What determines demand?
The answer to “What determines demand?” came sooner in history, but “What determines supply?” is a bit easier for the student to understand. We suppose that supply comes from the decisions of many business firms, and that the business firms want to hire enough labor and produce enough output so that profit will be as large as possible. As a start-up firm expands its labor force and output, it can increase its profits. Will this ever come to a stop? Here, Malthus’ principle of “diminishing returns” came back into the picture. As the firm increases its labor force, with its other input resources constant, the productivity of labor would decline, and as a result its costs would rise. To make these ideas more precise and complete, the earliest neoclassical economists had to invent a new approach (new to economics, anyway) called the “marginal” approach … [S]upply and demand could only work as long as all the resources used were paid for. What if they were not paid for because they were community property, or for some similar reason? In such a case, many microeconomists reasoned, markets might not lead to efficiency and there might be a role for government in promoting efficiency. (Roger A. McCain)