Demand and resource constraints

My default model for questions like, “what happens to prices if demand increases” is a typical Marshallian cross: supply slopes up and demand slopes down, so increases in demand (“outward” shifts) causes prices to go up. That is, I start from a model where resources are the relevant constraint.

One gets a different conclusion starting from a model where supply slopes down. Resources will eventually become scarce so supply has to eventually slope up, but maybe the fixed costs are relatively large and demand has not yet brought us to resource scarcity. Then an increase in demand could reduce prices.

I say “could” because it’s exactly when fixed costs are large and demand is constrained that markets tend to have few suppliers. “Natural monopoly” is a loaded term (“natural” often needs explaining) but a real phenomenon. So while average costs may go down and marginal costs may not go up, increased demand may not reduce prices if suppliers have market power.

These are very much “things you learn in econ 101” but also easy to forget in the weeds of econ 901. The gap is biggest, I think, in graduate curricula, where there’s pressure to cover technical material and research practices but less attention to ways the world is often weird-but-reasonable. I often think it would be useful to bring more “industry case studies” into graduate core micro courses. While the macroeconomists have thought quite a bit about problems of insufficient aggregate demand, I don’t know that the current microeconomics zeitgeist much emphasizes demand constraints at the industry level.

Demand constraints in this sense seem endemic in advanced technology sectors. Rockets, satellites, new clean energy systems, etc. I would not be surprised if there is a “simple” theorem on the relative merits of demand subsidies over input taxes in these cases (perhaps with strong assumptions on competition to keep it “simple”) that is either unproven or languishing in a theory paper from the 1970s.