General knowledge · Economics & society

Supply and demand

Diagram popularised by Alfred Marshall, 1890

Economics — the price mechanism and market equilibrium

The central model of price formation in a market economy: buyers want more of a good as its price falls, sellers want to offer more as it rises, and the price at which the two quantities match is the equilibrium. Alfred Marshall gave the model its familiar crossed-lines diagram in his Principles of Economics of 1890, and answered the long argument over whether value comes from usefulness or from cost of production by saying it was like asking which blade of a pair of scissors does the cutting. The model is a first approximation rather than a law: it assumes many buyers and sellers, decent information and everything else held constant, and economists spend much of their time on the cases where those assumptions fail.

How to spot them

▸Two lines crossing on a graph, one sloping down and one sloping up, meeting at the equilibrium price
▸Price is on the vertical axis and quantity on the horizontal — the reverse of the usual mathematical convention
▸The scissors metaphor: neither blade alone does the cutting
▸Anomalous goods where the downward-sloping line fails: inferior staples, and luxuries bought to be seen buying

Key facts

Alfred Marshall's pair of scissors, used to settle whether value comes from utility or from cost of production (1890)

From Principles of Economics: you might as reasonably ask which blade of the scissors cuts the paper

An inferior staple whose consumption rises as its price rises, named by Marshall after a Victorian statistician

The Giffen good, named for Sir Robert Giffen; empirical examples are rare and much argued over

A luxury bought partly because it is expensive, named for the author of The Theory of the Leisure Class (1899)

The Veblen good, from Thorstein Veblen's account of conspicuous consumption

Antoine Augustin Cournot drew the first graph of one of these two schedules in 1838 (1838)

In his Recherches sur les principes mathématiques de la théorie des richesses

The triangle between the price actually paid and what each buyer would have been willing to pay

Consumer surplus, devised by the French engineer Jules Dupuit in 1844 and popularised by Marshall

The proportional responsiveness of quantity to price, a coinage of Marshall's still measured as a ratio

Elasticity: greater than one is elastic, less than one inelastic

A price ceiling on rents or a floor under wages, holding the two schedules apart and creating a shortage or a surplus

The standard textbook illustration of what binding price controls do in the model

Key ideas

The model is about a whole market, not one buyer: individual demand curves are summed horizontally to give the market curve.
A movement along a curve is caused by a change in the good's own price; a shift of the whole curve is caused by anything else — income, tastes, the price of substitutes, technology, input costs.
Economists distinguish 'quantity demanded' from 'demand' precisely because the two are the difference between a movement and a shift.

Quick-fire facts

•Alfred Marshall's Principles of Economics (1890) was the standard English textbook for some forty years and put the crossed-lines diagram at the centre of teaching
•Marshall placed price on the vertical axis, reversing the usual convention of putting the independent variable on the horizontal — the habit has stuck ever since
•The Giffen good is named after Sir Robert Giffen, though Giffen himself never clearly stated the case in print; Marshall attributed it to him
•The Veblen good comes from Thorstein Veblen's The Theory of the Leisure Class (1899) and his phrase 'conspicuous consumption'
•Antoine Augustin Cournot drew the first published demand curve in 1838, half a century before Marshall
•Consumer surplus was first set out by the French engineer Jules Dupuit in 1844 in a paper on the utility of public works
•Marshall coined 'elasticity of demand'; a perfectly inelastic good has a vertical curve
•The First Fundamental Theorem of Welfare Economics, proved in the 1950s, is the formal statement that competitive equilibria are Pareto efficient under strong assumptions
•The textbook conditions for the model to hold — many small buyers and sellers, a homogeneous good, free entry, full information — define perfect competition, which almost no real market satisfies exactly

Drill it — 7 cards

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Sources

Alfred Marshall — Principles of Economics 1890; the source of the scissors metaphor and the standard diagram
Thorstein Veblen — The Theory of the Leisure Class 1899; conspicuous consumption