Principles of Demand and Supply
If price fluctuation is determined through interaction with demand and supply, what determines demand and supply? The mainstream economics teaches that utility determines demand and cost determine supply. Is this an appropriate logic? Is each of utility and cost a useful concept in reading price phenomena? The logic that cost determines supply is somewhat convincing since each cost can be summed and compared. And a company, the subject of supply, seeks profit, of which size is determined by the production cost together with the selling price. But the logic that utility determines demand has a serious problem as follows. The consumer, the subject of demand, does not exist only for a certain utility. There are various types of utilities and they can not be added together in one unit, nor can they be compared with each other. Can the indifference curve solves this problem? It is not. The indifference curve is only for intellectual play with little practical usefulness. Thus, it is an overly simplistic idea that utility determines demand.
While expanding the concept of utility as much as possible seems to take away the logical problem, the infinite expansion of the concept merely makes it into a grand discourse that is useless in reality. This logic corresponds to the 'error of simplification' in logics. This problem that the 'utility' of the mainstream economics is so comprehensive and vague has made the economic research about the 'kinds and changes of utilities' absolutely insufficient. From now on, let’s examine the scientific principle about the kinds of utilities and their variations so that the economic phenomena can be read more broadly and deeply. At first, what does the utility mean specifically?
The types of goods are so numerous that it is difficult to quantify and the consumer’s utility is different for each goods. For example, the utility of foods is basically out of the hunger and the utility of clothes is basically out of the cold. In addition, foods have a derivative demand of taste and clothes have a derivative demand of smartness. In addition, house, medicine, household appliance, automobile, mobile phone, painting, movy, music, sports, tourism, etc. have different utilities with each others. There are as many kinds of utilities as the kinds of commodities. Is it possible to group all these various utilities into one concept? Is this really desirable? It is not. This total concept is an serious obstacle for us to read all the economic phenomena.
When we look at the economic reality, the composition of goods consumed by consumers varies greatly as the income level fluctuates. For instance, if the income level is low the proportion of foods required for life support is relatively high. However, as the income level increases the composition of consumed goods becomes diverse and the proportion of various goods for cultural life or hobby becomes large in advance. Furthermore consumption contents vary greatly depending on the social class and the proportion of derivative demand such as ostentation consumption tends to increase as it goes to the upper class. In short, the utility varies according to income level and social class. The 'finite class' propounded by Thorstein B. Veblen(1857~1929) could be backed theoretically by the above logic. Other similar accomplishments of the institutionalism could also be backed by it.
In the proposition ‘utility decides demand’, the concept of ‘utility’ often covers a wide range of meaning and thus it often shows a decisive limitation in reading economic reality. Therefore, there is a renewed need for in-depth and diverse inquiry into the composition and variability of utility in order for us to understand 'demand' and to read price fluctuations accurately. It is necessary to identify at least the question of how the composition of demand fluctuates according to income level and social class. But the mainstream economics rarely explores or explains these problems. At best, Engel's law, like 'the lower the income, the higher the proportion of the groceries' was in the past. So how can the mainstream economics read price fluctuations properly!
The matter of utility composition is not only necessary to read the demand but also necessary to read the supply. In particular, there are not so many important issues in determining what quantity of goods to produce and what quality level of the goods to produce, which are the subject of supply. In reality, one of the many success conditions of a company can be considered to be satisfied at least if the company can know what goods consumers will consume and how they change their consumption composition according to their income level and social class.
What kind of business can be successful? What job can get into a rich life? One of the important variables that influence this question is the composition and variation of utility. In particular for a company, the composition and variability of utility is as important as any other important issues, since they are the core concern whether the products of it will increase or decrease and what industry will get the spotlight in the future. Therefore, it is one of the preconditions for a successful business or a successful life to understand how the composition of utility varies with increasing income and social class.
Just as price phenomenon can be read by looking at demand and supply together, it is necessary to look at the cost as well as the utility. The constituents of cost also vary in terms of wage, interest, technology fee, transportation and storage cost, inventory cost and company profit. Even if the costs can be summed up, it is important for a producer to comprehend the fact that the total cost varies depending on how the constituents of the cost are combined. Also, the share of each product participant varies with the cost component as the economy grows. Therefore, cost needs specific analysis as well as utility.
In reality, what determines utility and cost? From the conclusion, the income generated by the principle of income determines the size and composition of utility as well as the income determines the size and structure of cost. Thus, demand and supply do not directly correlate with the price theory, but rather they have a direct correlation with the income theory. This issue will be examined in the ‘Principle of Income Decision’ in earnest, while looking briefly at the ‘Reconsidering about Consumption, Distribution, Production, Distribution, and Market’ at first.
However, for all that, Choe's economics does not ignore the achievements of the mainstream economics. Much of the works on the principles of supply and demand play important roles in Choe's economics too. From now on, some of the major accomplishments in the mainstream economics will be examined first, and the content will be accepted critically into Choe's economics. In other words, the achievements about supply and demand of the mainstream economics will be to dissolved in order to assimilate them into a new paradigm.
(1) Value Paradox and Marginal Utility
'Air and water are worthful things which are indispensable for human beings to live but they do not have a meaningful price, but diamonds are very expensive while they are not necessary for human beings to live.' This is the famous 'value paradox' in economics. Early economists could hardly comprehend the reality that diamonds of no value are expensive, and the prices of air and water are priceless or cheap. So it was called 'Paradox.' To solve this problem, most economists fiercely devoted all their efforts until mid-nineteenth century, but it was not resolved.
Here are the reasons why Adam Smith, David Ricardo and Karl Marx who pioneered modern economics were obsessed with the 'labor value theory'. They believed that the labor value dominates the price of goods. It did not need to pay labor in order to get air and water, so they were seemed to get little price, and the average labor of getting the diamond are so much that it was seemed to cost a lot of labor. But the attempt to explain the value paradox with labor value appeared abnormal. It was the same whether it was a theorem of drop labor value or dominant labor value. The diamonds that were obtained by chance would have to be cheap. Above all, market prices fluctuated without regard to labor value.
It was the ‘marginal revolution’ to resolve this value paradox which had seemed to be impossible forever. The principle of ‘marginal revolution’ which means ‘the utility of the final unit determines the value.’ was discovered in the 1870s by three economists, William Stanley Jevons, Carl Menger and Leon Walras, almost simultaneously(Nowadays Alfred Marshall is accepted as contributing also to the marginal revolution). Actually, air and water are so common that the last unit used is very ineffective. They are often cheap or less expensive since they remain after used fully. Diamond, on the other hand, is very rare, so the final unit is very effective. Even the almost useless goods are sold at high prices if they are rare. The Marginal Revolution solved this value paradox clearly.
The concept of 'marginal' was applied only to demand at first and applied gradually to supply and distribution as well. The concept of marginal utility of the demand theory, marginal cost of the supply theory and marginal productivity of the distribution theory came into existence. They means that the utility of the final unit determines the demand, the cost of the final unit determines the supply and the productivity of the final unit determines the distribution. Thus, the neoclassical economics has reached a certain level of theoretical completeness to this day, even if it is based on unrealistic premises such as rational behavior, perfect competition and general equilibrium.
From a business perspective, this term of ‘marginal’ is very important. Companies that produce goods of which marginal utilities are big can earn as high prices as diamonds and make a lot of money. The wage is relatively high for those who work for such companies. Investment is the same. You can make more money by investing in products that have increasing marginal utility. It is for this reason that the prices of some artworks rise sharply when an outstanding artist dies. Since they can no longer be produced, the utility of the final unit is getting bigger. Of course they have to compete with the works of other great artists. Other collectibles, such as antiques and stamps, are the same as artworks.
The higher the marginal utility of other general merchandise, the higher the price, and the more money it produces. This is the reason why companies selling luxury goods restrict the quantity of their products by introducing 'limited sales'. Increasing output will increase profits in the short term, but in the long run the utility of the final unit, that is, the marginal utility, will fall and the price will drop and eventually the profit will decrease. There are many cases where high-class restaurants limit the number of seats, which is also the reason. Limiting the number of seats maintains the marginal utility of the final unit.
(2) Demand and supply elasticity and price differentiation
Some products have a relatively larger price increase even with a slight increase in demand, but any other products have a relatively lower price increase even when the demand increases much. In addition, demand for some goods increases relatively more when prices are lowered, while demand for other goods increases with less demand. The extent to which fluctuations in supply and demand cause price fluctuations and the degree to which fluctuations in price fluctuate supply and demand are called elasticity. This concept of elasticity plays a very important role in the economy. In reality, price differentiation is common, which is a representative example of maximizing profits by using the elasticity. Let's briefly look at the price differentiation of an optician, widely known by the mainstream economics.
It is normal for students to have elastic responses to the price of eyeglasses because their money is relatively insufficient. Students buy more if the glasses are cheaper and less if they are more expensive. On the other hand, it is common for the average person to show a relatively inelastic response to price. Because they earn money themselves, they tend to be more sensitive than students to the brand or social prestige. Therefore, even if it is sold at a high price to the general public, the demand does not decrease greatly. This is called price differentiation, in which the owner of the optician earns more money.
Price differentiation is not only for just an optician. Almost all companies operate in almost all industries. For example, automobile makers sell several different grades of vehicles, which is a kind of price differentiation. For the riches, they sell large, showy, high-quality and high-performance cars at relatively high price, and sell affordable cars at reasonable prices to ordinary people. Even Toyota, one of the world's leading car producers, sells the luxury car 'LEXUS', which is hard to find the name of Toyota in it. This is also a means of differentiating prices(Jim Moran, president of the US sales agency, said that he has persuaded this price differentiation).
This kind of price differentiation is realized conscious and unconscious in the sales of almost all products as well as cars. In the food street, organic products are introduced to differentiate prices. The shops on the street distinguishes themselves by introducing trendy fashion, outstanding design or attractive colors. As with other products, companies use different ways to differentiate their prices. They can earn more money by accurate understanding this price differentiation. Consumers can also benefit from knowing the price differentiation. An adults, for example, can buy glasses at cheaper price when accompanied by his daughter, a student. You can easily understand the point if you experience it yourself.
On the other hand, the price elasticity of supply is also economically important. The price of a certain product rises rapidly even if the supply decreases slightly, while the price of other products does not change much even if the supply decreases much. The elasticity of price for supply appears to be very different depending on the kinds of goods. This fact must be recognized with certainty, so that the profit can be increased and the loss can be minimized. As has already been proven through a number of oil shocks, prices of industrial resources such as oil are skyrocketing even with a slight decrease in supply, which has a significant impact on the economy as a whole. Likewise, the prices of basic resources such as natural resources or foods are also skyrocketing even if supply is slightly reduced. These properties are essential because they are essential for maintaining life. On the other hand, the prices of luxury goods such as gems or luxury handbags do not rise significantly even if supply is greatly reduced. Such a product is not essential for life.