WHICH IS WHY YOU BREAK THE BAKER'S WINDOW:

Supply Depends on the Demand for (Often Unseen) Alternatives: Another path from here to there. (Steven Horwitz, 8/12/10, The Freeman)

Imagine an entrepreneur considering making tents out of canvas. The price of canvas will be crucial to his ability to supply those tents. But the price of canvas is in turn determined by the demand for other consumer goods made of canvas. That is, the supply of tents depends on the demand for canvas sneakers, canvas drawing boards, and the like. Should there be a public craze for canvas sneakers, driving up their price, sneaker producers will bid canvas away from alternative uses and increase the quantity of sneakers. The higher price of canvas will in turn will reduce the supply of tents since our entrepreneur will face rising input costs.

Thus supply decisions are ultimately driven by demand for the alternative uses of the inputs. Or to put it in more colloquial terms: If we want people to do more of something we like, we either have to increase the benefit of their doing so or increase the cost of alternatives that use the same inputs. Because all supply is based on the demand for alternative uses of inputs, changing either the costs of one side or the benefits of the other will change the relative value of the two choices in the same direction, generating the same result.

Government (as any single investor would be) is really bad at picking the alternatives, but quite adept at forcing them. Just tax what you don't want.

Posted by Orrin Judd at August 12, 2010 6:01 AM