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By Teng Tai (Director of the Wanb Institute)
In the short term, demand affects supply, while in the long term, new supply creates new demand. When supply and consumption structures are relatively mature, supply can only meet demand. But when supply and consumption structures are upgraded, new supply will create an increasing number of demands.
Supply and demand are two sides of the same“economy coin.”Differences in perceptions or fundamental assumptions about them can lead to varied understandings of the overall economy.
Some economists, like Carl Menger, who contributed to the development of the theory of marginalism, and John Maynard Keynes, who established an aggregate-demand-oriented macroeconomic theory, placed emphasis on the dominant role of demand. According to their theories, changes in demand lead to changes in supply, thus the focus of macroeconomic regulation and control should be placed on demand.
Other economists study economic activity from the perspective of supply. French economist Jean-Baptiste Say believed that supply plays a dominant role in the supply-demand relationship, automatically creating its own demand. In the book titled The Wealth of Nations ,Adam Smith outlined the roles of institutions and the social division of labor in promoting economic development. Simon Kuznets focused on the input-output relationship and analyzed the role of population growth and production efficiency improvement in boosting economic growth. Joseph Schumpeter studied the process of economic growth from the perspective of technological innovation, which he argued was the core driving force of spiraling growth, while the creative destruction of technology and institutions promotes economic development in the long term.
Supplies without the support of real products or demands without the support of the ability to pay are only“desires.”People have different kinds of desires, which when inflated, can never be completely fulfilled. But this is different from supply and demand in economics. Economics studies the supply of real products or services and the demand with real affordability or willingness to pay.
People always have the desire for better products and services, but if there are no suitable products or services to meet these desires, they only stay at the psychological level. Only when new products or services emerge, can new demands be created. For instance, before the invention of cars, people wished to move around faster, but for centuries, the wish didn't create a real-life supply. Only when Karl Benz invented the world's first car, did the demand for cars appear. Humans had the dream to fly through the sky for thousands of years. However, before the Wright brothers invented the plane, it was only in fairy tales that humans could fly. Thus, only when the development of technology creates new supply which spurs a willingness to pay for new products and services is new demand in the economic sense created. In an isolated tribe where people didn't wear shoes, they still had a huge psychological need for footwear. So why was the supply for shoes not created for many years? This was due to the fact that the demand for shoes was only created when there was a real supply, that is, when shoe companies brought the product to the tribe. Therefore, an abstract desire cannot create supply, only real supply can create real demand.
Of course, in the short term, demand can affect supply. If there's not enough demand for consumption, investment or exportation, inventories will increase. As a result, manufacturers will lose motivation to produce and will reduce short-term supply. To summarize, supply creates demand in the long term, while demand affects supply in the short term.
In the existing market, for example during the agricultural era, people already had demand for food and housing. Supply could only meet demand but not create demand. However, in the new market, people's demands for movies, books and other information are created by the products themselves. Similarly, people's need for iPhones or Facebook appeared only after those products were created.
In a market with an unchanged supply structure, demand changes with changes in price, income and interest rate, among other factors.
D=f (P, I, R...)
D: Demand
P: Price
I: Income
R: Interest Rate
In an economy with a fast changing supply structure, market demand is not only affected by these factors, but also by new supply, which creates new demand.
D=f (P, I, R, NS...)
D: Demand
P: Price
I: Income
R: Interest Rate
NS: New Supply
Say believed that supply automatically creates an equivalent amount of demand. For example, the sales revenue for a supply of 1, 000 units of product will automatically turn into income for factor owners. Labor, capital, and land are reconsumed in the form of wages, interest and rent to form an equivalent expenditure of 1, 000 units.
Today, however, the idea that“supply automatically creates an equivalent amount of demand”doesn't hold water in most situations. It is an ideal state which is only true under certain circumstances. Most of the time, supply cannot create an equivalent amount of demand or any demand at all. What stops supply from creating an equivalent amount of demand?
From the income point of view, total income equals income from labor, capital and land. But when there is excess supply, it exceeds demand, leading to the overcapacity and overstocking of products. Surplus supply obviously cannot create an equivalent amount of demand.
Even when there's no excess supply, goods will still be unmarketable when supply is aging, which weakens supply's ability to create demand. In this situation, supply cannot create an equivalent amount of demand either.
New supply refers to new technology, products, business patterns or management models that can create new demand and new markets. Before Steve Jobs created the iPhone, there was no demand for the product. But once it came out, new demand was created. The touchscreen, the iOS operating system, the App Store and other functions have not only revolutionized people's understanding of phones, but also changed people's way of life.
New supply can be new technology or products like the iPhone. But it can also be a new business or management model. For example, Uber or Didi Chuxing do not sell any new products; instead, they created a new business model by integrating existing resources and collaborating with other industries. At the same time, they use the Internet and innovative technologies to provide comprehensive travel services for users, making it more convenient and cost-efficient.
New supply creates new markets by creating new demand. New supply in an industry can not only create new demand, but also stimulate demand in relevant supporting industries. Through industrial chains, new supply integrates with upstream and downstream industries and the entire economy to multiply new demand. Again as an example, the iPhone not only created its own demand, but also its own ecosystem with iOS and the APP Store. As the core of the ecosystem, the iPhone creates sustained new demand and new markets by upgrading its system and improving user experience.
New supply forms and creates new demand usually by mastering new knowledge, finding new factors, using new technologies and making system innovations. The process is restricted by economic policies and the cultural environment.
First, after gaining new knowledge, people can improve the ability to use resources efficiently, further creating new supply and thereby new demand. For instance, after grasping the characteristics of animals and plants, humans were able to raise livestock and plant fruit trees and grains. The expansion of food sources brought about new demands for food. People were no longer satisfied with hunting and instead began to systematically raise livestock and plant crops.
Second, finding new production factors can generate new supply and enhance supply's ability to create demand. The discovery of petroleum, for example, meant that there was a new energy resource that people could use, which created new demand.
Third, the emergence and application of new technology can also generate supply. The application of extraction and separation technology enabled chemists to extract gasoline and kerosene from petroleum for the production of dyes, artificial flavors and medicine, further improving supply. With the rapid development of the petrochemical industry, petroleum gradually replaced agricultural products as the main source of daily necessities.
In the Age of Discovery, people invented the sailboat and the compass. During the first industrial revolution, steamships and telegraphs appeared. The popularization of these products helped supply create demand.
Fourth, institutional innovation can also improve people's ability to utilize resources so as to create new supply. At the end of the 1970s, China implemented the household contract responsibility system with remuneration linked to output. Since factor supply conditions such as land, labor and technology remained unchanged in the short term, the system helped substantially enhance the supply capacity of agricultural products by raising productivity.
Sometimes, the direction and shape new supply takes is uncertain due to the fact that mineral resource exploration and technological innovation are hard to predict, while major geographical discoveries are accidental. However, new supply will definitely come in the form of a new product, technology, business pattern or management model and will create new demand and a new market by transforming people's living habits, improving production efficiency and changing the proportion of different supply factors.
We can find examples of new supply creating new demand at every economic development stage and in many aspects of people's lives. For example, during the time when people used candles for light and trained doves to be messengers, there was no need for lamps or cellphones. But once cars, lamps and communication products were introduced, new supply brought about new demand.
Let's look at how new supply creates new demand in Apple Inc.'s industrial chain.
First, the basis for new supply creating new demand is new commercial value, which is usually reflected in two ways: potential consumers and cost within a reasonable range. Before the iPhone was launched, keypad phones had developed steadily. Despite the emergence of a small number of smartphones, the entire industry was still dominated by keypad phones. This was all changed by Apple, which built a mobile platform and ecosystem that transferred the functions of searching the Internet, messaging and video communication, from the personal computer to the mobile terminal. People shed their dependence on office desks and desktop computers and gained a freer and more convenient information interaction experience. New commercial value was created in the process since the cost of this transformation was within reach of the target consumers because Apple controlled the development costs of its operating system and touchscreens.
Second, sustained investment in development and the improvement of user experience raised Apple's ability to create demand. Throughout the company's history, it has made several innovations in iOS and chip architecture to improve customer experience. Through continuous marketing and product upgrading, the iPhone created substantial new demand among customers.
Three, by integrating the upstream and downstream industries into an ecosystem, Apple formed a synergistic effect and created new markets. The company achieved deep product integration by establishing diversified platforms. For example, when people receive calls and messages on their iPhone, they can also get synchronous notifications on their iPad and MacBook. Notes, contacts, photos and apps can be synchronized in the cloud.
Four, improving supply's ability to create demand through the multiplier effect is an important way for new supply to drive economic growth. The sales revenue of Apple products and peripheral products turn into company profits, stock dividends, wages, interest, housing and land rent, which re-enters the economic cycle in the United States, accelerating the macrocyclic effect where supply creates its own demand. This helped the country to recover from recession.
Last but not least, Apple developed from having a strong pricing ability to forming a huge market. When the iPhone first arrived in the market, it mainly targeted certain customer segments; the original price was very high. The company earned surplus profit because of the scarcity of the product. When enough capital was accumulated for further expansion, Apple produced diversified products through marketing and technological upgrading and broadened its market to the average customer.