Speaking at a coal-fired power plant in Maidsville, W.Va., on Thursday, Energy Secretary Rick Perry made a strange argument about supply and demand, seeming to confuse the relationship between two of the essential forces in the economy.
“Here's a little economics lesson: supply and demand,” Perry said, according to Taylor Kuykendall of Standard & Poor's. “You put the supply out there, and demand will follow.”
People often talk about supply and demand in economics, but not in the way Perry used the terms. In essence, supply refers to whether goods and services are readily available on the market, and demand refers to how badly consumers want those products. Just supplying a product does not create demand for it.
If Perry was suggesting that no matter how much coal the industry produces, there will be demand for it, he was clearly mistaken. Of course, demand for coal — or any other item — is not infinite. People will only buy so much of it at a given price, and producers will only be able to sell more if they bring down the price.
Another possible interpretation of Perry's odd remark is that he might have been repeating a theory that was once widely accepted among economists. On this theory, demand and supply will always be in balance across the economy as a whole. These days, however, many economists view this logic as deeply and dangerously mistaken.
This reasoning is usually associated with the French economist Jean-Baptiste Say, who argued in 1803 that oversupply in excess of demand across the economy as a whole was impossible (although he did not use those terms exactly).
Say claimed that the money consumers use to buy goods and services must come from, ultimately, those same consumers selling something else on the market. As a result, the supply from producers on the market would always be matched by demand, since — according to Say — producers would use what they earned making sales to make purchases for themselves.
Or, as Say's British contemporary David Ricardo wrote, “I think that demand depends only on supply.”
As later economists argued, however, people do not always use their money to buy things. Sometimes, they prefer to save money instead, or to pay down debts. That is especially the case during a panic, when firms and households are looking for security.
In that situation, then the supply of goods and services the economy produces can exceed the demand for them. When goods go unsold because no one is buying them, factories will sit idle and workers will be unemployed. Say himself recognized this problem after a financial crisis in England in 1825 and changed his tune.
The fact that Say seems to have been wrong initially is crucial to how modern governments manage panics. Today, economists and policymakers generally agree that during a crash, governments should put more money into the economy. When households and businesses have more to spend with, the demand for goods and services will increase, putting the economy back into balance.
John Maynard Keynes is usually credited with developing this remedy. According to the Keynesian view, if you put the demand out there, the supply will follow — not the other way around, as Perry said.
Keynesianism has held sway over public policy for most of the past century, but there are still some conservative economists who disagree with him. Perry might have been thinking of conservative objections to Keynes when he said that demand follows supply.
Yet in the context of a visit to a coal plant, it is not clear whether those objections are relevant. Say's arguments about supply and demand only applied to the economy as a whole, not to specific goods such as coal or electricity.
Say always recognized that there could be surpluses of particular commodities if it turned out that customers did not want them. Instead, he believed that firms would adjust to produce those goods that consumers did want to buy using their earnings from selling to the market, so that demand would always balance supply overall.
If producers in a given industry simply “put the supply out there,” as Perry said, they'll be left with warehouses full of surplus goods. In other words, demand does not follow supply any more than one blade of a pair of scissors follows another, to borrow an analogy from the economist Alfred Marshall.
“We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper,” he wrote in 1890.