An Exploration of the Back-of-the-Envelope Supply and Demand Model
“All models are wrong, but some are useful”. George E. P. Box
Economics is absolutely notorious for one hallmark model, and one model alone — the supply and demand model. This back-of-the-envelope model is so popular that, an individual who has not yet taken an economics class could assume that all of Economics could be summed up into it. The model can add a lot of detail and orientation to an individual’s understanding of economics, but at the same time, the model totally misses the mark on many other aspects of the subject in comparison to its emphasis throughout the course. One could argue that for an introduction to the topic, the supply and demand model can properly introduce many key concepts in economics. While others believe that the model incorrectly frames an individual’s understanding of future iterations of microeconomics and should not be focused on as in-depth as it is currently. On a personal note, I would like to add that my class spent around two months learning about the supply and demand model and it was re-emphasized through the entire semester/year.
Before I dive into the many different takeaways, interpretations, and attributes of the model itself, I would like to add a couple of definitions and explanations of the model, so that I can bring all readers on the same page. The supply and demand model is shown in Figure 1. It mainly features an upward sloping line — denoting supply, a downward sloping line — denoting demand, and an equilibrium point, where the two aforementioned lines intersect. These attributes are defined by very key concepts in microeconomics, the Law of Demand for the demand line, and the Law of Supply for the supply line. Simply put, The demand line is the summation of every individual’s respective quantity demanded for a good at every price. The supply line is the summation of the quantity every producer is willing to supply at the respective point. At the simplest level, the Law of Demand denotes that as the price goes up, consumers demand less and less quantity of a good. Conversely, the Law of Supply denotes that as the price goes up, producers are willing to supply more and more of a good to the market of a good. The equilibrium point is where the quantities consumers demand, and the supply that producers can supply are equal. Consumer surplus, which is the upper triangle to the left of the equilibrium point, is the summation of the difference in price between how much consumers are willing to pay for the good and the price at the equilibrium. Producer surplus, which is the lower triangle to the left of the equilibrium point, is the summation of the difference in price between how much revenue producers are willing to receive for the good sold and the price at the equilibrium point. The Elasticity of demand is the instantaneous slope of the line at a point on the demand line representing how much a consumer is willing to buy if the price were to change. The Elasticity of supply is the instantaneous slope of the line at a point on the supply line representing how much a producer is willing to produce if the price changed. Please re-read this paragraph to make sure you understand all of its elements and derivations.
The supply and demand model is the first major model taught in an Economics 101 class. It is usually taught to emphasize a competitive market with many producers and consumers and ends up rearing its head throughout the course in terms of the Labor Supply model, Imperfectly-competitive models, and even in the aggregate supply and demand model in Macroeconomics. As the first Economics model introduced to students in a class, it does a very good job of displaying very key concepts: demand, supply, equilibrium, elasticities, surpluses, etc. It also gives the introductory students a familiar face they can call on to reference aspects as they progress through the treacherous journey of economics. This model also does a good job of being a relatively easy diagram for students to grasp and reproduce when needed. How much this model is reproduced and represented in popular media is proof that it is overemphasized. The overemphasis on this model can be a pro if students need a keepsake to hold on to as they approach new, and unfamiliar concepts in their journey in economics.
After the first Economics class, the reliance and emphasis on this model can be ill-fated and cause inefficiencies in understanding. There are a couple of misunderstandings and gripes that many have with this model. It can be argued for the sake of simplicity and easy-understanding, there are a lot of hand-wavey aspects that do not translate to more rigorous economics. One of the first issues a new student may have with this model is “Why is the quantity on the x-axis and the price on the y-axis? According to the Laws of Supply and Demand, shouldn’t price be an input and supply be an output of both the quantity demanded by consumers and quantity supplied by producers?” As new students to economics, this is a confusing point as students have been used to having input variables be on the x-axis and transformed on to the y-axis through their mathematics classes. This also peels back a layer of abstraction into how arbitrarily prices are agreed upon in this model. Prices are not arbitrated in this model but are very vaguely “given” to both suppliers and consumers (Shostak). They are given and taken but the method by which this occurs is not agreed upon (Shostak). This point of confusion can cause troubles down the line as students are not used to prices benign negotiated.
Another oversight of this model is how it fails to approximate what occurs in real-life. There are no supply and demand curves in real life, it is not that simple. In reality, there are no equilibrium points as well. In the equities and derivatives markets, there is no equilibrium point. At your local Walmart, there is also no equilibrium point for goods as well. Trade and price-arbitration are attributes that have no accurate, true-to-life models. Its overemphasis shows in how introductory Economics students will try to see the whole world through this model. These aspects are both time-variant, and the supply and demand model does not display this at all. This specific point can be confusing to students as it frames a poor view of other, time-variant, models in economics.
The demand and supply model has an overemphasis on economics and for good reason. The aspects of this model show up through the course of a degree in economics. Noting the many problems of this specific model, it highlights many key aspects that are continuing themes throughout economics. This model is overemphasized because it is taught in a beginner class and is given to students to use to frame all of Economics forthcoming. This model is overemphasized but the pros of its popularity far outweigh the cons.
Works Cited:
Shostak, Frank. “Problems with Mainstream Theories of Supply and Demand: Frank
Shostak.” Mises Institute, 22 June 2018, mises.org/wire/problems-mainstream-theories-supply-and-demand.
