Adaptive Supply Theory

These are just some notes that need editing.

This is an idea that I have been toying with for a while.  Sometimes it feels either flawed or trivial but I still think there might be something to it.  The basic thought is this: efficient markets require supply to adapt to demand.  The basic reason is because demand is either fixed or stubborn and so in order for markets to clear supply must work to meet demand.

This is a crude sketch which doesn’t account for the fact that demand can be manipulated (e.g. through advertisement) or that supply does not always have to work to meet demand (e.g. by luck or monopoly power).  And I think the notion of adaptive supply is only mildly interesting or even trivial in some markets like the market for consumer goods – of course companies have to invent, compete and predict to satisfy consumer demand.  However I think the concept becomes interesting and important when applied to labor markets where it is just as vital, yet less obvious.

First some overview on the idea.  Steve Jobs says:

“One thing I have always found is that you have to start with the customer experience and work backwards to the technology.  You can’t start with the technology and try to figure out where you are going to try to sell it.  And I have made this mistake more than anyone else in this room and I have scar tissue to prove it… And as we have tried to come up with a strategy and a vision for Apple it started with what incredible benefits can we give to the customer, where can we take the customer.  Not starting with let’s sit down with the engineers and figure out what awesome technology we have and then how are we going to market that.”

Jobs describes Apple’s success as hinging on the ability of Apple to predict what experiences will benefit consumers and thus sell products.  I think this might highlight a basic facts about supply and demand:

  • Producers (supply) have to predict and adapt to what consumers want (demand), how much they want, and what they are willing to pay for it.
  • Consumers, by contrast do not, in general, change their preferences to satisfy supply.  (I know this isn’t strictly true).
  • To the extent that producers fail to predict/adapt to demand, the market is inefficient.

To illustrate why consider an imaginary market for widgets where suppliers produce widgets completely randomly: some widgets are huge, some are tiny, some are shaped like hammers, some like discs, and most are completely useless.  Accordingly, there is little overlap between what producers supply and consumers demand, leading to a huge surplus.  This market is deeply inefficient (a perfectly inefficient market would have no overlap between supply and demand and wouldn’t be much of a market at all).  What can be done to reduce the surplus?

From the demand side of things we can assume that consumer preferences are largely immutable.  They may be subject to some influences (e.g. advertising), but if they do change they change gradually.  In this case, let’s stipulate that they are static – the consumers will not be convinced to buy junk.

Instead it is the producers in these markets need to wise up and reduce their surplus by producing things that consumers demand and, importantly, things that consumers will demand.  Doing so requires predicting what kind and how many widgets consumers will buy.  If consumer demand is constant then the amount of surplus – and efficiency of the market – is determined by the supply’s ability to predict and adapt to demand.

Initial Impressions of Implications for Goods & Labor

I venture to say this quality of supply predicting demand is a prominent feature in most efficient markets for goods and services.  In the case of Apple this ability to predict may have stemmed from the oracle Jobs and his circle of technology wizards.  Facebook and Google have had different strategies releasing half-formed services/changes and quickly adjusting to user feedback.  When companies do not predict and adapt at pace with their competitors they fade away.

In labor markets adaptive supply is another story: adaptation takes much longer and demand is much harder to predict.  To begin with people do not (always) have and raise children so that their children will meet what the parents anticipate the labor demand will be 16 – 30 years later.  It’s probably safe (if not, hopeful) to say that many children are conceived under some sort of vague plan for their wellbeing but that the details of the plan will be filled in as time passes.  Even though this is vagueness is preferable to having the child’s life/profession meticulously planned from an early age it is not exactly in line with the prediction and adaptation necessary for a labor market with minimal surplus.

Perhaps more importantly many people are not primarily driven by their predictions of the demand for labor.  Many students will study what interests them instead of what they perceive will be the most valuable skills to future employers.  Again, there are many good reasons for pursuing one’s interests over the acquisition of perceived valuable skill, but doing so creates a lag between the demand for labor and the supply’s ability to adapt.

Finally, few people can reliably forecast the future demand for labor, especially at a time where the demand changes rapidly.  During the housing boom few people knew how much of a bubble there was in the demand for construction labor.  Construction workers could not have been expected to foresee the housing crash and to start retraining themselves for new work.

The upshot/hypothesis: The ability of supply to predict demand largely determines the surplus in that market.  Since labor lags in its ability to predict demand there will be larger surpluses in labor markets than there are for goods and services.


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