Thursday, April 17, 2008

Economics: bottlenecks, supply and demand

Part I: Value and cost
Part II: Price and competition

See the Proviso.

(I'm being quite cavalier about precisely what I mean by a "dollar", and precisely what sort of quantity dollars are measuring. This omission is by design. At present, these quantities can be taken just as expressions of strict less-than comparability between the various commodities:
  1. the "worth" of a gizmo is less than that of a widget
  2. the effort involved to make a gizmo (the cost) is the same as that to make a widget
  3. the effort to make each of the products is less than its "worth"
I've arbitrarily chosen the specific numbers. As the series progresses, I'll more rigorously relate these abstractions to more concrete considerations.)

In the previous posts, I talked about various abstract products (commodities): Everything costs $1.00 to make, but the abstract products have different inherent values:
  • widgets: $2.00
  • gizmos: $1.60
  • doodads: $1.50
  • geegaws: $1.40

We've seen that opportunity-adjusted cost to make any product tends towards its true cost, and the competition-adjusted price also tends towards its true cost. Thus the excess value of a product, under the simplifying assumptions so far, accrues to its consumer, not its producer.

There is, however, an exception (albeit temporary) to the above tendency: If there is a labor bottleneck, then competition is impossible, and the price will tend towards the inherent value, not it's true cost. (Note that we need to consider only labor bottlenecks; a bottleneck in the supply chain (i.e. a limited physical amount of iron) just moves the problem to a different area of endeavor.

If, for example, there is only one person who knows how to make a gizmo, then the doodad and (potential) geegaw producers cannot offer to compete with him, and drive down the price. Therefore, the one gizmo-guy can now charge $1.60 for a gizmo (and pay the other 9 people the usual $1.41 / 10 to keep them from making gizmos).

In this case, a gizmo ($1.60) would be more expensive than a higher-value widget ($1.40), and the gizmo-guy will benefit more than the widget producer.

This is the law of supply and demand: where the demand for labor is high relative to supply, the price tends toward the value, not the cost.

This creates an obvious incentive for other people to learn how to create gizmos. Assuming that one does not have to be a super-genius to create a gizmo (and we can look at the modern computer to see an enormously complicated device reduced to near its cost to understand that only the most esoteric products cannot generate competition) then sooner or later enough people will learn how to produce gizmos that the bottleneck will be relieved, and the price of gizmos will drop to its cost.

What pays in a truly free market (but only for a finite time) is not the production of the most value, but rather control of a bottleneck.

A bottleneck can delay the tendency of the price to go to the cost, but it cannot prevent this tendency.

This is about all we can say about theoretic economics at the lower level. If people were not intelligent, economics would reduce to a kind of thermodynamics, with an analog of the second law: "The price of a product will tend to reach equilibrium with its true cost over time." (And rather quickly in a large enough economy.)

But human beings are intelligent; unlike atoms, we can "change the game" and make economics move away from equilibrium.


  1. I'd be curious to see your economic take on celebrities, be they in sports or entertainment - they don't produce "widgets" - they perform. There will generally be only one of a given celebrity, so if millions of people like them and want to see them or hear them, be it by buying a ticket to a game or a concert or by buying their picture or seeking their autograph, that person can make millions, far more than your typical person. How do you see that under the umbrella of socialism/communism? Would it just be a case of taxation?

  2. Some celebrities, especially athletes, are sitting on one of the very very few natural bottlenecks that supply and demand cannot widen. The professional rank is a percentage of the population; having more people train just makes the professionals better, it doesn't make more professionals.

    However, supply and demand in this rare case works the opposite way, by pushing the true cost up to the inherent value; the true cost must account for all the people who train but fail to become professional.

  3. Something else that occurs to me is that all of the "widget" production in the US is in the process of being shipped to other countries so the only professions left here will be the entertainers and the service type jobs (obviously an exageration, but you get the point). And in a sense, you can see that as prices for goods drop as they are built overseas for peanuts, the consumer here does benefit from that, matching with what you said about most of the value going to the consumer.

    I would think an economy based on services rather than making things would be somewhat of a different animal. There, you see bottlenecks created by licensing - you can't be a lawyer without a license, for instance - which makes some sense - and then there are also licenses for freaking flower arrangers, which really does not. (Except to create an artificial bottleneck).

    Even where there are no licenses, there can be a bottleneck created by the limits of the population - which may be what you were getting at about the professional rank. Even with a totally free education, only so many people are going to be PhDs in quantum physics because most people lack the brainpower to tackle it - I think I'm at least somewhat smart and just the start of the higher math required for that stuff gives me a headache.

    The same could be true of other professions. I've often heard it said that while there is an overabundance of lawyers, there is always a drastic shortage of GOOD lawyers - and believe me, I've seen plenty of examples of some pretty bad ones. The trouble there is, both because of the shortage and also because most lay people really have no way to tell the difference (when it comes to deciding who to hire as a lawyer), the bad ones still make a living. Come to think of it, one last reason bad lawyers can make a living is that some people are just vindictive assholes who will go through many good lawyers (as the lawyers ethically refuse to do what is asked) until they finally find a bad one who will do it just to get paid.

  4. Keep in mind, DBB, that I'm a philosopher, not an economist.

    Economics is a serious discipline to the extent that, just as in thermodynamics, a collection of very simple rules leads to complicated emergent behavior, and figuring out how to apply the simple rules to specific real-world behavior is a decidedly non-trivial task.

    I would think an economy based on services rather than making things would be somewhat of a different animal.

    Not really. It's easier (in some sense) to talk about products, but a service is no less "congealed human labor" (to use Marx's term) than is a physical commodity such as a computer. Regardless of what kind of product, and regardless of what kind of real bottlenecks exist exists, a closed first-order economic system will come to an equilibrium where the price equals the true cost.

    There's a huge piece of the puzzle missing (which you touch on by mentioning licensing) that I have not yet discussed. This omission is by design: I want to convince the readers that without this piece, we can seem to discuss all of our intuitive notions about economics, but still completely fail to model modern and historical economic reality.

    In Das Kapital Marx simply handwaves over this missing piece, calling it commodity fetishism. But there's more to the story, which I think I can explain without resort to magic.


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