SUPPLY AND DEMAND. Economics, or political econ omy, is sometimes defined as the science of supply and demand. Although this is an inadequate definition it cannot be said to be altogether misleading. A very important part of Economics, and the part which probably has the best title to the name of science, has to do with the operations of supply and demand and with the way in which variations of supply and demand are related to the movements of prices and to changes in the production and dis tribution of wealth. The "law of supply and demand" was not invented or discovered by the economists, however, nor do they lean very heavily upon it as a general explanatory formula. Long before there was any systematic analysis of economic processes men had observed that prices vary with supply and demand, and from the earliest days, traders have had to take account of that circumstance. The economist's task has been to scrutinize those characteristics of human behaviour and of the physical en vironment which determine the various forms or patterns in which supply and demand appear and to inquire into the compli cated interactions of the demand for and the supply of different commodities and services.
Elementary Principles.—Consider the familiar theorem that the price of a commodity must be such as to make supply and demand equal. If supply is taken to mean the amount sold and demand the amount bought the theorem is mere tautology, for supply and demand become different names for the amount trans ferred from sellers to buyers at any price whatever. But if it be understood that demand means the amount which buyers would be willing to take at a specified price, that supply means similarly the amount which sellers would be willing to part with at a specified price, and that demand and supply vary in some systematic and continuous way and in opposite directions as the price is raised or lowered, the theorem has meaning and signifi cance, for there will be one price, and only one price, at which supply and demand will be equal.
In another elementary theorem, namely that an increase of de mand for a commodity will raise its price, that an increase of supply will lower it, and that a decrease of supply or of demand will have an opposite effect, other meanings are attached to changes of supply and demand. Here an increase of demand or supply means an increase of the amounts which will be taken at given prices, not an increase which is dependent upon a reduc tion of price. The general state of supply and demand, in the sense specified in the preceding paragraph, can be represented by lists or "schedules" of "supply prices" and "demand prices." In this other sense, however, supply and demand are regarded as independent variables, and a change of supply or demand means an alteration of the schedule of supply prices or demand prices, such as might come on the one hand from a change of consum er's preferences or an enlarging of the market or, on the other hand, from a change of costs of production.
It is proper to assume that at any given time the immediate general condition of supply might be represented by a schedule in which the progressively higher prices which are required to evoke a progressively larger supply are set forth. But if the commodity is one which can be produced more economically if produced in large quantities, the ultimate effect of an increase of demand, in the sense of an increase of the amounts which will be taken at specified prices, will ordinarily be to reduce the price per unit at which these larger amounts will be supplied. In a schedule of supply prices constructed on the assumption that sufficient time is allowed to permit the necessary economies to be effected, larger supply will be associated with lower prices. When the long period schedule of supply prices is of this type, the commodity is said to be produced under conditions of decreasing costs or of increasing returns. When, on the other hand, because of the scarcity of some necessary productive factor, increased supply cannot be had, even in the long run, except at a higher price, the condition is described as one of increasing costs or of diminishing returns. The factors which give rise to increasing returns should not be confused with the circumstance that in many industries certain outlays (e.g., for plant and equipment) have to be in curred in advance or with the further circumstance that in a growing industry such outlays are ordinarily considerably larger than the volume of output immediately in prospect would re quire. Under such circumstances the additional or "prime" costs incurred by reason of an increase of output may be rela tively small. Furthermore, with a progressive increase of output there will be a progressive diminution of costs per unit of output, because the general, supplementary, or "overhead" costs will be spread over a large number of units. But although when the mar ket is sluggish or when competition is especially keen, prices may be cut to a point where they barely suffice to cover the addi tional or "prime" costs, this condition, which cannot be lasting, should not be confused with a true condition of increasing re turns, for this last condition is to be found only when a gradual increase of output is attended, in the long run, with genuine econ omies.