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In his hugely successful book, Thomas Piketty writes:

To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process: the mechanism of supply and demand. If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which should lead to a decline in its price.

This is circular, because a decline in price $p$ would again lead to an increase in quantity demanded $q$ which would again contribute to a situation of excess demand, right?

$\text{Excess demand} \implies p\uparrow \implies q\downarrow \implies p\downarrow \implies d\uparrow \implies \text{Excess demand}$

Is Mr. Piketty forgetting to consider a possible supply-side reaction to the described excess-demand situation situation? What could be the reasons not to include this? Does it serve his argument? Is it economically as untenable as it appears?

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    $\begingroup$ This is more a comment rather than a question. $\endgroup$ – user157623 Dec 15 '14 at 19:45
  • $\begingroup$ The part of your question :"this is circular..." is your thoughts or it continues the quotation? $\endgroup$ – Alecos Papadopoulos Dec 15 '14 at 19:46
  • $\begingroup$ @user157623: My question is whether this is as untenable as it seems, from an academic point of view or whether it can somehow be justified economically within the framework of economic reasoning. The reason why I am asking is because it seems so unlikely that such a successful book would contain such an obvious flaw. So, is there a flaw? $\endgroup$ – Constantin Dec 15 '14 at 20:04
  • $\begingroup$ @AlecosPapadopoulos: That is part of my question (as is evident from it not being part of the blockquote). Piketty suggests that the mechanism he describes "resolves the problem" of high prices. What he does not mention is that there is again a reaction to a decrease in prices, which would lead -- in my understanding -- to the same situation of excess demand. Now I naively assumed that the flaw is more likely in my reasoning rather than that of Mr. Piketty. That is what my question is about. $\endgroup$ – Constantin Dec 15 '14 at 20:06
  • $\begingroup$ You might want to have a look at this question: economics.stackexchange.com/questions/29660/… $\endgroup$ – Hans-Peter Stricker Jun 5 at 13:05
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The quote describes a very specific situation, which is not the general description through which the "law of supply and demand" is presented in non-technical terms.

It says

If the supply of any good is insufficient

The correct term would be "quantity supplied at a specific point in time". Then the "insufficient" part, supposedly means "quantity supplied is less then quantity demanded". Ok. Then it says

and its price is too high

So not only suppliers bring in the market a lower quantity that the quantity demanded by the consumers, they also "charge" a "too high" price... "too high" with respect to what? Presumably the consumers' "willingness to pay"?

So the first part of the quote describes consumers that have a priori specified both quantity desired and maximum acceptable unit price: "I want to buy 4 kgr of bread but at a price of no more than 0.5 euro/ Kgr." I understand that this sounds familiar: we tend to determine our needs/wants both in terms of quantity and we have some idea about what a "reasonable price" could be, by our past experience.

But once a consumer has specified two aspects distinctly, it must also decide on priority, if any: if the price is above 0.5 euros/Kgr, will he buy nothing? if this is case, then this consumer has "lexicographic preferences" over the unit price: he cares first for the unit price, and then for satisfying his needs through the consumption of bread. If the unit price is not right, he won't buy at all. This is a special situation, not just theoretically, but as to the degree it represents the "majority" of consumer behavior as observed in practice.

But ok, let's analyze the special situation presented in the quote.

The bakery has only 2 kgr and sells for 1 euro/Kgr. I won't buy at all, because the unit price is not right. I don't care whether the baker brings in 2 more Kgr to reach 4 - as long as "the price is not right", I am not buying. So for this special case, "supply responses" are irrelevant. Now if the baker lowers the price to 0.5 euro per Kgr, I will buy his 2 kgrs, (Piketty's quote ends here)
and I will tell him that I am willing to buy 2 more Kgrs as long as he will sell these 2 additional Kgrs also for 0.5 euros. If the baker agrees, "supply responds" and the price is not raised back. If he brings in the 2 additional Kgrs but raises the price above 0.5 euro/Kgr, they will be left unsold, and we will have excess quantity supplied, not excess quantity demanded.

What would be a more general framework?

"I will spend 2 euros for bread. if the price is 0.5 euros/Kgr, I will buy 4 kgr. If it is 1 euro/Kgr, I will buy 2 Kgr. Etc". In other words, through its utility maximization, the consumer will determine the budget share that he will allocate to bread, and quantity demanded will be determined by the price. Assume that there exists also a second consumer, that he has decided to allocate 4 euros for bread. The baker appears with 4 Kgrs charging 1 euro each.
The first consumer asks 2 kgrs and the second asks for 4 kgrs, for a total of 6 Kgrs. We have excess quantity demanded, but not "too high a price".
Now, the baker is not in our heads, he does not know the budget shares we have allocated for bread: he thinks "hey, these guys ask for more than I have, so it may be the case that I can still sell my 4 Kgrs for a higher unit price, -they seem to really want that bread so maybe they are willing to pay a higher unit price".
He then declares that the price of bread is now 2 euros/Kgr. The first consumer then asks for 1 kgr, the second asks 2 kgr, for a total of 3 Kgrs. Now we have excess quantity supplied. This is how the "cobweb" theorem works bringing market equilibrium.

Of course the baker could conceivably think "hey, let's make 2 more Kgrs, since these guys ask for 6 Kgrs in total, keeping the price at 1 euro/Kgr". Whether he will choose to sell his 4 Kgrs for 1.5 euro/Kgr, or 6 Kgrs for 1 euro/Kgr, I will leave for the OP to contemplate.

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