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Modern Economics Only Applies to Ancient Times

(Cost and Demand Theory)

Pan Biao

Why can modern economics only be used to explain ancient societies? Well, this situation is a bit like ancient Newtonian mechanics being insufficient to explain the current world, and then quantum mechanics and relativity finally appeared.

Everyone knows that the foundation of economics is a theory called "supply and demand". Open any economics textbook, The starting point is to introduce this theory. See Figure 1.

In short, the demand curve means that the lower the price of a commodity, the more consumers will buy; while the supply curve is just the opposite, the higher the market price, the more producers will produce. The intersection of the two curves constitutes the price.

Of course, this theory has also become the foundation of macroeconomics, known as the "aggregate supply and aggregate demand" theory, with similar graphical and analytical methods. For instance, when analyzing inflation, it is caused by an excess of aggregate demand, which shifts the curve to the right and intersects the aggregate supply curve at a higher price point.

Why does the supply curve indicate that the higher the price, the more goods will be produced? According to modern economics, this is because the more goods a manufacturer produces, the higher the cost. However, in the real world, the opposite is true!

When you go shopping, whether it is as small as a pins, cookies, Windows 11, or as big as a TV, sofa, car... the more you buy, the cheaper it is! Why is this so? In addition to the fact that the more the merchant sells, the lower the commercial costs, the main reason is that the more the merchant purchases, the cheaper it is. Why is the more the purchase, the cheaper it is? Because the more the manufacturer produces, the cheaper it is!

 If the supply curve in the real world today is not like that of current economics, then, modern economics based on the theory of supply and demand is basically wrong!

Take information products, one of the most important products in today's world, as an example, and you will understand at a glance.

For example: application software, short videos, games, online novels, popular music... The characteristic of information products is that the cost of producing the first product is very high, but from the second one onwards, the cost is zero! Because it can be produced by automatic copying. Therefore, you can never draw the conclusion of modern economics that the more you produce, the higher the cost!

We cannot just brush it off as a special case, as information products are one of the most important products in today's world, It is enough to overthrow the current economics.

Why is it that in the real world, the more supply there is, the cheaper things become?

The following is the proof I have made based on the real world.

Take automobiles, one of the most important commodities in the industrial era, as an example. Major automobile companies invest a huge amount of money every year in the research and development of new models (for example, Volkswagen invested the equivalent of 110 billion yuan in research and development in 2023). Every car we buy now includes the cost of research and development.

Assuming Ford invests about 10 billion yuan in the development of new models of about 100,000 yuan every once in a while, it can sell about 1 million vehicles. [Based on this, it can be deduced that the R&D cost of each vehicle is about 10,000 yuan, that is, 10 billion yuan divided by 1 million vehicles. The remaining costs of each vehicle (including raw materials, factory buildings, machinery, labor, energy, etc.) are about 90,000 yuan.]

This time, Ford invested another 10 billion yuan to develop a new car. This happened to coincide with the signing of a peace agreement among oil-producing countries, which led to a sharp drop in oil prices and a surge in demand for cars, reaching 1.5 million vehicles in three years. So, how should Ford set the price?

According to the theory of modern economics, enterprises are priced according to marginal cost. (Marginal means newly added, and marginal cost refers to the newly added cost generated by the increase in production. It is precisely because as production increases, the production cost of each product gradually becomes higher, that the supply curve curves upwards to the right.). 

So, Ford has increased its production by 500,000 units this time. What is the cost (i.e., marginal cost) of these 500,000 additional units? It's 90,000 yuan per vehicle! Strange, in the past when producing 1 million units, the cost per vehicle was clearly 100,000 yuan. Why is it that with the addition of 500,000 units, the cost decreases as production increases?

Because for the additional 500,000 units produced, there's no longer a need for research and development expenses!!! Industrial products have a characteristic: technology can be replicated without cost! When you increase production, there's no need to conduct new research and development; simply follow the previous drawings and processes.

Coming back to the previous question, how should we price these 1.5 million vehicles? If we adopt the marginal cost pricing method in economics, each vehicle would be sold for 90,000 yuan. However, we would never be able to recover the 10 billion yuan invested in research and development! Therefore, no company would follow the principles of economics!

 In other words, the company can only set a higher price. How high should it be? In the past, the price of a new model produced in 1 million units was set at 100,000 yuan per unit. This time, the demand for the new model has increased significantly. Logically, setting a higher price, consumers will also accept it. Okay, let's assume that Ford sets the price at 130,000 yuan per unit.

What happens in a perfectly competitive market?

At this point, General Motors, seeing the potential profit, will immediately set the price of a new model of the same grade at 120,000 yuan, aiming to capture Ford's market. For Ford, the consequences are very serious, which will lead to the inability to sell their new cars!

Similarly, Volkswagen saw that it was profitable and quickly priced its new model of the same level at 110,000 yuan. Toyota also saw this and quickly priced its new model of the same level at 100,000 yuan! Do you think that’s enough? BYD took a look and priced its new model of the same level directly at 96,700 yuan!!!

Finally, all car companies can only set the price of this new model at around 96,700 yuan!

(In reality, there are some differences in the prices of vehicles of the same level among major car companies, but when converted into cost-effectiveness, they are all similar.)

Wait a moment. In previous competitions, didn't Ford set the price of its new model at 100,000 yuan? If the price is set at 96,700 yuan this time, won't it incur losses?

Analysis method of cost and demand theory

When demand increases, the demand curve shifts to the right, intersecting the cost curve at a lower position, resulting in a decrease in price and an increase in sales volume. (The opposite occurs when demand decreases, and the analytical method remains the same.).

When costs decrease, the cost curve shifts downward, intersecting the demand curve at a lower position, resulting in a decrease in price and an increase in sales volume. (The opposite occurs when costs increase, and the analysis method remains the same).

Current economics teaches us that the higher the price, the greater the supply; the lower the price, the less the supply.

 However, Cost and demand theory holds that, It's not that the higher the price, the greater the supply! Instead, as long as the price is higher than the cost (that is, the current price, that is, the intersection of cost and demand curve), enterprises can supply countless! (relative to human needs). Because the more enterprises produce, the lower the cost, as long as there is demand in this price market, they will work hard to produce!

It's not that the lower the price, the less the supply. Rather, as soon as the price falls below the cost, the supply becomes zero! As the saying goes, there are people who will do business even if it means risking their lives, but no one will do business at a loss.

Therefore, when something becomes cheaper the more it is produced, the supply curve of modern economics, which determines the output according to the market price, no longer exists. In reality, companies can supply an unlimited amount of goods at the current price (i.e. cost) (as long as there is demand), so there is simply no opportunity for the situation where higher prices lead to more supply to occur.

 Instead, it is replaced by the average cost curve: companies adjust supply prices according to the increase or decrease in demand, a market signal (rather than adjusting output according to price, a market signal, as in current economics): when market demand increases, output is increased, and supply prices fall due to lower costs (the same applies when demand decreases).

Why does modern economics lead to marginal cost pricing?

So, how does the marginal cost pricing (i.e., the supply curve is the marginal cost curve) of enterprises in modern economics come about? Here is my proof.

In the past, a landlord hired five farmers for 100 copper coins, and invested another 300 copper coins in other costs (including cattle, land, seeds, fertilizer, farming tools, etc.). The total cost was 400 copper coins, and 800 kilograms of grain were produced. The market price was 0.5 copper coins per kilogram, which was exactly equal to the landlord's investment cost. Therefore, the landlord's profit in perfect competition was zero (in economics, zero profit refers to zero excess profit. That is, only normal micro-profits were obtained. The normal micro-profits have already been included in the landlord's investment cost. The same applies to the example of the car mentioned above, where normal micro-profits are already included in the average cost).

Then, a significant issue arose!  

With the continuous surge in population, the demand for food has been steadily increasing. At the same time, all the arable land has been planted and cannot be increased. At this point, the price of grain has reached 1 copper coin per kilogram.

Therefore, in this crop, the landlord hired 5 more farmers for 100 copper coins. Because the cultivated land could not be increased, now 10 farmers were put into the original land. These extra hands could only weed, drive away birds, catch insects more frequently... to make the harvest as much as possible. Finally, the harvest reached 900 kilograms.

Let's calculate: In the previous crop, the landlord could produce 2 kilograms of grain for every 1 copper coin invested. In this crop, the landlord has newly invested an additional 100 copper coins. Based on the previous situation, an additional 200 kilograms of grain should be produced. However, due to the law of diminishing returns (i.e., the newly added benefits continue to decrease, meaning that the more you produce, the higher the cost), only an additional 100 kilograms of grain can be produced.

The question arises: why would the landlord still work even though the yield has decreased by 100 kilograms compared to before? - Because the grain price has reached 1 copper coin per kilogram at this time!

The landlord's newly increased investment of 100 copper coins can be sold for 100 copper coins, which just covers the cost, with a profit of zero. In other words, if the grain price does not reach 1 copper coin per kilogram, the landlord will not increase his investment, otherwise, this newly increased investment will result in a loss.

So, can the landlord sell at a high price? For example, selling for 1.1 copper coins per kilogram. No, it won't sell because there are countless competitors in the market who are competing to lower the price, eventually driving it down to only 1 copper coin per kilogram. It can't be lowered any further, otherwise everyone's newly increased investment will result in a loss - that's right! This is what is called marginal cost pricing in economics!

However, the total investment for this crop was 500 copper coins, and the total harvest yielded 900 kilograms, which could be sold for 900 copper coins. The landlord made an excessive profit of 400 copper coins! - This is exactly the opposite of one of the most important conclusions in economics: that corporate profits are zero in perfect competition and that the market economy is efficient.

So, how did economics come to the conclusion that the profit of enterprises in perfect competition is zero? The economic deduction is: when there is excess profit in a certain industry, more enterprises will join in production, which will increase supply (that is, the supply curve shifts to the right), and push down prices until the profit is zero.

But the problem is that the law of diminishing returns holds true precisely because resources (farmland) are depleted! When farmland is no longer increasing, may I ask what other enterprises that wish to join the production process will use to produce grain?!

Therefore, one of the most important conclusions of Economics: the law of diminishing returns, is contradictory to one of the most important conclusions of Economics: Zero profits of enterprises in perfect competition.

Only within the framework of cost and demand theory can we draw the conclusion that the profit of enterprises in perfect competition is zero!

(In fact, even if this batch of landlords did not make additional marginal investments and invested as usual, there would be no marginal benefits, and they would only harvest 800 kilograms, but would still earn a huge profit of 400 copper coins! But without the normal small profit from marginal input).

Why did ancient economists come up with the law of diminishing marginal returns?

So, why did ancient economists come to the conclusion that the more supply, the higher the cost, that is, the law of diminishing returns? In fact, this was true in the agricultural era!

The reasons can be summarized as follows: population explosion and technological stagnation. As Malthus once put it, the population is growing exponentially. While technology has seen little significant progress for thousands of years.

If you look at the explanations of supply and demand theory in various modern economics books, the examples given are basically: wheat, corn, grapes, tomatoes, etc. This is because in the agricultural era, the most important products of human society are crops. And often the population grows too much while the arable land is limited.

When explaining why the more supply there is, the higher the cost, economics believes that due to limited land, in order to produce more agricultural products, more manpower, seeds, and so on can only be invested on the same piece of land. As the land is increasingly densely cultivated, the output cannot increase in proportion to the input, and the increased output becomes less and less, naturally leading to higher and higher costs.

[Therefore, there are conditions for the diminishing returns. The first condition is that in the production of products (such as food), some resources no longer increase (such as arable land in ancient times).

When explaining the diminishing returns of grain production in ancient times, economics gave the reason that “arable land no longer increases”. Then, when economics proves that modern agriculture, industry, and information industry also have diminishing returns, it must also give a reason! - Please prove that what resources no longer increase! Is it that the world's industrial land has run out, or that oil has run out, or that all workers have been fully employed? You can't just make a nonsensical claim based on ancient theories that the same is true in modern times! ]

Therefore, modern economics is completely correct in explaining the ancient agricultural era! The problem is that human history has not only entered the industrial age! Human history has entered the information age!

Why is there no diminishing return in modern agriculture?

First, because population growth has slowed sharply, many countries are now calling for fertility to be too low. At the same time, with the rapid development of science and technology, chemical fertilizers, pesticides, tractors, harvesters, genetically modified crops have been invented... New land is constantly being cultivated. Making the growth rate of grain production exceed the growth rate of population, resulting in a large number of vacant arable land in the world today!

The supply curve depicted in Figure 3 is also applicable to low-end manufacturing and commerce, as they also adhere to economies of scale.

Low-end industrial products, such as ordinary clothing, footwear, stationery, and personal care products, do not incur research and development costs. Therefore, they cannot achieve significant cost reductions through scale expansion, as high-end manufacturing industries (such as automobiles) or the information industry do, thereby forming a strong economies of scale. To facilitate understanding, I have drawn their average cost curve with a less steep slope compared to that of high-end manufacturing industries.

How does low-end manufacturing generate economies of scale? mainly factory buildings, machines, executive salaries, funds... these major costs, when production increases significantly, in addition to overtime, two or even three shifts can be adopted, then these costs will be reduced to 1/2 or even 1/3 of the previous ones. As for labor, although overtime pay has increased, various security benefits have been diluted. What if production continues to increase significantly in the long run? Just build a new factory!

How does commerce generate economies of scale? Mainly the shop rent, labor... these major costs, the more goods are sold, the more these costs are diluted.

Actually, products in today's world are basically economies of scale! Look at the giants in today's world: Tesla, Wal Mart, Amazon, Toyota, Aramco, Boeing, Coca-Cola... Which is not the larger the scale, the lower the cost?!

Paul Samuelson wrote in his world's best-selling economics textbook "Economics": One of the most famous laws in all economics, the law of diminishing returns.

In this regard, I believe that one of the most famous laws in all economics, the law of diminishing average cost.

Is it possible to have diminishing returns in modern times?

So, is it possible for modern industry to experience diminishing returns that are consistent with economics?

Assuming that interest rates are cut sharply now, the demand for cars will surge, then the surge in demand for iron ore and power will indeed cause a short-term increase in the prices of these resources (the more production, the higher the cost of these resources). But what happens next? The demand for cars plummets, because if you buy one now, you won't buy it again within 10 years. Then, these resources that have temporarily increased in price will fall back to their original prices. The underlying logic is: the population has not increased significantly.

So, even if there is a temporary increase in resource prices, Will there be diminishing returns for automobiles in the short term?

Assuming that the average research and development cost per vehicle is 20,000 yuan, if sales double, Then, the demand for iron ore and energy surged. However, unlike arable land, these resources are not depleted, but rather, the cost of extraction increases if more is mined.

So, a situation arises: the rise in these resources has led to a 2000 yuan increase in car costs, but, but, the average research and development cost has dropped by 10000 yuan! As a result, the car price has actually dropped by 8000 yuan!

Why is this counterintuitive? Because when the R&D cost of 10 billion yuan is used to produce only 10,000 vehicles, the R&D cost per vehicle is as high as 1 million yuan! If the production volume is expanded tenfold, the R&D cost per vehicle will drop dramatically to only 100,000 yuan! That is, the sky-high R&D cost decreases dramatically due to a sharp increase in production volume, far exceeding the rise in resource prices.

[Therefore, the second condition that causes diminishing returns is: even if resources no longer increase (for example, the production speed of lithium for new energy vehicles could not keep up with the surge in demand for a period of time, and speculation led to a price increase of lithium batteries), the resulting increase in resource costs must be greater than the cost reduction caused by economies of scale (for example, the extremely strong economies of scale in the automobile industry have led to a sharp drop in the prices of new energy vehicles, which cannot lead to diminishing returns). ]

Let me make another assumption. If the population grows significantly like in ancient times, will it lead to diminishing returns? No, it won't. Because a significant population growth takes time, let's say 25 years for one generation. But during these 25 years, human technology has grown significantly again, eliminating the causes of resource depletion!

As we all know, the marginal cost curve in economics goes down at the beginning, but when the cultivated land is fully planted and the law of diminishing returns is triggered, the marginal cost will continue to go up.

Therefore, as long as we keep resources from being exhausted, the marginal cost will not rise! How can we do this? As long as we keep the technological progress greater than the population growth!!!

Okay, if we have to write a science fiction novel that depicts a future where population grows exponentially but technology stagnates, will there be a law of diminishing returns in industrial products? This will happen. (At this time, the company's supply curve will automatically change from the average cost curve to the marginal cost curve, and the price will be determined according to the marginal cost. Therefore, modern economics is basically invalid in modern times, It is not that modern economics is wrong, but that the times have changed. In modern society, basically no products are priced according to marginal costs).

But please remember, this kind of thing is only written in science fiction, but not in economics. Because the most fundamental reason why the law of diminishing returns fails is that technology grows at a cubic rate!!!

The supply curve of information products

Oh right, Haven't derived the supply curve for information products yet!

For perfectly competitive information products, its supply curve can also be derived according to the above-mentioned idea of ​​the car.

Firstly, the marginal cost of information products is zero, so it is impossible for anyone to price them based on marginal cost as stated in current economics. What if they set a high price? For example, if a financial software or antivirus software is priced high, other strong competitors will undercut each other until they can only obtain normal meager profits with zero excess profits.

 The concepts of long run and average cost in modern economics

Since almost all companies in the real world use average cost pricing, what should modern economics do? It uses a concept that is generally recognized to be very vague: long run, to apply to average cost. It is believed that average cost pricing is only used by companies in the long run, and marginal cost pricing is still used in normal times.

The reason is: For example, in a clothing factory, when demand increases for a long run, the enterprise can keep the production cost unchanged by continuously building new factories and adding new machines to expand the scale. However, if the demand increases sharply in the short run, it will definitely not be able to build new factories and add new machines to significantly increase production. Increasing production can only be achieved by continuously recruiting workers and increasing manpower input, which leads to diminishing returns and rising marginal costs.

In fact, the long run, like marginal cost, is a concept that only existed in the ancient agricultural era. Let me give you an example of the Chinese game "Black Myth: Wukong" which is currently selling well all over the world, and you will understand it at a glance.

When this game demands 100,000 copies a day, the game company produces them in just 0.1 seconds! The production time is merely the instant when the system automatically confirms the payment made by the user online. As this game becomes increasingly popular, and the demand skyrockets 20 times in a single day, reaching 2 million copies, how long will it take to produce it? It's still 0.1 seconds! Because game companies can produce it without building new factories or adding new machines! - There is simply no such thing as the concept of long run!

So, why did the concept of long run exist in ancient times? Here is my proof.

The most important product in ancient times was grain, but grain production required a long period of time, about half a year to a year. 

If the general environment in a certain place this year is similar to previous years, and the grain price is 1 copper coin per kilogram, then the grain price this year will probably fluctuate slightly around this price, which is approximately equal to the production cost.

However, if a flood occurs locally, destroying a significant portion of the farmland, the following day, everyone panics and rushes to buy grain while simultaneously being afraid to sell it. This is because grain cannot be produced in the short term, leading to a surge in grain prices (i.e., only through significant long run production increases can grain prices drop to a level equivalent to the cost price). Subsequently, famine ensues, causing grain prices to skyrocket even further.

In other words, in ancient times, the different impacts of long run and short run on agricultural product prices is a concept that has certain use.

So, what will happen to modern agriculture when it encounters the above situation?

When the media pushes to you: A flood occurred in the rural area of ​​your province, and all the food was washed away. What will your reaction be? - You are not even interested in taking a look!!!

Why? Because you know, whether there's a flood or not, the price of rice in supermarkets and online stores remains at 5 yuan/kilogram, unchanged!!! Why was it a matter of life and death in ancient times, but has no impact in modern times? Because modern agriculture has four powerful tools: information, transportation, storage, and, most importantly, market economy!

In ancient times, a major famine occurred in a province, and it took a long time for the news to reach the central government. Then the central government organized disaster relief, purchasing grain from various provinces and transporting it to the affected provinces. During the long transportation process, the grain had already been depleted to a small amount. By the time this small amount of grain reached the disaster area, the population in the disaster area had also been reduced to a small number.

In modern times, when a province suffers from floods and a poor harvest, not only is the local large amount of stored grain enough to last for many days, but the next day, grain from surrounding provinces will automatically pour in! Similarly, if a country has a poor harvest, grain from all over the world will automatically pour in! - Everyone is rushing to do business!

Alright, let's talk about modern industry. In the real world, what should we do when an extremely rare situation occurs and the total demand for shirts increases by 50% in a short period of time? Just clear out the inventory and the problem is solved. Yes, it's that simple!!!

If we have to assume that total demand continues to increase? Just increase production through overtime. If it still needs to increase, a two-shift system will suffice.

What is a two-shift system? It is a common practice in China: a garment factory hires twice as many workers and divides them into day shifts and night shifts to work in rotation. The effect is similar to opening an additional factory, with production nearly doubled! At the same time, costs such as machinery, factory buildings, interest, and core management personnel salaries... have decreased by nearly half!

When two-shift systems are frequently implemented, The enterprise has already started production in the newly built factory.

Therefore, modern economics does not require the concepts of short run and long run, as they have little impact on prices. (Here's a funny one: the long run aggregate supply curve in modern economics is actually a vertical line! The reason is that in the long run, labor is limited, so supply cannot increase further. But for information products, from the second production, the cost is 0, and supply can be infinite. You can't possibly come up with the conclusion that supply is limited, even if you rack your brain!!!)

Important conclusions of cost and demand theory

Based on the theory of cost and demand, I have also drawn some extremely important conclusions:

1. The main feature of information products and high-end industrial products is that the technical cost is very high, but the technology can be copied at no cost!

Therefore, as long as we have good relations with the most advanced countries and humbly ask for advice from the most advanced researchers, it is equivalent to saving astronomical amounts of research and development funds! Used to improve people's livelihood. In addition, these great technologies that do not cost money can create astronomical amounts of wealth! The country will become rich!

The renowned Indian generic drugs serve as an example. Just imagine, if India were to rely solely on itself to develop these innovative drugs, it would be impossible for the entire country to succeed even if it were to invest all its wealth!

This is exactly the underlying logic of what Deng Xiaoping said: all countries that have good relations with the United States will become rich.

2. Current economics teaches us that a perfectly competitive market is the best, with the lowest prices, consumers benefiting the most, and resources being the most efficient in perfect competition. Monopoly is the worst, so laws are firmly established to combat monopoly.

However, the theory of cost and demand suggests that when the market is dominated by only two largest companies, it is already closest to monopoly, but it is the best! Because at this time, the economies of scale are large enough, and the cost is the cheapest.

For instance, there are currently only two super large aircraft companies in the world, Boeing and Airbus. Their mutual competition is the best for consumers. Imagine if there were many large aircraft companies in the world, each of which had to invest astronomical amounts of money in research and development, the cost of research and development per aircraft would definitely be shocking!!!

The best drink in the world is the cheapest in the world! Yes! I mean Coca Cola and Pepsi!

3. Current economics teaches us that the greater the demand, the higher the price (that is, the demand curve moves right) ; the less the demand, the lower the price.

However, The cost and demand theory holds that, It’s not that the more demand there is, the higher the price will be. Since the invention of Coke, the demand has increased infinitely! If this important conclusion of economics is correct, then Trump certainly can't afford to drink 12 cans of Coke a day!

Nor is it that the less demand, the lower the price.

Let me tell you a true story. Not long ago, I needed to use an incandescent bulb for testing when repairing an induction cooker. To my surprise, I couldn't find it in many nearby hardware and electrical stores! The next day, I went to another city to buy it, and the boss said that there were some in the warehouse, priced at 1.5 yuan each, and asked me to wait in the store. I waited for nearly half an hour, but he told me that he couldn't find them. I felt very strange and asked him, "Why are incandescent bulbs nowhere to be found now?" The boss said, "Actually, many years ago, people have already switched to energy-saving LED bulbs.

I remember the last time I bought an incandescent bulb was when I was young. Now the demand for incandescent bulbs has dropped by a thousand times. According to current economic theory, they should be as cheap as one cent for two bulbs. But taking inflation into account, the price remains unchanged, precisely because the cost hasn't changed!