Saturday, October 15, 2005

Haunting Theory

Jason Dawe (Sunday Times) writing for its sister paper, The Times,
13 October, produces “The theory of supply and demand must be followed”, which includes:

“Adam Smith, accredited with being the founder of modern economic theory, knew all about supply and demand. He said that when demand is high and supply is low then you can up your prices. But if demand is low and supply is high you have to reduce them.”


This is better understood by adding ‘when the quantity demanded is higher than the quantity supplied, the seller can increase her prices; when the quantity demanded is lower than the quantity supplied, the seller is advised to lower them, qualified by the ability to store the products or postpone the purchases until the imbalances reverse. Obviously perishable goods must be disposed off or wasted; cars can be stored, or their purchase postponed

“While this theory is simple to understand, the reality can be difficult to manage. The economic models suggest that to maximise sales and profitability you want supply and demand to be similar – not that easy in a global economy.”


True, to the extent that the balance can be maintained indefinitely. Less easy when internet sales – the global economy – can be tapped to overcome local shortages or surpluses

“But the laws of supply and demand do occasionally work in favour of the car companies, particularly when they design and build a car that proves to be a bigger hit with buyers than anticipated. With demand outstripping supply, discounts are forgotten as waiting lists grow and customers pay top dollar for the latest, shiniest new models. … But … the situation doesn’t last forever - demand eases back, production levels often increase and ultimately prices start to come under pressure.”


Yes, differentiated product offerings that consumers prefer leads to surges in the quantity demanded but equilibrium in markets is always under siege.

"If car manufacturers continue to a) over-produce and b) target niche markets they will find Adam Smith’s theories on supply and demand will come back to haunt them. Making a car that appeals only to a limited number of people could be a very costly strategy.”


Sorry, but Adam Smith’s analysis of 18th-century markets is ever present, 'haunting' or otherwise. Making a car that appeals to a wide range of people can also be a 'very costly strategy' if a rival does it better. That's the business risk of entrepreneurship; wrong, then 'very costly'; right then very 'lucrative'. The choice of strategy is not included in the theory of the quantities demanded and supplied. If it was easy, many more would be showing the others how.


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