Chicken or Egg: The Origin of Supply and Demand

There are a lot of questions within the academic discipline of economics that ranges from whether certain goods and services should be supplied by the state or the private sector or both, to whether an economy can indeed afford minimum wage laws or not. Probably...

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There are a lot of questions within the academic discipline of economics that ranges from whether certain goods and services should be supplied by the state or the private sector or both, to whether an economy can indeed afford minimum wage laws or not. Probably the biggest and most fundamental question pertains to supply and demand and which of them is largely responsible for the other one.

A good analogy is the chicken and egg analogy: did the chicken precede the existence of the egg or vice versa? Evolutionary biological research put aside, the question poses a philosophical cause and effect conundrum as the chicken comes from an egg but the egg requires the chicken for it to even come into existence in the first place. The same dilemma exists when posing the question of whether supply creates demand or vice versa. But before we can delve into the question itself, we have to clarify what the economic definition of demand is.

Colloquially, having a demand for something means wanting something. I want to have a Mercedes S600 parked in the garage of my R10 million Camps Bay mansion, but that does not mean that I have a demand therefore in economic terms. Demand is defined as wanting something whilst at the same time being able to afford it. The latter part of the definition cannot simply be done away with. Here’s why.

When it comes to economic analysis, prices are everything. Prices are essentially “signals” that contain a ton of information that are sent out into the market. This information, on a macroeconomic level, pertains to things such as whether there exists a shortage of something or an excess. Even on a microeconomic level, we as individual economic entities use prices to signal our preferences: the more utility something provides to us, the more we are willing to pay for it. Prices are thus central to an economy in that they convey a world of information about factors such as subjective preferences, costs, shortages, excesses, etc. Being able to afford something is subsequently a central part of the definition of demand as the price you are willing to pay for something reveals your subjective preference for it based on the utility it will provide to you. Without incorporating ability to pay into the definition of demand, it would be literally impossible to accurately determine the level of demand and we would end up with extremely inaccurate pseudonymous demand curves that merely convey a bunch of guesswork. Now that we’ve got that out of the way, we can examine the fundamental question of whether supply creates demand or whether it is the other way around.

In order to have a demand for a certain good or service, you must have the ability to pay for it. In order to have the ability to pay for it, you must generate an income for yourself. In order to do that, you need to supply something to other market entities, whether it be a product, a service, or your own labour. However, no rational person would supply something where there is no demand for it. So, in order to be able to demand goods and services, you need to supply something to the market so as to generate disposable income for yourself, but you cannot supply anything to the market if nobody demands it as it would be a waste of resources. I think you get the picture: supply and demand clearly share some sort of interdependent causal nexus with each other. But the debate is not settled, at least not according to Jean-Baptiste Say and John Maynard Keynes.

Say was a classical economist who posited in the early 1800s that production must precede demand; “a product is no sooner created than it…affords a market for other products to the full extent of its own value”.  What Say did not posit is that producing something will automatically cause that particular thing to be sold. He merely said that, on a macroeconomic level, you first have to produce in order to attain money (the fruit of your labour) so that you can demand other things. to A little over a hundred years later, however, Keynes came along during The Great Depression and posited that demand precedes supply over the short term and that we cannot depend on supply preceding demand because slumps in supply during recessions cannot be explained by Say’s thinking and would kill us all in the long run; “in the long run we are all dead”. Keynes did bastardise Say’s position a bit though by stating in The General Theory of Employment, Interest, and Money that supply creates demand according to Say. Say merely said that supply precedes demand in general. Supply only creates demand for the specific product supplied if the supplier responds to a specific demand for it or successfully markets it. Keynes’ misstatement of Say’s Law has led to some misunderstanding of Say’s position when applied on a microeconomic level, but Keynes’ view that economic recessions are caused by slumps in aggregate demand and that boosting the aforementioned through quantitative easing has indeed been proven to have validity.

This debate between Say’s Law and Keynesian economics is still prevalent on today’s political stage, especially in the US. Republicans are basically the disciples of Say and propose that the government create a favourable laissez-faire business environment so as to boost the supply of goods and services within the market and that aggregate demand will increase correspondingly because of the boost in economic output and thus income. Democrats, on the other hand, propose that the government focus on boosting the aggregate demand for goods and services so as to incentivise the supply thereof. Essentially, both parties want to boost the economy, they just differ on which side to boost it from.

The debate surrounding supply and demand and which of them comes first and thus deserves prioritisation when it comes to policy considerations is one that has raged for more than a century and will probably keep raging on forever. Mainstream economists now recognise that both supply and demand are deserving of much consideration but are still divided over which deserves the most attention when economies tank and we enter recessions. To date, nobody knows for a fact which it is, and only politicians pretend that they do.

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