2. Supply & Demand

In a market economy like Hegemony, the prices of most goods and services are not set by a central authority. Instead, they are determined by supply and demand. Supply and demand are core principles of economics, introduced by economist Alfred Marshall in the 19th century. They apply to a wide range of goods and services in the modern economy. Supply is the total amount of a good or service that producers are willing to sell at different prices, depending on their cost of production. Consider the example of bread. In a market town with many bakeries, each one will be willing to sell bread for a price that covers at least the cost of baking it. A lot of bakeries will be happy to sell bread when the price is high, but only those that can bake bread at a low cost will accept a low price. Thus, the higher the price, the greater the total supply of bread to the market. Demand is the total amount of a good or service that consumers are willing and able to buy at different prices. People who love bread and have money available will be happy to pay a high price, in contrast to those who don’t particularly like bread or have limited funds. If bad weather leads to a surge in the cost of flour and bread becomes very expensive, then only a few wealthy, bread-loving consumers will want bread, and total demand will be low. But if bread is cheap, then many consumers will want to buy it, including all those who would have been happy to pay more.

How do supply and demand interact? Marshall argued that there is usually a price, called the equilibrium or market price, at which the quantities supplied and demanded are equal. In a market with many buyers and sellers, supply and demand keep the price close to equilibrium.

In one of his books, The Wealth of Nations, Adam Smith, an 18th-century philosopher and economist named this seemingly natural movement of supply and demand towards the equilibrium in a free market the “invisible hand”. The “invisible hand” is a metaphor for the unseen forces of the market that lead to the most efficient allocation of limited resources. The idea is that if each consumer can choose freely what they buy, and if each producer can choose freely what to sell, then a market with many buyers and sellers will determine the prices and quantities traded, satisfying each market participant as much as possible. How- ever, nowadays many scholars contest the notion that free markets always lead to the most socially desirable outcomes. Examples of market failure, described below, show that there is no guarantee that the “invisible hand” will always lead economic agents to make decisions in everyone’s best interest.

200 years later, Friedrich Hayek, a 20th-century economist, contended that prices are messages, capable of coordinating the actions of thousands of buyers and sellers, who have never met each other. That is because price changes contain all the information about shifts in supply and demand that economic agents need to make decisions. For example, if bread becomes part of a fashionable new diet and consumers want more of it, its price will rise. Bakeries will respond by increasing production, even if they are not aware of the new fad. The rising price gives them all the information they need to respond to growing demand.