The Science of Demand (28) - Unofficial Translation of Steven Cheung's 经济解释 - 科学说需求

Chapter V.  The Law of Demand

In the economic explanation paradigm, the law of demand, as far as I know, is the only indispensable theory. Either explicitly or implicitly, all the aforementioned postulates are incorporated in the demand curve of this law. All the other economic theories, if not dispensable, can be substituted by some others. The most important law of marginal output in the output theory, made famous by me when I first started, has seldom been used by me again when I grew older, since it can be substituted by the law of demand. That’s right – the food that we eat is a consumer good as well as a factor of production.

Until now at least, the law of demand is the only theory that has not been substituted by its counterparts. Being just a single curve, it incorporates much content, has plentiful variations, and involves profound concepts. Therefore, mastering the law of demand is never easy. And I say so from the economic explanation paradigm. The discussions and analyses throughout this whole book are all demonstrating either the content of this law, or how this law should be applied.

The law of demand says that whenever the price of a good declines, its quantity demanded will rise. From archaic days till now, irrespective of time or place, there are no exceptions. Using the vertical axis as price and the horizontal axis as quantity, the demand curve therein must slope downward from left to right. Certain books say that there are exceptions, for their authors are not treating economics as an empirical science. The reason is simple. In applying theory to explain phenomena or behavior, the theory itself must be refutable by phenomena or behavior. I have in Chapter I made this point clear. Supposing there are exceptions, and whenever refuted implications encountered are treated as exceptions, what then is empirical testing?

The law of demand is the spirit of economics. In any economics publications, I am able to assess the standard of the author simply by looking at his mastery of this law. This law needs not be literally mentioned, though content-wise it must be strictly followed – in my doctoral thesis, “The Theory of Share Tenancy”, I deliberately avoided mentioning “demand” to flaunt to my teachers.

Section 1.  Observation and Testing

In the previous chapter we said that with the three postulates of the utility analysis, given the existence of the Giffen paradox, we are unable to confirm the inexorable law between the decline in price and the increase in quantity demanded. A demand curve can be derived from the utility analysis, though this curve may not necessarily be sloping downward toward the right. In other words, the utility analysis cannot deduce the law of demand. On the other hand, the law of demand is not confined to the relationship between changes in price and quantity demanded. A good number of goods do not have market price, or under certain systems there is no market, yet the law of demand is still applicable. Without market price, we can instead use option forgone. In other words, any change in constraint can be interpreted as change in option forgone. The law of demand is still applicable to economic goods that cannot be exchanged due to their nature or the non-existence of a market. The approach, being a bit more complicated, will be explored later.

If the three postulates in the utility analysis could deduce the law of demand, then it would have been both rigorously logical and remarkably beautiful. However, from the perspective of explaining behavior, as long as we acknowledge that the law of demand itself is a postulate, or agree to my proposition that Giffen goods are not logically allowed to exist in a competitive society, then the three postulates in the utility analysis are superfluous. This is because the law of demand not only incorporates all the behavioral constraints of these postulates, but also one additional point: Giffen goods do not exist in a society. With changes in price or option forgone leading to a change in quantity demanded, the law already encompasses the postulate of substitution; and by refuting the existence of Giffen goods, its restraint on behavior is greater than that of the convexity postulate. Moreover, the selfish postulate that we mentioned in Chapter II – constrained maximization of an individual – is also incorporated in the law of demand, since as long as the choice stays along the same demand curve, it must follow the postulate of constrained maximization. In other words, as long as we accept the law of demand, the indifference curve analysis is redundant.

The price or option forgone in the law of demand is factual and observable in principle. However, quantity demanded refers only to the intended quantity of demanders which does not exist in the real world. As such, the law of demand itself is not testable. We must, therefore, assert additional test conditions, i.e., by specifying changes in observable constraints, before we can apply the law to yield hypothesis that is refutable by facts. In the next chapter I will demonstrate with a few real-world examples.

My point here is that if the price or option forgone in the law of demand is like quantity demanded – non-observable and non-factual – then the law of demand will be unable to derive any refutable implications, thus losing its function in explaining behavior. Simply one non-observable variable – quantity demanded – is hard enough to resolve, though resolving is still possible. We therefore have no options but to face the challenge of having an unreal quantity demanded.

Abstractive castle in the air is generally the starting point in theorizing, but for the sake of empirical testing, our hypothesis has to be inferred to observable phenomenon or behavior. In other words, abstract is necessary, though in general the less the better. As regards observation, there are three categories. The first one is non-observable and non-existent in practice. It is therefore insane to claim that they are observable. Quantity demanded belongs to this category. So does utility. The less from this category is certainly the better in testing. After decades of testing work, quantity demanded is the only non-observable “item” that I have to accept. The second category is real and observable. Price belongs to this category, and its level of difficulty gets relatively higher when approaching from the perspective of option forgone is required. The third category is observable in principle yet hard to observe in practice. We need to find indirect substitute for testing. The often-said marginal product in economics belongs here. Though it does exist, if not controlled in an artificial laboratory, it is close to non-observable. If “marginal” product is only imaginary and non-factual, then the “marginal product theory” in economics will suffer a crushing defeat. Note that quantity demanded belongs to the first category of observation which does not really exist but is only conceived by economists. We have to face it nonetheless. How we approach it could show the difference between an adult and a child.

“Utility” is also unreal. It is a great pity that the utility analysis could only derive the demand curve but not the law of demand. On the other hand, as will be shown in Section 5 of this chapter, the law of demand does not require any utility concept. The law of demand possesses greater restraint on behavior than the indifference curve analysis, but since it encompasses more concepts and variations which require ingenious handling, it is not at all easy to master.

Today’s development of economics indeed uses too many non-observable “intentions” or “motives” to tell nice and credible tales. But since these cannot be tested, the very nature of empirical science is contravened. To explain behavior requires the derivation of hypothesis that can be empirically tested. The less usage of variables or jargons which are non-existent in the real world, the better it is. Storytelling and scientific explanation are two distinct matters.

So complicated is the world that it is preferable to use simple theory to explain real-world phenomena. Utility analysis is usable, though it makes theory more complicated. Innumerable articles using the utility theory to “explain” behavior have their emptiness mercilessly exposed after the veil of mathematical formulae is lifted. The strengths of the utility analysis include its beauty, neatness and orderly structure if applied by masters, while its weakness lies in its proneness to fall into the trap of tautology. The law of demand can do without any content of “utility”, therefore is less liable to fall into this same trap. Without “utility” means the loss of a layer of façade decoration, forcing us to focus on the aspect of explaining behavior. Due to the relative simplicity of the law of demand, we can come up with variations more readily, and a simple theory with infinite variations displays the beauty of a different art. That said, rigorous utility analysis can nonetheless explain behavior. It is far from useless, though it needs not be used. The law of demand is another matter. Without the law of demand, never can economic hypotheses be tested!