What is demand?

It occurs to me that many misunderstandings of economics today come from a confusion with "demand" and "need". A common broken window fallacy is to say things like "World War 2 boosted demand for tanks and similar resources to fight off the Nazi's, and since a depression is essentially a lack of demand, World War 2 (and big government spending in general) ended the Great Depression. Furthermore, the bombing raids that destroy people's homes increases demand as well, as those people will now need to buy new homes.", or similar reasoning.

"What actually brought the Great Depression to an end was the enormous public spending program otherwise known as World War II."

- Paul Krugman

These statements only appear to have some genuine reasoning behind them because the english language has two different uses for the word "demand".

In one sense, demand can mean a need or desire. It is certainly true that war can create very pressing needs in society, both for protection from destruction and repairs for the damages it causes, just as it is true that breaking a shopkeeper's window creates a need from him for a new window.

Look at this thriving economy!

But the other meaning that I think economists are more familiar with when talking about markets is desire enabled by purchasing power. It doesn't matter how much I want something if I don't have the ability to purchase it from someone else. An increase in purchasing power, not need, is what increases demand.

So with this distinction, we can immediately see a problem with the idea that that destruction increases demand as it focuses on generating need as compared to empowering already present needs. But to avoid further logical blunders and to understand the full extent of the damages of destruction, one must understand what purchasing power is.

So where does purchasing power come from? If you ask your average Joe how you can increase your purchasing power the first response you'll likely here is "get more money". This appears to be true at first. If I want to make more purchases, I need to have more money. If you look at supply and demand charts, the axis beside whatever you are trying to purchase is measured in dollars as well. 

But it goes a little bit further than this. If money itself was what enabled demand, then simply printing more money could increase demand. This is exactly the mistake people make when they support "stimulus packages" that will save the economy by giving everyone more money, thus letting them buy more things and fixing the economy forever. But that's only looking at half of the story. Money is just a commonly used medium of exchange. Take out the extra step, consider trade in the term of bartering, and you can see its true nature.

To be able to demand anything you need to produce something someone *else* demands. To be able to offer something in trade, you need to have produced that thing that you offer in trade, just as they needed to produce the thing they are offering to you.

On markets, products are exchanged against products.

With this, we can see that words like "supply" and "demand" are really entirely relative terms. They're two sides of the same coin. The graph above would be just as accurate, nay, more accurate to say "quantity A" and "quantity B" instead of "quantity" and "price". The x-axis could be the quantity of wheat demanded while the y-axis could be the quantity of corn, alcohol, televisions, gold, or dollars. My supply is your demand and your demand is my supply.

Jean-Baptiste Say, along with his market

So in answer to the original question, purchasing power comes from production, from the supply of goods that can be offered in trade. This is the essential lesson of Say's Law of Markets.  If one wants to increase demand, simply printing more money will do you no good as it adds no more things to indirectly trade for. People will receive a sudden increase in dollars and mistakenly believe themselves to be rich only to find that they have nothing to buy. Its a medium of exchange with nothing to mediate between. Furthermore, this reveals new light on the destruction of war. Not only does destroying things fail to increase demand, but it actually reduces demand as people now have less products to trade against to other people!

In short, production of what people want is what creates demand, while the destruction of things people want destroys demand.

The Basic History of Money

It's true, there is nothing quite as wonderful as money. A man can only produce so many things on his own, but thanks to money he can obtain things he never could have on his own. Money allows us access to the production of others without the use of coercion.

But to best understand this, we need to know how the economy works, at the most basic level. As the creation of matter ex nihilo is beyond our mortal grasps, we are faced with the problem of scarcity. Not everyone can use the same thing. Everyone can not stand on the same spot, they can't eat the same food, nor can we own the same property. To be able to survive, man must collect resources. To thrive, man must improve upon these resources. This is why property rights are so important.

Now there are a lot of theories on property that I will not bring up here. But given that you have property, what then? What if someone else has something you want?

There are two methods of obtaining this item. There is the involuntary way, whereby the item is stolen or the person is threatened into handing it over. This is the method of criminals and politicians. Then there is the voluntary means, whereby the other people freely gives you the item.

But this usually is not out of the goodness of that person's heart. Normally, this is done by trade. Trade is when you offer something to that person in return for whatever they offer you.

The most basic form of trade is the bartering system. This is the simplest and most direct means of trading. If you've ever traded a Pokemon card, you should understand how this works. You offer one good or service to a person in return for another good or service. It's a very simple concept.

But there is a basic flaw in this system. Not everyone values your stuff as much as you do, or as another person might. One person might be willing to trade you a lot of stuff for fish, while another person wouldn't want fish at all. To be able to trade with this person, I would have to discover what he wants, and then track down someone else who has that item and hope that they like my apples more than the first guy did so that I can trade with him. As I'm sure you can imagine, this heavily limits the number of people you can trade with.

This is where money is invented. Money, in the most basic sense of the word, is a commonly used medium of exchange. This means that whatever is being used as money is something most people consider valuable. So instead of directly trading my apples with the person who wants them, I sell them for money and then use that money to purchase the item.

This money could be anything. It could be corn, dried fish, shells, alcohol, goats, salt, whatever. As long as it was commonly valued and tradeable, it works. But by far the most practical and universally accepted item has been silver and gold.

Gold and silver, silver and gold.

Both were, and still are, considered precious metals. They are rare enough to be highly valued, but common enough that it could be commonly used in trade. Not only that, they both melt at relatively low temperatures and therefore can be shaped into different shapes, like coins.

Thus, humanity naturally established a common medium of exchange. Eventually though, as bigger purchases needed to be made, carrying around around the actual pieces of gold became very costly, being both heavy and leaving it open to be stolen by thieves. So what happened was the money was put into a bank. The bank would give you what effectively works out to be an I.O.U. for however many pieces of gold you deposited into the bank. So instead of trading the actual pieces of gold, people just traded the I.O.U.'s. This is how paper money was invented.

But people became greedy. Governments began switching over to something called legal tender and establishing a fiat currency. This is what every country in the world uses today. Instead of your money being valuable because it is tied to something that is generally considered inherently valuable, such as gold, governments now just print pieces of paper, point a gun to your head and demand that you treat it like gold. You are legally required to accept dollars as payment. That's why all United States dollars are marked "THIS NOTE IS LEGAL TENDER FOR ALL DEBTS PUBLIC AND PRIVATE".

This is what people mean when they say a currency is "backed by a government's name". It's not backed by something considered genuinely valuable, like gold, but is instead backed up by the gun of the government.

The world today is not running off of real money, but something that has been imposed on us against our will. This gives government a dangerous power over people, opening us to the governments manipulation of the economy and its theft via inflation. This currency is weak, and when times get hard, people will abandon the dollar in what is known as a "flight into real values".

And that's essentially what money is, how it works, and why we do not have it today.