Update: 1/13/20
Christian Economics: Teacher's Edition
Afterward Ben-hadad king of Syria mustered his entire army and went up and besieged Samaria. And there was a great famine in Samaria, as they besieged it, until a donkey's head was sold for eighty shekels of silver, and the fourth part of a kab of dove's dung for five shekels of silver (II Kings 6:24--25).But Elisha said, Hear the word of the Lord: thus says the Lord, Tomorrow about this time a seah of fine flour shall be sold for a shekel, and two seahs of barley for a shekel, at the gate of Samaria (II Kings 7:1).
This passage is an aspect of point three of the biblical covenant: ethics. It relates to theft. The market process allocated food to the highest bidders. There was no law against this. This was an aspect of property rights. The Mosaic law allowed people to exchange food for money. The right to disown something is implied in the right of ownership. People had the right to disown money to buy food.
A military siege had cut the supply of food into the capital city. The prices of various forms of food went up. People subsequently imputed great value to food under these circumstances. Without food, they would objectively starve. So, from the point of view of subjective economic value, food was high on everyone's scale of values.
Food was so valuable that two women made a corrupt bargain. They agreed to eat each other's children. But after they ate one woman's child, the other woman refused her part of the bargain. The woman whose child they had both eaten then complained to the king (II Kings 6: 28--29). She regarded the other woman's decision as a breach of contract. She expected the king to provide justice along these lines. "Turn over your son, madam, so that you both may enjoy the feast." The king was appalled (v. 30). But he did not try them both in a court for murder. (Note: this behavior had been predicted by Moses: Deuteronomy 28:53.) Instead, politician that he was, he blamed Elisha for his troubles, threatening to kill him that very day (v. 31).
Elisha made a prediction. It was in fact a prophecy. The next day, food would be cheap, he said. Elisha was making more than a prediction about food's price. He was making a prediction about food's supply. There was only one way for prices to fall this much: a huge increase in the food supply. But how could this be? The implication was obvious: the siege would end the next day. A high-level military official critic dismissed this as impossible. Elisha cursed him: the critic would eat none of it (I Kings 7:2). All of this came true the next day. The army of Ben-Hadad fled during the night. It was in such a rush that it left behind its food. Some lepers found the camp deserted. They found gold. They found food. They hid the gold. Then they reported the fact about the food to the gatekeepers, who told the king. The crowd rushed out to get the food, trampling Elisha's critic (v. 20). He ate no food ever again.
There is nothing economically unique about this story. We understand it easily. Elisha used the price of food to make a prediction about the food supply. The critic fully understood this. The low prices could mean only one thing: lots of food. Elisha's critic understood price theory. Supply and demand balance because of adjustments in prices. The price of food had soared because of an artificial restriction of supply: the siege. A falling price meant the end of the siege coupled with a huge increase in the supply of food. The critic, who was military, could not imagine that Ben-Hadad's army would somehow lift the siege and also supply the city with food. He was wrong. Dead wrong.
The phrase "supply and demand" is so familiar as a concept that sometimes people speak of "the law of supply and demand." People recognized this law in Elisha's day, and they still do.
The buyer makes decisions about what to buy. He has specific goals in mind. He seeks to achieve these goals in terms of the money he has available. He decides what to buy in terms of the prices attached to the various things he wants to buy or rent. Prices send a signal. They tell the buyer what sellers are willing to accept. They also tell the buyer what prices the sellers think that buyers are willing and able to pay.
Prices are in part the outcome of competition among buyers. There are lots of buyers who would like to own goods offered for sale. They are willing to bid on these items. In an auction, these bids keep getting higher until there is only one person willing to pay for the item. The auctioneer sells it at this lone price. But in a developed market for goods, the buyers and sellers do not want to spend the time it takes to negotiate a separate price for each item offered for sale. They can use an auction site such as eBay. But eBay tends to offer used goods or collectors' items, i.e., one-of-a-kind items. Most retail sales are not conducted by an open auction process. So, manufacturers initially decide what the retail price should be. They sell their supplies in bulk to retailers at a price they think the retailers will be willing to pay. Meanwhile, buyers are shopping. They are looking for low prices and fast delivery. They are looking for free shipping and money-back guarantees. They are bidding against each other, just as sellers are bidding against each other.
The buyer wants a market in which there is a huge supply of whatever item he wants to buy. He also wants potential buyers to be interested in buying something else. If there are few buyers and lots of sellers, some of the sellers will be ready to bargain. How do they bargain? By offering price discounts or special terms of sale. "No payment due for six months!"
Buyers possess the most marketable commodity: money. But money can fail, as it did in Egypt in Joseph's day. In times of famine, people seek to buy food. If someone has food to sell, he can command a high price. Hungry people may be willing to trade previously valuable heirlooms for food. But these are one-at-a-time sales. In a famine, the division of labor breaks down because the money system breaks down. There is no longer a common commodity by which to assess the prices of everything offered for sale. Information is lost under such conditions. People don't know what specific items sell for. Prices no longer convey accurate information to the broad mass of the population: buyers and sellers.
People use money to "save for a rainy day." Money is assumed to be the means of exchange under all conditions. But in a time of famine, people hoard food rather than money. They are not sure that markets will still function tomorrow. They start buying the goods they will consume if the crisis continues. We see this phenomenon in the hours before a hurricane is expected to strike a coastal city. Buyers go to stores and empty the shelves of food, flashlights, batteries, and ice. Most of them wait until the last few hours. Then they head for the store, hoping to avoid the rush. Under these conditions, there is more demand than supply at yesterday's prices.
Store owners rarely hike prices. Raising prices during a disaster is sometimes illegal. In all cases, it makes buyers angry. They may seek revenge after the hurricane has blown over. In a crisis, people lose faith in the pricing system. They revert to "first come, first served." The store's manager may put up a sign: Limit: "One Item Per Customer." Most buyers accept this limitation as morally legitimate.
The seller has estimated what demand will be at some price. He plans to deliver exactly the right supply of goods to sell all of them at the price he has guessed will prevail. He wants no unsold goods. He also wants no angry people who wanted to buy, but who arrived too late.
Consider a sports event. The seller has seats for sale. He wants to fill every seat with a paying customer. If the price is too high for the event, there will be empty seats. That is bad for business. He loses money. If he prices seats too low, there will be people lined up who were willing to pay more. That is bad for business. He forfeits money. He wants the Goldilocks price: not too low, not too high, but just right. "Just right" means no unsold seats and no people lined up who cannot get in.
Sellers must be forecasters. They must be entrepreneurs. They must plan in advance what items to produce, in what quantity, delivered where, delivered when, at what price. They do not know in advance what demand will be. They also do not know what their competitors will be doing when it comes time to make a sale. This is why there are profits for some and losses for others.
Sellers look at today's prices, just as buyers do. They make forecasts about prices later on. Buyers are less interested in this. They assume that profit-seeking sellers will deliver the goods where buyers want to buy, when buyers want to buy, at prices that buyers are willing to pay. Usually, they are correct. But sellers dare not be lackadaisical about such matters. They must pay attention to business, and business success depends on forecasting accurately.
Prices convey crucial information about the prevailing conditions of supply and demand. There are specialized markets that predict the future prices of basic commodities. These are called commodity futures markets. They are vital for guiding some producers and retailers. Prices are signals that convey information about what successful entrepreneurs and price speculators believe the conditions of supply and demand will be.
Changing prices alert entrepreneurs to possible opportunities. If they believe that rising prices are the result of rising demand, they purchase raw materials, capital equipment, and labor in order to take advantage of this increased demand. They make these purchases by outbidding other entrepreneurs, who had other plans for these scarce resources. This bidding process re-directs resources to meet the expected demand of buyers. If this demand continues, the new supplies provided by entrepreneurs will tend to call a halt to rising prices in this sector of the economy. The new, increased supply will find buyers at existing prices. Buyers had bid up the prices of specific consumer goods. Now their combined bidding is sufficient to absorb all of the new supply without driving prices even higher. In this way, the free market generates increased supplies of heavily demanded goods and services. Buyers get all they want at the prices they are willing and able to pay.
Sellers seek profits by providing whatever buyers are bidding to purchase. If prices begin to fall, indicating reduced demand or excessive supply, this sends a signal to entrepreneurs: it is time to stop bidding for the production goods that are used to meet existing demand. The resulting bids in the market for these production goods are lower. This makes it possible for other entrepreneurs to outbid them for control of these goods. This re-directs resources away from the production of consumer goods that are no longer in such great demand as before.
There is no central planning board of bureaucrats whose combined opinions are required to accomplish this allocation of resources.
Supply and demand are constantly changing because conditions are constantly changing. This includes changing tastes.
I return again to the lowly pencil. Both the supply and the demand for pencils are far more predictable than the supply and demand for smart phones. Pencils are old and respected consumer products. There are rarely wild swings in demand for pencils. New types of pencils come and go, but the familiar yellow pencil and pink eraser are part of every child's youth but few teenagers' remembrances. A pencil is at hand any time that someone wants one in-hand.
A steady flow of resources is directed into the production of pencils. We use the passive voice when we do not understand the process. What does this sentence mean? "A steady flow of resources is directed into the production of pencils." It means that profit-seeking entrepreneurs purchase resources from other profit-seeking entrepreneurs in order to combine them in specific ways to produce certain kinds of pencils. These entrepreneurs make a living because they possess information on how to produce these pencils at a profit. The profit will not be large. Profits arise as a result of what economists describe as the exploitation of previously unexploited opportunities. There are few unexploited opportunities in the market for pencils. The product is familiar. It is a large market, but it is filled by producers who trade in familiar knowledge. The producers benefit from some minimal degree of brand loyalty. It is not a fanatical loyalty. It is loyalty based on decades of predictable performance: of the pencils and of the producers. There is an American phrase: "If it ain't broke, don't fix it." There is another phrase: "Leave good enough alone." There is another phrase: "Dance with the person who brought you." There is another phrase: "Don't change horses in mid-stream." They all convey the same message: change is uncertain. Better to stick with what you know.
This is why Leonard Read's essay is remarkable. He picked a consumer good that everyone recognizes and understands. There is nothing surprising in a pencil. It occurred to him that no one knows how to make one. The complexity of the production process is profound. Read exercised an entrepreneur's insight. He saw an unexploited opportunity: the opportunity to introduce readers to this complexity of the production process by means of a simple tool that everyone has used and no one regards as remarkable. What is remarkable is the production process that produces pencils in abundance. He wrote what has become a classic article.
I, too, am an entrepreneur in ideas. I am using Read's article for my own purposes. No one else has used his admittedly brilliant article as the means of explaining the actual operations of the production process that Read wrote about but failed to explain. This has been an unexploited opportunity ever since 1958.
The phrase "supply and demand" refers to a single process. People who use this phrase have some understanding of the fact that it is a single process. They may not be able to explain the process, but they understand that the process is independent of central planners. This is why the phrase is a convenient tool in refuting the economics of central planning. Those who have heard it already have some idea of the process of production.
Supply rises to meet rising demand. Supply falls to meet falling demand. Inquiring people may ask: "How does this work?" It works because of the bidding process. Buyers bid against buyers. Sellers bid against sellers. Out of this continual bidding process comes an array of prices: consumer prices and producer prices. These prices convey information about unexploited opportunities. If there is a discrepancy between what final consumers seem to be willing to pay for finished goods vs. prices of resources used to produce these goods, entrepreneurs are alerted to a profit opportunity. The goal is always the same: "Buy low and sell high." The technique is to buy now in the expectation of selling higher later.
We see this process at its best in a stadium or concert hall filled with paying customers, but without anyone standing in line outside, vainly hoping to buy a ticket. The number of tickets sold exactly matches the number of seats available. This did not happen by magic. This is not a miracle. It is also not a mystery, or shouldn't be if you have read this chapter. It is surely not the result of a government-operated central planning committee. It is the result of an entrepreneur who correctly guessed the clearing prices of the tickets: every seat filled, and no one disappointed that he did not get a seat. In some cases, the entrepreneurs were "ticket scalpers" who bought tickets in bulk, and then sold them at much higher prices just before the event. Or, if they guessed wrong, they sold them for less than they paid. But the seats got filled, one way or another.
The miracle would be if every person who bought a seat went home after the event satisfied that he had not paid too much, and none of his friends are envious of him after he finishes telling them for the third time how great the event was, and how they missed out, big-time.
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