Exceptions to Supply and Demand Economics

Like any other model of economics, supply and demand economics can’t describe everything in a market correctly. However, it is one of the best tools available to understand market and price mechanism.

Rephrasing Prof. Mukul Asher, it can be said that a good theory helps us to understand particular hypothesis. However, it can't be perfect. Robert S. Pindyck & Daniel L. Rubinfeld in the text book “Microeconomics” say:

“No theory, whether in economics, physics, or any other science, is perfectly correct. The usefulness and validity of a theory depend on whether it succeeds in explaining and predicting the set of phenomena that it is intended to explain and predict.”

Following the same line, we need to take supply and demand economics to explain and predict the quantities of supply and demand in comparison to price in an entirely free (open) market (which rarely exists in the real world).

Alfred Marshall on Exceptions

The originator of the model, Alfred Marshall, was quite aware of specific exceptions to the supply and demand theory. In his masterpiece “Principles of Economics,” he suggests:

“. . . It is not descriptive, nor does it deal constructively with real problems. But it sets out the theoretical backbone of our knowledge of the causes which govern value [price], and thus prepares the way for the construction which is to begin in the following Book. It aims not so much at the attainment of knowledge, as at the power to obtain and arrange knowledge concerning two opposing sets of forces, those which impel man to economic efforts and sacrifices, and those which hold him back. “

He clarifies at the very start of his book that the model can’t deal with all problems of the real world. However, it can be used to understand price mechanism of an open market. It is a simple view to the understanding visible world of economics around us. We make specific predictions which may or may not prove.

Extreme Views of Keynesian

Like marginal school, Keynesian economists are not fond of supply and demand model. They think that this model does not help in creating efficiency. The free actions of individuals and firms on a broader level can create inefficiency in the market. They think that a mixed economy involving the moderate role of public policy can create the required efficiency in the economics.

Furthermore, they don’t consider the prices necessarily being governed by the supply and demand theory. They see possibility in prices being sticky and resisting against change. The views of Keynesians regarding wages are quite sharp.

According to Keynes the workers and employers don’t negotiate on real but on nominal wages. He argues to trigger economic growth the real wages are to be reduced. However, it may also end in market failure.

Criticism by other Economists

The demand and supply model has more lovers now than in the past. However, still, there are many economists who criticize the model for its simplicity and overemphasize.

Robert Wayne Clower (1998) thinks that it is wrong to take supply and demand economics for an explanation of the real-life issues. In his essay, “Three centuries of demand and supply,” he analyses the model in detail. He criticizes the economists on focusing the models too much instead of strengthening the economic institutions.

Similarly, Gregory Mankiw (1992) discusses irrational actors in the market and questions certain assumptions of the supply and demand theory. It is widely admitted that the model can help us to understand price mechanism in specific markets. It can also help us to understand certain human behaviors in making decisions to purchase now or later (it is another disputable presumption like rationality of choices). For example, when prices increase, purchasers try to delay their decisions of purchase. And when prices fall, the purchasers decide to purchase as many things as possible. The model can also be used to understand changes in the cost of production that can affect prices in the market. Such views are not only too simplistic but fail to sustain for a long run.

Natural Resources and War Conditions

The presence of natural resources and happening of war in any country can create macro problems like Dutch disease. But if we try to apply supply and demand economics in such situations we again meet to exceptions of the model. For example, if a product is being produced only by nature, the supplier can’t increase supply whatever prices may be. Sooner or later there is going to be a market failure.

Similarly, as pointed out by Dr. Leith and many others, the time is the most crucial factor in the supply and demand economics. The model can work in typical situations, but during the war, it fails to explain market trends.

What do you think of these exceptions to supply and demand economics?