Organizing Production - Matching Supply To Demand
For physical goods, there is an easy way to match supply to demand. Demand is the driving force of production. We decide how much of a given good we would like to buy at the price determined by the cost of the labor and raw materials used to produce it. The business that produces the good then tries to make enough of it to meet the demand. If demand increases, the business would see its inventory of the good being drawn down. The decrease in its inventory would provide a clear signal to the management of the business that production needs to be increased. Conversely, if demand falls, the inventory of the good would increase. This would signal to the business that production needs to be cut back.
In service industries, such as law firms, there is no inventory to monitor. Instead, managers of a law firm need to monitor how busy their lawyers are. If the lawyers are idle much of the time, some lawyers need to be laid off. Conversely, if they are having trouble getting through all the work they have, more lawyers need to be hired. Data on how busy the lawyers are can be quantified and tracked. It is just as useful as data on inventories for making decisions about hiring staff.
If all businesses make decisions on how much to produce based on either inventory levels or how busy their staff is, demand for a product causes businesses to create it. Even complex products, such as cars, that are produced with contributions from many different businesses, can be made. The demand for the car causes a cascade of demand throughout all the businesses involved in building it. The car company sees its inventory go down so it increases production. One step in increasing production is to order parts from its suppliers. The suppliers then see their inventories go down and they too increase production. This chain progresses, causing production to increase for all the bits and pieces needed to build a car.
Each business makes decisions on how much to produce based on information it has about its own operations. As with market economies, a master plan isn't needed to coordinate the work done by different businesses.
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