The Third Law of Economics.
“Economists do not know very much.” by Richard Feynman.
Ben Bernanke (known as Helicopter Ben) was the head of the US Federal Reserve when the US banks were bailed out. He co-wrote an economics book “Principles of Micro-Economics.” which shows the reality of Feynman’s law of economics.
In chapter 6 the authors try to justify the economist’s supply graph. This is a graph of supply quantity versus the market price of a good. It is shown as a graph with a positive slope often as a straight line with a constant gradient (sometimes nonsensically through the graph origin). This is a fundamental dogma of economists.
Quoting from the textbook: “To gain a deeper understanding of the origins of the supply curve, it is helpful to consider a perfectly competitive firm confronting the decision of how many to produce.” He doesn’t realise that most manufacturing is done to satisfy orders and not in the hope for a sale.
“The firm in question is a small company that makes glass bottles. To keep things simple, suppose, that the silica required for making bottles is available free of charge from a nearby desert, and the only costs incurred by the firm are the wages it pays its employees and the lease payment on its bottle-making machine.” Much ignorance is shown here: Desert sand is not a free resource that can be used. Locating a plant near a desert would induce many extra costs of transport etc not included. The silicon dioxide is the essential resource which has costs to mine, extract, and grind to a sand size, plus transport costs. Transport costs mean that the best place for a plant is near the market not a place near one of the material supply. There are many more fixed costs than just the bottle-making machine. The plant, and administration are costs to be included.
“The employees and the machine are the firms only two factors of production.” Very wrong; The silicon dioxide is a significant cost, the sodium carbonate component has a cost and the lime (calcium carbonate) are variable costs to be included. If cullet is used, then this will incur some costs. The bottle-making plant is not the only fixed cost. The furnace for melting the glass is a significant cost having only about a five year life span before having to be rebuilt. The fuel for heat is a very significant cost. Heat is required to melt the ingredients initially and then required to keep the furnace hot all the time as heat is radiated away from the furnace independent of the production rate, plus all the gobs of molten glass extracted to make a bottle also take away heat from the furnace. The bottle-making machine will have a number of bottle moulds which will have to be installed to satisfy the orders (say a winery that favours its own bottle designs.) with the machine idle. There will be a cost for each run of a bottle type (because of the significant time to change the moulds) so the contracts for supply will have a cheaper rate for longer runs. (Note more = cheaper.) Not considered at all is the annealing plant that is used to bring the bottle temperature down slowly to remove stresses. Again a fixed cost that operation will induce variable costs such as electricity to operate.
The authors also say: “For our bottle market, we will assume that the number of employees can be varied on short notice but the capacity of its bottle making machine can be altered only with significant delay.” Note the use of the words suppose and assume as in most economics textbooks. They are two words that indicate that economics is not a science. In reality, if the skills required are to kept, then employees should not be altered at short notice and the assumption eliminated by reference to the reality of bottle producers need to keep trained workers included.
The book asserts without evidence that: “ … beyond some point the additional output that results from unit of labour begins to diminish.” The book continues to create a phony table of costs to produce marginal costs per bottle that increase after only two points in the seven point table. If the authors had seriously looked into the reality of bottle making they would have found that the variable costs in practice attributable to labour are about one quarter of the total variable costs. As the machine actually makes the bottle from each gob of molten glass, the variable labour costs are not linear with production but more connected to the rate of change of bottle type.
A true cost tabulation would show that the cost is the total of a fixed cost plus variable costs strictly related to the rate of production plus the labour costs which may have a diminishing effectiveness or even an increasing effectiveness.
As an equation: Cost per financial period = fixed costs per period plus variable cost rate multiplied by the quantity of production in the period. Transforming this equation to get a price per unit compared with the quantity of production we get: Price per unit = Fixed cost divided by the rate of production plus the variable cost rate. A plot of this will show a graph with a negative gradient, not the economists positive gradient fantasy. The higher the production rate, the more the fixed costs are spread over the production, making the costs lower for higher production orders. The winery ordering its favoured bottles must consider it’s cost of holding big volumes of bottles and its cheaper cost versus holding less and ordering as needed with higher unit costs. The fundamental flaw in the economists theory of supply and demand equilibrium is shown in this example.
Further the supply of a bottle of wine to an actual purchaser is not made by the bottle maker. Nor is it made by the vineyard. The purchase is made from another party (a shop I categorize as a distributing agent) who purchases in bulk from the vineyard and sells individually to the consumer. This is where the greatest cost increment of supply takes place unconnected to the costs of manufacture (often in multiple steps).
The consumer/ supplier model is wrong. The model should be consumer/ distributor/ manufacturer one. The distributor exploits the difference between market demands and producer costs to its advantage.
If this the most suitable argument to justify the economists supply curve, then I have a thought that economics is more like a religion with an unjustified faith in an idea that is contrary to reality. No theories based on assumptions can be called scientific.