Saturday, February 16, 2019

What Drives Price?

Saturday Mail Bag

John W. emails:

Dear Sir,

I'm a regular reader of EPJ.

I recently watched your video about Say's Law. Could you possibly explain a little more how the process of market clearing causes it to be untrue that there can ever be a deficiency of demand?

What drives price more: production or consumption, and why?

As a second question, am I understanding you correctly to say that markets always clear?

Thank you very much!


John W.

RW response:

The idea that there can never be a deficiency in demand is a pretty simple concept.

If something is an economic good, that is, it is something consumers desire, it will have a price. This is in contrast to a non-economic good, say, a pile of dust that no one is interested in consuming.

Think of it this way. Have you ever seen a BMW automobile or a mansion on a California beach that can't be sold for 10 cents? 

Markets clear, that is there is a price for every economic good. There may be people who don't like the market price but there is a price. 

How could a market not clear? If there are condos selling for $100,000 and there are buyers for that type of condo (and they are aware of the condos) that are willing to pay up to $110,000, why wouldn't they buy the condos?

If there is a condo owner demanding $10 million for a condo that others are willing to pay only $110,000 for, it just means the current condo owner prefers the condo more than the bid price, but for economic goods there are always bid prices and ask prices where exchanges can take place.

As for what drives prices more production or consumption, at one level, they both can have an immediate impact. The more of something produced will mean downward pressure on prices. At the same time, increased demand will mean upward pressure on prices.

Longer term, the consumer is in the driver's seat. A producer has to worry about the costs of production, if the costs are greater than what a consumer is willing to pay for a good the good won't be produced.


  1. I understand why you are saying the consumer determines the prices ultimately, but why dont they both really determine it together? I am just thinking about this on a small-scale free trade bartering example where one person makes arrows and another makes tamales and they trade. Which is the consumer and which is the producer? Dont they both have to come to an agreement that the other has something they value more so they can make the exchange. The consumer is basically "making" money and the producer making a product, and they can only make an exchange if they both agree on the terms. What am I missing where the consumer determines prices? Sure, but if those prices aren't high enough, the producer can also do something else that's more profitable.

    1. To think of things this way just makes it confusing. No one is trading arrows for tamales in the current global economy. Barter is near zero. You are completely ignoring the role of capital and the imputation theory:

    2. Hey, thanks! Watched the video and read about imputation theory and it makes a lot more sense now.