On Supply and Demand:
A Conversation
by Paul Lytle
Jefferson was roused almost immediately from his leather bound book and looked to us with a furrowed brow. "What did you say?" he said, and closed the book around his long thumb, which became his temporary bookmark. The room we were in was a shared library and billiard room, and three walls were almost completely covered by leather bound books. Only when desperate would Jefferson buy a paperback or even a regular cloth hardcover, and these times of desperation came most often when he was looking for a text which was long out-of-print, for Jefferson owned not one book that had not aged fifty years or more.
The floor of the room was shared by three leather chairs and a billiards table, the latter of which was holding my and Steve's attention, while Jefferson sat in his customary chair to, until Steve had drawn his attention, read.
"I was merely saying," Steve said, "that this increase of the minimum wage Congress is proposing is a good idea."
"I suppose it is if you want to make less this year than you did last." And he reopened his book.
"What?" demanded Steve, incredulous. "How do you figure that I will make less every year if the minimum wage is increased?"
"Simple Supply and Demand," Jefferson replied, and he put up his book again, this time for good. Without looking he retrieved his pipe from the table beside him and began to fill it with tobacco. I sat down also, knowing that our billiards game would have to wait.
"Do you understand how the supply curve and the demand curve are formed?" Jefferson asked, his eyebrow askew. Steve shifted his weight from one foot to another, and Jefferson said, "I suppose not. Useful things are not always taught in public schools these days."
He took a piece of paper from his desk and drew a large "L" upon it. The bottom, horizontal line he labeled "Price," and the line to the left, the vertical one, he labeled "Quantity." We recognized then that he was making a graph, but he put no values in the fields, but left the equation theoretical.
"Now, Steven," he said, looking up. "Let us pretend that we manufacture televisions, and we can make a television in about an hour's time, meaning that we can make eight in an average work day, and so on. If you could sell one of those televisions for ten dollars, would you go into business making the televisions?"
"Wait just a moment," I said. "What about costs of production? How much does it cost us to make that television?"
"We will get to that in a moment, so let us say that it costs nothing to make the television. So all ten dollars would be profit; that is, ten dollars an hour. Would you do it, Steven?"
"Yes," was the reply.
"What about you, Paul?"
"No," I replied. "I make more than that already."
"And neither would I," Jefferson said. He placed a dot near the meeting of the two graph lines. "At ten dollars, only one of us would produce televisions. But what about fifty dollars? Steven?"
"Certainly."
"And you, Paul?"
"For fifty, I would."
"But I would not," said Jefferson. "My salary well exceeds that hourly rate, and it would not profit me to leave the practice of the law to manufacture televisions." He placed another dot, one higher and to the right. "But at a hundred I probably would. You, Steven?"
"Of course."
"And Paul?"
"Yes."
He marked his last dot. "What we have now is the supply line." He drew a line connecting the three dots, and the line went from the bottom left corner to the top right. "Do you see how, when the price of a product increases, more people would be interested in producing it?"
"But we only have three marks," Steven said. "How can that represent everyone?"
"Do you not see that a few people would form a business if it promised ten dollars an hour's profit, and more for fifty, and yet more for a hundred?"
"Yes, I see that."
"We do not have complete information, but the information will do for our purposes. It is unscientific, but we are only looking at trends, not actual numbers. Let us move to demand. For ten dollars, how many here would buy a quality television?" We all said that we would, and he made the mark, which was close to the left for a low price, but high on the page for high quantity. "For fifty?"
"I would," I said.
"Not me," said Steven. "I already have a television."
"Two then." The mark was exactly at the center of the supply line. "For a hundred dollars?"
"Perhaps not," I said. "I do not need a television that badly."
"But I might," said Jefferson. His last mark was low on the quantity side, but high in price. Once he connected the lines, the graph looked like this:
"Demand goes in the opposite direction," said Jefferson. "The higher the price, the fewer people would be willing to buy it."
"I see," said Steve.
"Do you concede to the trends I have described?" Jefferson asked.
"I do, but what does this have to do with the minimum wage?"
"Patience, Steven," Jefferson said. "What happens if the price is set too low?"
"The three of us all want televisions, but only one person is manufacturing them," I said.
"And too high?"
"Everyone's making them," said Steve, "but only you are buying."
"And since you want to sell for as high as you can without having too much inventory left over," Jefferson said, "what price would you put on your televisions?"
Steve and I agreed on fifty dollars.
"But we are not done, because televisions are not free to build. What if the materials and such costs us ten dollars per television? Steven, would you still sell for ten?"
"If ten dollars were lost up front to materials?"
"Yes."
"No, I would not manufacture them for ten dollars, but I would for twenty."
"Good." He redrew the graph carefully, but this time there was an extra line to the left, which he labeled "materials." The demand curve he left where it was, but the supply curve he moved in accordance with the new costs. "None of us would simply swallow these costs. Steven would sell for ten before, but not anymore, and nor would I sell for one hundred, but it must be one hundred ten now, else I would not go into the television business. We are interested, after all, in profit, and not simply price."
"So would we want to price the televisions at sixty now?" asked Steve.
"Not necessarily. You see, the demand curve has not changed. The consumer does not care about our costs of doing business. They do not care about our profit, but only price. If we price at sixty dollars, we have perhaps priced too highly, and we will have inventory left over. We must remember that these are curves, and so the optimum price does not change in exactly the same amount as the supply curve. The price is a meeting of the curves, or a compromise between them. We must account for that compromise. Since this is a scribbling, and not an exact graph, I cannot say what our optimum price would be, but it would be nearer to fifty-seven or -eight."
"So we are making less money," I said.
"Exactly. Where once we were making fifty dollars profit, we are now only making, say, forty-eight after the ten dollars we spent on materials. Besides which, we are now selling fewer televisions. We have concentrated on the price portion of the graph, but look now at the quantity. Look at how the optimum price is lower on the graph than it once was! Do you see it?"
"I do," I said.
"We are making less per television, and we are selling fewer. We could increase our prices to make more, but then we would have too many televisions. If we lower our prices too much, we will have a shortage. Neither the business man nor the consumer benefits from higher costs of doing business."
"So we would try to keep our costs down as low as possible."
"Certainly. The costs of materials, and buildings, and especially labor will push the supply curve to the right. Some things will affect the demand curve also. If the Super Bowl is approaching, more people will buy televisions, and the demand curve will move to the right. More people will buy, and the optimum price will rise. But if there is a rumor that our televisions are defective in some manner, it will move to the left, and the optimum price will lower."
"Now," Jefferson continued, "we should note that not all supply curves are the same, and neither are the demand curves."
"What do you mean?" asked Steve.
"I mean that a television is a luxury item, and though it does well as our example, if we set the price too high, no one will buy at all. But what about things that are more necessary? Perhaps electricity. When power rates increase, we might raise the temperature on the thermostat a little during the summer, but the rates would have to reach an incredible high before we would completely stop using electricity."
"Agreed," I said.
"So, in this case, price matters less than it does with television. The demand curve is flatter. But it can also get very steep. Would anyone here buy a pack of gum for five dollars?"
We agreed that we would not.
"The demand curve is very steep in this case, since everyone would take a free pack, but almost no one would spend five dollars, and still few would spend two dollars."
"What about the supply curve?" I asked.
"We know it is very difficult to build airplanes," Jefferson explained. "Even if you could make a million dollars on each airplane, none of us would go into the business, for we do not have the knowledge and we don't have the capital to start the company. No matter the price, few people will supply airplanes. The supply curve is rather flat."
"But if we could sell gum for five dollars," I said, "everyone would be making gum."
"Exactly. In this case, the supply curve would be very steep."
"So what does this have to do with the minimum wage?" asked Steve.
"We are getting to that," Jefferson said. "Consider that these costs move the supply curve to the right and raises the price. No one is happy with this. We are making less money, and the price for the consumer is raised. But cannot government regulation move the graph also? What if the government requires us to put a V-Chip into each television, and each one costs us a dollar?"
"The curve will move slightly to the right, which will increase price and decrease profit," I said.
"And if the government says I must hire Union workers only?"
"Price goes up, and profits down."
"And if I have to put in place new environmental regulations on my plant?"
"Again, the prices rise, and profits shrink."
"Some of these are, perhaps, good ideas, but we should understand the costs involved in any government action on our business. What happens if an overactive government places so many regulations on me as to push my costs out here?" He redrew the graph, with another new line labeled "Government." That line pushed the supply curve far to the right. It looked like this:
"We sell very few televisions and not make very much for each one," said Steven.
"And sometimes a government will put a price cap on our product, which is an ignorant thing to do, because it will insure that there will be a shortage of the product."
"How do you mean?"
"Simple. Think of our first graph. What happens if the government tells us that we cannot sell televisions for more than ten dollars?"
"I would be the only one supplying televisions," said Steve.
Jefferson nodded. "But how many would want a television?"
"All of us. Almost everyone in America."
"And there are not enough televisions to go around, so most of us will have to go without. The government sometimes decides that the Market's optimum price is unfair, but price is the most fair thing in the world! It measures how much a consumer wants an item by how much he is willing to pay, and everyone who wants our televisions enough to pay fifty dollars of one will get one. How is that less fair than people suffering through a shortage?"
"But we are selling televisions," said Steve. "How are we suffering all that much if we do not buy one?"
"True, a television is a luxury item, as I have said. But what about electricity? In this industry, the demand curve is more flat, but it is not completely flat. If power prices are very low, we may not turn down our air-conditioning when we leave during the day, or maybe leave all the lights on in the evening instead of turning each off as we leave that room. If the price is low enough, then it is simply not worth the trouble for the average man to conserve electricity."
"And this may cause a shortage?" I asked.
"Of course. If a government caps energy prices too much, then fewer companies will seek to provide power. Furthermore, more people will want to use it more often. We will eventually have a shortage. California did several years ago. They blamed everyone else for their problems, but it is undeniable that the blackouts would never have occurred if they had lessened the regulations and removed the price caps. But I am getting off the subject. In our company, government interference has increased our costs. What can we do about it?"
"Lower costs somehow or suffer," I said. "Perhaps fire some people and make those who remain work harder."
"The prices are high, and the profits are low. No one is happy. Would not a higher minimum wage do the same thing?"
"How do you mean?" asked Steve.
Jefferson said, "If it costs me more to hire a person, would not hiring him increase the costs of doing business?"
"I am not sure."
"Well, I must pay him, correct?"
"Yes."
"And paying him is more expensive than not hiring anyone."
"Yes, of course."
"Therefore my costs increase."
"I follow you now."
"Which would move the demand curve to the right."
"Yes."
"If I want to keep my profits up and the price of the television low, I must lower costs."
"Yes."
"If I am getting as cheap of materials as possible, and my building's taxes and maintenance cannot be changed, I must fire people."
"I see now. So raising the minimum wage makes it less desirable to hire someone."
"And this will happen for all industries?"
Steve shrugged. "I don't know."
"It is true that an increase in the minimum wage does not legally affect those who are already making above the new minimum wage, but an increase in wages in general would affect industries in general, would it not?"
"That is true."
"So the prices we find in stores of all kinds would go up."
"It seems so."
"So, Steven, the money you make now, will it not be worth less if the minimum wage increases?"
"I still don't follow," Steve answered.
Jefferson frowned. "If all the prices go up, you will not be able to buy as much unless your wages go up as well."
"Oh, I see."
"So what will a higher minimum wage do? Either prices will go up, increasing the cost of living, and thus lowering the actual value of what we all actually make, or unemployment goes up. And oftentimes both!" Jefferson snuffed out his pipe then, and the conversation was over.
Hungry for more of Jefferson? His first article can be found here.
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