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8. Distribution of Wealth Model and Supply and Demand
Distribution of Wealth Model and Supply and Demand
In the previous article "Explanation of inflation and model of inflation hyperinflation" I had mentioned that
r-q = I
q = probability of transaction
r = probability of replacement
I = inflation
This equation was derived from the demand side of the curve and r is the probability of replacement of customers. That is new customers are coming in every day to buy products as in consumer goods and services. q is the inherent probability of transaction within the market or economy and we could for the time being, for simplification purposes, say that it represent supply.
Let us look at the model from this equation was derived from.
The Distribution of Wealth vs Supply and Demand
If we measure how much money in a given population, an individual has to purchase a product it would be distributed according to the Distribution of Wealth chart shown below.
An example of the Distribution of Wealth Model
This is a fictitious chart and shown here as an example. From here you can observe how rich or poor a certain population is. You will observe that 10 people can afford to purchase a product at $100 but 30 people can afford to purchase a similar product at $9. Which group would you target? How much profit do you think you can make from any target group? Profitability would depend upon the cost of the product for that target market. For example the cost of manufacturing a Mercedes Benz would be very much higher than that of a Proton Saga. But it may be worthwhile looking at whether the Proton Saga should be stripped down and sold to the 36 people who could only afford $6 and some fixtures added to sell to the 25 people who could afford $13. Hence you can end up selling 25+30+36=91 cars per month or per year according to this example instead of trying to compete with Mercedes Benz to sell to 10 customers.
If you just focused on the 30 people who could afford $9 then after selling to the first 10 customers you will find that there are only 20 customers left. It would appear as if demand is dropping. In actual fact there is a rate of replacement of potential customers. Every month or day or year, 30 more customers walk in the door.
What is the initial probability of transaction for the $9 product? At first glance it looks like 30/165=0.18 where 165 is the total population. That is an 18% chance of selling to people selected at random. In actual fact the probability of transaction can be 129/165= 0.78 where 129 is the total population that can afford the product – including all people on the left of the $30 segment. This translates to 78% chance of selling to people selected at random. Which would be easier to sell, the $100 product or the $30 product?
If we considered the case where buyers on the left of the $9 market segment, that is buyers of more expensive products, are willing to purchase the $9 product then in the case shown in the chart below there would be 75 buyers for the $9 product. This indicates a probability of transaction of 0.45 or 45% of the people who walk into your door will purchase the $9 product.
Did you notice that the DOW curve indicates the total money supply into this market?
The market or rather sales begin to oscillate when no new customers walk in the door. This is the Origin of Movements and the basic source of economic oscillations. When replacement customers walk in the door the market or sales becomes inflationary. That is the replacement customers are dampening the oscillations to inflationary behaviour.
Distribution of Wealth is not Demand Curve?
Now you could say that the curve I have shown is a Demand Curve. It does look like a Demand Curve but the Distribution of Wealth model explains a lot more than a Demand Curve. Furthermore this curve is also the Supply Curve with different number of people as suppliers instead of buyers. And for these reasons this Distribution of Wealth model is an Alternative Theory to the conventional Supply and Demand curve.
Conventional Supply and Demand curve pitfalls
Now, q the probability of transaction, should be the point, in conventional Economics, in the Supply and Demand chart, it is where the Demand curve cuts the Supply curve.
Conventional Supply and Demand
As I was examining the conventional Supply & Demand curves my suspicions were aroused. Is this not quite right? For example, if I started a poultry farm supply eggs at a retail price of RM0.40 (USD$0.13) per egg, I would be competing with every other supplier and supplying eggs into the market. If I developed a RM100/- (USD$32.00/-) egg, the supply curve shows that there should be many many more suppliers trying to sell RM100/- eggs. But I do know from experience, that I have priced myself out of the market and no one would buy the RM100/- eggs. Eventually, my business will close and all the other suppliers that were trying to promote RM100 eggs would close too. In reality it does not happen. The Supply curve should probably look like, the chart shown below.
Conventional Supply and Demand curve pitfall
This is where the 'Distribution of Wealth' model fits in. Not only can the 'Distribution of Wealth' model be used to represent Demand or Potential Demand but it does show how rich a population group is. Hence the Supply curve will be a region around the Demand Curve. That is, those suppliers who 'cling' closely to the Demand Curve Distribution will survive and succeed. Those suppliers whose products are priced 'way off' the Demand Distribution Curve will find it difficult to survive and fail and disappear from the 'conventional Supply curve' distribution.
Copyright (c) Dr. Peter Achutha, 2011 for this article "Distribution of Wealth Model and Supply and Demand" - 22 July 2011
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