The Science of Demand (29) - Unofficial Translation of Steven Cheung's 经济解释 - 科学说需求

Section 2.  Friedman’s Analysis

Price is a variable, so is quantity demanded. The law of demand says that these two variables are inversely related (the demand curve must slope downward from left to right). However, using a single good as an example, besides the price of that good, there are infinite other variables or things that can affect its quantity demanded. The other things that can change but are assumed unchanged (or ceteris paribus) are called parameters. Although we have refuted the existence of Giffen goods in a competitive society, let’s not leave the theme of Giffen paradox so soon, since in remedying this paradox, we can learn a great deal on how to approach variables and invariables. This is crucial in comprehending the law of demand.

To safeguard the explanatory power of the law of demand, it is a crucial topic about which thing can change and which cannot. There are two reasons. First, economists hope that in managing the variation or non-variation of other things, the predicament that the law of demand cannot be derived due to the Giffen paradox could be remedied. Second, the law of demand cannot assume the aforementioned other things all vary or all constant. That is, besides a good’s price and quantity demanded, the law of demand is also founded on the premise that certain things are allowed to change, while some other things are restrained not to change. As such, choosing things that can change and cannot change becomes a science.

Let’s discuss the first point: using the choice of invariables to refute the Giffen paradox. I will mainly discuss Friedman’s 1949 article, “The Marshallian Demand Curve”. I consider the Marshallian demand curve elucidated by Friedman not Marshall’s but Friedman’s himself. I also consider the focus of the article brilliant but not without problem. Knowing how talented Milton was, this extraordinary article was repeatedly studied by me as a student, altering my view on economics. Whoever does not believe Milton is indeed the twentieth century’s dean of economics should take a close look at that article. I sincerely admire Friedman, and am whole-heartedly grateful for his teachings, though at times disagree with him. This is an utterly opposite phenomenon between Western and Eastern academia.

Friedman’s “The Marshallian Demand Curve” is rich in content and profound in thought. It will take a long while to discuss in length, so we will only comment on one of its main points here.

Friedman was concerned that the utility analysis could not derive the law of demand – i.e., could not deduce that the demand curve must slope downward toward the right. This law is indispensable, and if utility number remains unchanged (or real income unchanged), then the convexity postulate is the same as the law of demand. The problem is if we assume money income unchanged (generally assumed), a fall in price will lead to a rise in real income, then the law of demand will be perplexed by the Giffen paradox. Friedman asked: “Should the demand curve assume money income unchanged or real income (utility number) unchanged?” His answer was that either one was about the same! As such, the demand curve, only allowed to slope downward toward the right, becomes a law.

The prediction of Friedman was, in a society without unemployment, a fall in price of a good will not lead to any rise in real income. This is due to price changes only causing a shift in the allocation of resources instead of an increase in income in the society. That is, the Giffen paradox in the utility analysis is merely the result of partial equilibrium. If we view the world from the perspective of general equilibrium of the society as a whole, the Giffen paradox is untenable. As such, the law of demand is established.

Generally speaking, this Friedman’s analysis is correct. The problem is exceptions still exist. For instance, in a bumper harvest, the price of agricultural produce will fall significantly, yet people’s real income will rise. And when the government provides substantial subsidy for education, school fees will tend to fall to almost zero. Though the income of the society as a whole will not rise, the real income of students will increase, hence logically the Giffen paradox might appear in the stratum of students.

No capable economists would disagree that if the law of demand were untenable, the entire economic framework would fall apart and be destroyed. Strictly speaking, Friedman’s aforementioned article does not resolve the Giffen paradox issue, yet this article is important in the sense that his partial equilibrium analysis has the substance of general equilibrium. More importantly, in demand analysis’ choice of variables and invariables, this article and Friedman’s “Price Theory” in 1962 have taught us a great deal.