Thursday, May 28, 2015

I think I learned something from yesterday's post

Just the other day I wrote

It ain't demand if you don't put your money where your mouth is.

Now I'm starting to "get" Scott Sumner's definition of demand, the economists' definition. I guess the stuff we buy measures actualized demand or realized demand or something like that. But it doesn't fully describe the "shape" of demand. For if the stuff we bought had been selling at different prices, the actualized or realized demand would have been different.

Let's say demand is a line on a graph. It runs from high on the left, to low on the right. As it goes from the left to the right, the x-axis value increases. "Quantity demanded" increases.

As it goes from high to low, the y-axis value falls. The price falls.

This graph -- this is the part I get now, that I didn't get before -- this graph is not a picture of demand over some period of time. It is a picture of demand at a moment, at any given time. The present moment, say.

How can there be a whole bunch of different quantities demanded, and a whole bunch of different prices, all at the same time? Because, I think, because it's not a demand-side picture of demand. It's a supply-side picture of demand. The graph is for a supplier who is considering his possibilities: If I sell it for this much, I'll sell this many; if I sell it for that much, I'll sell that many. It makes sense to me, this way.

And, granted, if sellers lowered their prices, we probably would buy more.

It's a "ceteris paribus" graph, nothing else changes but price and (as a result) the quantity demanded. And the line on the graph, the line that shows all those hypothetical quantities demanded at all those possible prices, that line is "demand", according to economists. I still prefer the Keynesian call: it's a demand schedule. But economists just call it "demand". And you have to we have to understand what the economists are thinking, or we get scolded by people like Sumner

The amount of ice cream you want at a fixed price level is quantity demanded. One of the most basic concepts in economics is that one should never confuse demand and quantity demanded.

and David Glasner

Never Mistake a Change in Quantity Demanded for a Change in Demand

(read the Glasner post, for more on this topic) and no doubt by others. And we don't want to get scolded!


So. At this writing (26 May) it is less than a week since I said Demand is measured by what we spend. But now I'm singing a somewhat different tune. (Maybe that makes up for some of the fun things I've been saying? Maybe not.) But here's what I learned:

The thing that consumers (like me) call "demand" is not the same as what economists call "demand". What we call demand, Sumner calls quantity demanded. It's a location on the x-axis. It's one of a whole possible range of quantities that would (or could, or might) be demanded, depending on where the price is set.

Let's push this to macro.

GDP is a point on the x-axis. It is a "quantity demanded". It is not "demand", not for economists. For economists, demand (or at the macro level, aggregate demand) is the line on the graph. It includes all the possible quantities demanded at all the possible prices. Possible or reasonable prices. Whatever.

The thing that economists call "demand" is a demand schedule. And the thing that consumers call "demand" -- a single point on that line on the graph -- I'm thinking now that maybe that is effective demand. I'm saying, the point on the aggregate demand curve that corresponds to what we actually bought -- to GDP -- that point gives us "effective demand".

I don't know. I sure hope this is right.


jim said...

Although today's post corrects some of the factual errors of the last few days, I think "Sumner was just being a dick" was still closer to the truth.

The Arthurian said...

:) Thanks, bud.

Greg said...

Good series of posts Art and you are right about dick! Ive spent a good bit of time over the years (none recently) following his stuff and he's just plain................... dickish. Thats the only way to describe him

All that said I actually think I agree with him about global aggregate demand (I hope this doesn't make me a supply sider or monetarist!!) but I have a caveat. If you look at global aggregate demand as the inability to buy everything for sale, obviously the price matters. If everything for sale were cheaper, at the same current income levels, then all the output would be more affordable and sales would increase. But the problems are two fold it seems 1) income doesn't stay the same when prices are falling 2) the aggregate income doesn't matter to sales, only distribution By #2 I mean that regardless of total GDP, the distribution is more important to total sales than absolute level. With 300 million people if only 3 million earn enough to afford a car while the others earn enough just for food and survival you cant sell to more than 3 million people. So to sell 9 million cars each person is going to need to demand 3. So have policies which force redistribution to the other 297 million and allows 100 million plus to afford a car.

Price adjustments alone cant correct the imbalance, distribution is as much the problem as price/income ratios.

As a business owner I'd rather have 100 million potential customers rather than 3 million.

The Arthurian said...

Pierre Lemieux does a great job of laying out [effective] demand versus demand [schedule]:

A Frequent Confusion and the Yo-Yo Economic Model