoly, the supplier can determine the price. Right?

Sure, but what has that got to do with anything, you can still calculate the price based on supply and demand and use that to determine the price the monopolist will set if he wishes to maximize his profit. presuming you have the right data of course.

 

[Mark]

Supply and demand still works in a monopoly situation, yes.

You have clearly never been involved with the operatons of a cable company in any given city.

This is changing now that satellite has provided competition, but until then cable companies could do anything they wanted within legal guidelines which had nothing to do with S&D.

 

[RandFan]

Supply and demand still works in a monopoly situation, yes.

You are absolutely correct and my apologies to Art for suggesting otherwise.
However Art's suggestion that "what the market will bear" is a misconception is at odds with his own equation. Art emphatically demonstrates "what the market will bear" in his equation when he says:

There are 10 million people in the world that like widgets, and all of them would get one if they were free. However, every increase of one dollar in the price reduces the customer base by one million.

9,000,000 units sold at $1.00 per unit is "what the market will bear".
8,000,000 units sold at $2.00 per unit is "what the market will bear".
And so on.

ETA: The title of this thread obviously misstates Art's position and for that I apologize.

 

[BPSCG]

You have clearly never been involved with the operatons of a cable company in any given city.

Ugh. George Will once wrote that football (US football, not the European variety) combines two of the worst characteristics of American culture: violence and committee meetings.

Cable companies combine two more: monopoly and government price regulation.

 

[shanek]

ETA: Nah you're right, no supply curve for a monopoly, I guess it's been to long since I took economics.

No, that's wrong; monopolies do have a supply curve as they'd still want to sell more of an item if its price is higher. The presence of competition changes the dynamic of it, of course.

 

[shanek]

You have clearly never been involved with the operatons of a cable company in any given city.

This is changing now that satellite has provided competition, but until then cable companies could do anything they wanted within legal guidelines which had nothing to do with S&D.

Cable companies most certainly found that there was a limit to the amount they could raise prices and still increase profits. That limit is way above what it would be with competition, but it still exists. As the price level rises, more people are going to decide they're just going to do without cable TV.

What if the cable companies had decided to charge $1,000,000 a month for their services? Do you really think they'd still have all of their subscribers?

 

[shanek]

You are absolutely correct and my apologies to Art for suggesting otherwise.
However Art's suggestion that "what the market will bear" is a misconception is at odds with his own equation. Art emphatically demonstrates "what the market will bear" in his equation when he says:
9,000,000 units sold at $1.00 per unit is "what the market will bear".
8,000,000 units sold at $2.00 per unit is "what the market will bear".
And so on.

ETA: The title of this thread obviously misstates Art's position and for that I apologize.

I agree. Thank you for clarifying.

 

[Mark]

Cable companies most certainly found that there was a limit to the amount they could raise prices and still increase profits. That limit is way above what it would be with competition, but it still exists. As the price level rises, more people are going to decide they're just going to do without cable TV.

What if the cable companies had decided to charge $1,000,000 a month for their services? Do you really think they'd still have all of their subscribers?

Of course not. But supply and demand was the least important aspect to what they were able to charge. Not non-existent, but very, very minor, since there was absolutely no competition. As evidenced by the fact that my own local cable company is now charging 1/2 of what they used to charge...and are offering $200 cash rebates to help buy people out of their satellite contracts.

Because now supply and demand can work fairly well, which they could NOT under a monopoly.