Portion of Income

Supply, Demand, and the Individual Consumers

Last Update: December 2011

 
Basic economics focus solely on goods and price. The graphs are always shown in the middle. This approach lends to some misleading implications. Showing the graphs in the middle create the illusion that the potential supply is effectively infinite - supply can always rise to meet demand. Both analytically and intuitively we know this is not true. Yet our graphs don't analyze the limits. Ultimately an economy is about the citizens, not the goods. Yet the graphs focus on the goods, not the citizens. We wish to start a discussion in economics that recognizes the citizens as central and recognizes the finiteness of resources.

Let's switch from focusing on graphs that ignore citizens and finiteness to graphs that focus on citizens and finiteness. We'll start with a simple graph that acknowledges that production costs (and resource limitations) contribute to finite limits to goods. We compare three scenarios.

Situation C on the graph correlates to the traditional supply demand graphs used in popular economic debates. Situation C will allow for multiple producers, competing products, and multiple options. Situation C will allow both the producers to be happy with the profit they make and the buyers to be happy with the deal they are getting. But we don't always get this in real life.
In Situation B, the maximum the buyer can afford to pay is about the same as the production costs. Production and transaction can occur. But the producer will barely cover costs and the buyer will feel tapped. The economy will tend to slow down as both producer and buyer deplete funds. This is effectively what happens at the end of a bubble. Neither buyers nor sellers can afford the price of the transaction.

In situation A, (also shown on a traditional supply-demand graph) the minimum cost of production is higher than the maximum that the buyer can afford to pay. A transaction, and consequently production, can not occur without one or both parties suffering a loss. This situation will typically occur when resources become scarce. It also occurs after a bubble bursts when neither the buyer nor the seller can afford the new price of the transaction.
Sometimes production costs are high. Sometimes resource extraction costs are high. Sometimes resources are finite and competing demands for the same resource are so high that resources can not be used to cost effectively produce goods. When these things happen, we get situations A or B.

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The Housing Bubble

Over the last 50 years of the twentieth century, housing prices seemed to fit classic market theory. Prices fluctuated with supply and demand. Like situation C, in our graph, suppliers were able to produce large quantities with many variations. By 2002 a bubble started forming. By late 2007, the bubble was reaching its end. Situation B was occurring. By late, 2008, the bubble burst. Our economy reached situation A. Sellers could not find a market price that would cover their costs. Buyers could not find a price that they could afford. The economy as a whole no longer functioned.

 

Commodities

The housing bubble was exacerbated by commodity prices. Extraction costs, shortages, and speculation all drove commodity prices up. This limited what citizens could afford to spend on other desires such as housing. For many commodities the potential for problems still exist. Available sources are decreasing and extraction costs are increasing. Should the current demand trends continue against these increasing production costs eventually we will reach a situations B and A where production can not occur as production costs rise above potential purchasing funds.

 

  The more common scenario is that some potential buyers have enough funds to buy, and some do not. To address the consumers instead of the goods, we seek to create graphs to represent how different potential buyers will partition their purchasing based on income. Each line represents a consumer's total income. The first line represents a consumer earning about $22,000 and the last goes of the chart at the right for a consumer earning about $180,000.
 
Consider the buyers shown on the chart. They range from near poverty to near wealthy. The first consumer has a low income. He spends about 85% on necessities and about 15% on comforts, as demonstrated by where his line crosses the shading. The third consumer is middle class. He will spend about 30% on necessities, the middle 45% on comforts, and the last (top) 25% he can use for luxuries and investments. You can read similar information for the other consumers in the chart.
The black line on the chart represents the minimum production cost of a specific good. We can see that the poorer two consumers on our chart can not buy the item on a year's wages. The third consumer can but he would have to give up 95% of his wages to do so. His opportunity costs would include giving up necessities. The wealthiest consumer in our example would only have to spend about 35% of his annual income for this item. This chart provides a good starting perspective for considering how different costs will affect consumers with varying incomes.

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  But most items can be purchased with time. Either a consumer can save until they have enough money, or they can take out a loan. The question then becomes, how long will it take for the consumer to pay for an item. So to represent the burden of purchase we create a chart showing how long it will take for consumers to purchase an item. In this chart, we will assume that necessities will be paid for before saving for this item can start. (We can also create similar charts for necessities.)

On the chart, each line represents a different consumer by his income level. The lines start at the left side showing how much time would be required for each consumer to purchase a $1000 item. They end of the right showing the time needed to purchase a $100,000 item.

If an item cost about $1000, it will take a person whose income is just above the poverty line, about a year to save up for it. It will take a person whose income is about $100,000 less than a week to pay for it. Incomes over $1 million will require less than a day to pay for this item.

By the time we get up to a $10,000 item (such as a down payment on a house) it takes our near poverty consumer 10 years of responsible sacrifice and saving to have the funds. The person at $100,000 could have the funds for the same item in just 37 days. The person earning $1 million could purchase the same item in just 4 days. We see that time to purchase (after necessities) is key to understanding the burden of buying an item.
 
  Traditional supply-demand graphs may be good for discussing quantity and price. But they are not good for discussing how those prices will impact the consumers, the citizens. So we proposed here two alternative graphs to show the impacts on consumers. Had these graphs been used during the first decade, economists and bankers might have realized that with housing and commodity costs rising faster than incomes consumers could no longer afford the goods. They would have known that the bubble was due to burst. Ultimately this is what we need to know: how does the cost affect the citizens?  
 

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