10/15/2009

What's More Stimulating...Supply or Demand?

Over the past year, we have seen various stimulus packages in an attempt to re-energize the economy i.e. the cash for clunkers, bank bailouts, individual tax credits, and the housing stimulus tax credit. An article I read introduces the idea of stimulating the supply of goods, not the demand. It talks about how consumers have unlimited needs and wants, so the demand for a product is always there. It is in the supply of a good, more specifically the price of a good supplied, which deters one from purchasing the product. "Supply stimulation is achieved through the transfer of productive assets from those who paid too much, to those who can put the assets to profitable use at a lower purchase price." What this means is that instead of sitting on abandoned homes and idle manufacturing plants, the assets need to be sold at a loss to someone who could create the product at a market-clearing price. "Through the creation of supply at lower prices, demand is stimulated."

Although I see the logic behind the author's reasoning, I am not fully convinced supply is the answer to solving an economic recession. According to a recent Gallup poll on consumer confidence, the demand for products has decreased dramatically from a $116 3-day rolling average in September 2008 to a $52 3-day rolling average in September 2009. That is a decrease of over 50% in spending per person on a 3-day average. Prices may be too high; agreed. But even people who have not been affected by the economic hardship are still skeptical on spending. Even if the supply has reached a market-clearing price, less people are inclined to demand products. Only at market equilibrium can supply and demand be maximized. And if one is able to produce supplies at a lower cost, then more power to them. However, it will not cure the lack of products demanded.

This article can be found at:
http://www.realclearmarkets.com/articles/2009/03/its_time_to_stimulate_supply_n.html

5 comments:

skylar said...
This comment has been removed by the author.
skylar said...

I am not so sure that I agree with the article. Consumers do not have an unlimited needs and wants for goods. Yes our wants are unlimited in some cases but our needs are very little. It is interesting to see how the government likes to play with the demand and supply of products, not only governments but financial institutions like to play in the same field.
I do agree that we should not sit on abandoned homes and idle manufacturing plants, but when the price is right they will all be put into use rapidly. Things are still out of whack! When supply and demand work themselves out, which they also do, things will get better with time.

Rebecca said...

I think Say's law proposed the same theory that "supply creates its own demand." That one didn't really play out too well.

The best way to stimulate demand is to increase income, particularly, disposable income. Income is increased through creation of jobs. Job creation is not hard. Hire firms and people to dig holes in the desert and then go back and fill them up. Viola, jobs. Once people have money burning a hole in the proverbial pocket, they won't save it (this is America), they will spend it.

That is the idea behind Recovery or Stimulus projects. The drawback is that large firms well versed in government procurement take most of the stimulus dollars and only a small percentage (in the form of wages) goes to the working class.

So neither is more stimulating, they both are constantly changing in response to incomes, prices and each other.

Dr. Tufte said...

-1 on Rebecca: you spelled the musical instrument "viola" when you meant "ouila".

Recessions are about coordination failures: people who will buy not connecting with people who will sell. We don't understand why that happens.

It also isn't clear whether stimulating supply or demand can really help that much. We are also unsure of the role played by uncertainty about policy: are people refusing to coordinate because they feel the ground shifting under them? We just don't know.

Rachel said...

I think supply and demand is two sides of one coin. In this recession demand decrease because people spending less than before and supply still there. When house hold income increase, demand increase automatically because people spend more. For increase income government need to produce new job in market. Or firms can control on the supply and make balance for market supply and demand. I agree with Rebecca Supply and demand are both depending on income, price and inflation. So I think stimulation for only supply is not more effective for recession.