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Difference between revisions of "Economics Lecture Two"
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''You can post answers here: [[Economics Homework 2 Answers]]''
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In the last lecture we introduced the fundamental concepts of economics.  Now we are ready to explore several issues in greater detail.
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<br>{{Economics_Lectures}}
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One miracle is mentioned in all four Gospels of the Bible: the multiplication of the loaves and fish by Jesus to feed the crowd of thousands.  It illustrates God easily '''''overcoming''''' a scarcity in food.  Similarly, the devout Puritans overcame scarcity and created wealth under harsh conditions in New England in the early 1600s.  Scarcity is no problem for God, but it can be a huge problem for those who turn away from God.
  
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A focus of economics is on the purchase and sale of goods and services in free enterprise.  By “free enterprise,” I mean business transactions that are "free of" interference by someone other than the buyer and seller, such as government. Free enterprise has little or no government interference in the setting of prices and selling of the goods or services.  Assume that transactions discussed in this course are in free enterprise unless stated otherwise.
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Economics is the study of the '''''transfer''''' of goods and services.  What determines the '''''price''''' and '''''quantity''''' of goods transferred? How much must a buyer pay in order to acquire the good (the price), and how many units of the good (the quantity) will the seller be able to sell at that price?
  
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The first obvious question about the purchase and sale of goods is this: what determines the '''''price''''' and '''''quantity''''' of goods sold? In other words, how much must a buyer pay for the good (the price), and how many units of the good will the seller be able to sell at that price?
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Let's take an example.  Suppose you '''''own''''' a candy store, and you sell chocolate candy bars.  What price should you use to sell those candy bars?  If you sell them for $1 each, many people will buy them.  But if you charge $5 per candy bar, fewer will buy them at that price.  You will not be able to sell as many candy bars at the price of $5 each. If, on the other hand, you sell the candy bars for only 10 cents per bar, you'll sell out quickly as people rush to buy the bars at that low price.  It might seem like you'd be happy at selling so many, but you make much less money overall at 10 cents per bar than at $1 per bar.  As the candy store owner you're worse off if you set the price at only 10 cents per bar, because you receive too little for each bar, and you're worse off if you set the price at $5 per bar, because you sell too few bars.  The price at which you make the most money is probably around $1 per bar.
  
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Let's take an example.  Suppose you own a candy store, and you sell chocolate Hershey candy bars.  What price should you use for those candy bars?  If you sell them for $1 each, many people will buy them.  But if you charge $5 per candy bar, fewer will buy them at that price.  Your quantity of goods sold will be much less.  If, on the other hand, you sell the candy bars for only 10 cents per bar, you'll sell out quickly as people rush to buy the bars at that low price.  It might seem like you'd be happy at selling so many, but you make much less money at 10 cents per bar than at $1 per bar.  So you're worse off if you set the price at only 10 cents per bar, because you receive too little for each bar, and you're worse off if you set the price at $5 per bar, because you sell too few bars.  The best price for you to use for the candy bars is around $1 per bar.
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The above example is the sale of a good (a candy bar).  The same analysis applies to the sale of services (such as a car mechanic repairing cars).  People sell their time as much as they sell what they own.  In this sense, "'''''time is money'''''" because time can be converted into money by spending that time working.  You could convert 8 hours of time into about $60 by working at minimum wage.
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The above analysis applies to the sale of a good (a candy bar), but the same analysis applies to the sale of services (such as a car mechanic selling his car repair services).  People sell their time as much as they sell what they own.  In this sense, "'''''time is money'''''" because time can be converted into money by spending that time working.  You could take convert 8 hours of time a day into about $50 by working at McDonalds each day, for example.
 
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We could spend the remainder of this course on pricing goods and services.  Millions of businesses succeed or fail based on how they price their goods or services.  Thousands of people and factors affect the pricing of a good or service, so this question is not as simple as it looks.  Assumptions have to be made in order to draw conclusions.  In some cases, price behavior baffles even the greatest experts in the field.
 
  
 
== Price of Stocks ==
 
== Price of Stocks ==
  
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For example, the pricing of stocks freely traded on the stock exchanges is sometimes mysterious.  The value of a company’s stock reflects how much people are willing to pay for it.  A company that has one billion shares of stock in the market, valued at $15 per share, has a market value of $15 billion.  Logic dictates that when a stock increases its value, then the company is increasing its overall value.
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The price of a company’s stock is a compromise between (i) the price at which people are willing to sell it (the supply price) and (ii) the price at which other people are willing to buy it (the demand price).  A "sale" of the stock occurs only when '''''the supply price equals the demand price'''''.
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But stock values, like economics in general, is about '''''the future''''' rather than the past.  Often a company announces a profit for the year, and yet its stock value goes down on the news.  That would be because people would not expect the company to be as profitable in the next year, in the future.  Past profits do not matter to the price of a stock today; profits in the future do.
 
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During the internet “dot-com” boom of the late 1990s, stock prices were increasing for companies that were losing money.  That was because people expected the companies to be very profitable in the future.  Sometimes it seemed like the more a dot-com company lost money, the higher its stock would go!  That was based on expectations about the future.  As it turned out, most of these companies went bankrupt, because the internet was profitable for only a few companies like Google.
 
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The stock value in a company that consistently loses money declines to approach zero.  The stock value in a company that increases its profits each year increases to reflect those higher profits.
 
  
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Stock prices on the New York Stock Exchange and NASDAQ (the stock exchange for new and often high-tech companies) are determined entirely by “bid” and “ask” prices of the buyers and sellers.  Someone will “bid” a certain amount to buy a stock, and a seller will “ask” for a certain price.  When the bid and ask amounts equal, then a sales transaction occurs.  Prices can move very quickly and unpredictably when millions of people are involved.
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Specifically, stock prices on the New York Stock Exchange and NASDAQ (the stock exchange for new and often high-tech companies) are determined entirely by the “bid” and “ask” prices of the buyers and sellers.  Someone will “bid” a certain amount to buy a stock, and a seller will “ask” for a higher price.  When the bid and ask prices are equal, then a sales transaction occurs.  Prices can move very quickly and unpredictably when millions of people are involved.  When the overall trend of most stocks from day-to-day is an increase in their prices, then it is known as a "bull market"; when the overall trend of stocks from day-to-day decreases in price, then it is known as a "bear market."  You can remember that by thinking of how bears are scary, and stock markets that crash in their prices are scary things.
  
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The price that a stock trades on the exchange is where the “supply” by sellers equals the “demand” by buyers.  When a seller of stock asks too high a price, then there are no buyers and the stock does not trade.  When a buyer of stock offers too little a price, then there are no sellers and the stock does not trade.  The transaction only occurs when SUPPLY EQUALS DEMAND.
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As explained above, the price that a stock trades on the exchange is where the “supply” by sellers equals the “demand” by buyers.  When a seller of stock asks too high a price, then there are no buyers and the stock does not trade.  When a buyer of stock offers to pay too little a price, then there are no sellers at that low price and the stock does not trade.  The transaction (trade) occurs only when SUPPLY EQUALS DEMAND.
  
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Today we will discuss this important principle of economics and many of the surrounding issues.
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This is the most basic concept in all of economics:  '''''transactions occur only where "supply meets demand."'''''  Let's discuss this further.
  
 
==Supply and Demand==
 
==Supply and Demand==
  
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For any given good or service, there is a supply and demand.  The supply consists of quantity and price.  The price has enormous influence over the quantity. No company can afford to build cars to sell at a price of only $1.  But at a sales price of $30,000, a vast number of cars can be built.  The cause is price, and the effect is quantity.
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The '''''supply''''' of a good is how much of it (the quantity), and at what price, is provided by a seller of the good.  Grocery stores, factories, malls, amazon.com, and candy stores all '''''supply''''' goods.  Services, like entertainment, are supplied by Hollywood, Major League Baseball, the NFL and also doctors, lawyers, accountants, and so on.  The supply side consists of the producers, providers and sellers of goods and services.
  
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The demand for a good can be described in terms of price and quantity also.  At a given price, there is an amount of demand by the public for the good.  A billion people might buy a car if the price were only $1.  At a much higher price of $30,000, the demand drops to a quantity in the millions range.  At a still higher price of $100,000, the demand falls much further to the thousands range.
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The '''''demand''''' for a good is how much of it, and at what price, is wanted by the public seeking to buy it.  Shoppers, moviegoers, baseball and football fans, and people needing medical care, are on the demand side.  Often buyers of goods and services are called "consumers".
  
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Because supply and demand can both be expressed in terms of price and quantity, they can be plotted on the same graph.  The y-axis is typically price, and the x-axis is usually quantity.  The supply curve is usually upward sloping: the higher the sales price, the higher the quantity that companies can produce for sale.  That is because higher sales prices bring in greater revenue to fund the production costs.
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For any given good or service, there is a supply and demand.  The supply can be described in terms of the possible production of different quantities at different prices.  The demand can be described separately as the willingness of the public to purchase different quantities at different prices.  The price is the key to both the supply and demand side; it is the price that determines the quantity transacted.
  
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The supply and demand is the most basic relationship in all of economics.  It usually looks like this:<ref>The graphs here use Wikipedia open source images.</ref>
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No company can afford to build cars (supply them) if the sales price is only $1.  But at a sales price of $30,000, a vast number of cars can be built.  '''The cause is price, and the effect is quantity''': the higher the market price for something, the more that manufacturers will want to make and sell it.
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[[File:Red Lamborghini.png|200px|thumb|right|Impress the girls with this Lamborghini sports car, at a cost of $350,000.  Not a high demand at that price!]]
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The demand for a good is also described in terms of price and quantity.  At a given price, there is a specific quantity demanded by the public for the good.  A billion people might buy a car if the price were only $1 (unrealistic).  At a much higher price of $30,000, the demand drops to a quantity of millions sold (realistic).  At a still higher price of more than $100,000, the demand falls much further to the range of only a few thousand that can be sold (these are the very luxurious cars, like the Lamborghini sports car shown at the right).
  
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[[Image:Supply_and_demand.gif]]
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Because supply and demand can both be expressed in terms of price and quantity, they can be plotted on the same graph.  '''''Price (P) is on the y-axis, and quantity (Q) is on the x-axis'''''.  This is in alphabetical order: "p" for price is lower in the alphabet than "q" for quantity, and "p" appears first on the graph as one reads from left to right.  Put another way, the graph is of "Ps and Qs," in that order from left to right (P on the y-axis to the left, and Q on the x-axis to the right).
  
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The above model for supply and demand helps us to consider the effect of shifts in demand and supply. First consider an increase in demand:
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The supply curve is always '''''upward sloping''''': '''the higher the sales price, the higher the quantity that companies will produce for sale'''.  That is because higher sales prices bring in greater revenue -- and greater profits -- to provide the incentive to increase the supply quantity.
  
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[[Image:Demand_curve_shift.gif]]
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The demand curve is always '''''downward sloping''''': the higher the sales price, the '''''lower''''' the quantity the public is willing to buy.  Few people will buy a candy bar if it costs $5: if that price is lowered to $2, then more people will want to buy it, and if its price is lowered to $1, then even more will want to buy it, and if its price is lowered to 50 cents, then the demand by the public for that candy bar will be even greater.  As the price for something goes down, the demand goes up.  That results in a downward-sloping demand curve: as the price goes down the slope of the curve, the '''''quantity''''' demanded (sought) by the public goes up (see the curve labeled "Demand" on the graph below).
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An increase in demand causes price to rise.  The new equilibrium is at a point with higher price and greater quantity than before. 
 
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What could cause an increase in demand?  For gasoline, more people driving would cause an increase in demand.  For heating oil, a colder winter would cause an increase in demand.  For sports entertainment, a close rivalry can cause an increase in demand (spectators).  In all those cases, price and quantity tend to rise.  If there is a decrease in demand, then the opposite is generally true:  prices and quantity tend to decrease.
 
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Next consider an increase in supply.  Suppose farmers have better weather, for example, causing more crops at the harvest.  Or suppose there is discovery of huge new oil reserves underground. Or suppose a new invention, such as Eli Whitney’s cotton gin, increases the production of a good (cotton). This curve shows what happens when there is an increase in supply:
 
  
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[[Image:Supply_curve_shift.gif]]
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The supply and demand form the most basic relationship in all of economics.  They are independent of each other, but are placed on the same graph so that it becomes easy to find "equilibrium": the point where supply and demand have the same value for their price, '''''and''''' the same value for their quantity (the point of the intersection of their curves).
  
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Can you interpret that?  When the supply curve shifted downward as supply increased, the price decreased but the quantity increased.  The new equilibrium is at lower price and greater quantity than before.  Consumers are happier as supply increases.  The discovery of new oil reserves, or inventions like the cotton gin, make consumers better off.
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If the price is higher than the equilibrium price, then there will be unsold goods due to fewer people wanting to pay the higher price.  The sellers then need to lower their price in order to sell these leftover or unsold goods, and that forces the price downward to the equilibrium price.  Conversely, if the price is lower than the equilibrium price, then the sellers will not have enough goods to satisfy the higher demand by the public.  The sellers will then increase their price (and their revenue) to take advantage of the higher demand.  These market forces both above and below the equilibrium price are what push the final price to the point where the supply curve intersects the demand curve.  At this point the price and quantity for the supply are precisely equal to the price and quantity for the demand.
  
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== Example: The Tyndale Bible ==
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The supply and demand curves usually look like this:
  
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The Tyndale Bible was an illegal translation of portions of the Bible into English, the first high-quality English translation that was based on the ancient Greek.  Though prohibited by King Henry VIII and the Catholic Church, William Tyndale secretly did the translation in the early 1500s (around the same time that Martin Luther was translating the Bible into German), and then Tyndale arranged for sale of copies of his work to the public in England.
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[[Image:Supply_and_demand.gif]]
  
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Demand by the public in England was high for this Bible, but the supply was low due to limitations of the printing press and the opposition by the King and other authorities.  High demand and low supply means this:  a high price.  The King and church authorities began buying up copies of this Bible to keep it out of the hands of the public, but often had to pay the "market price" to buy up the copies.  This money then went to the printers and provided the funds for them to pay for the printing of more Tyndale Bibles.  The operation of supply and demand in the free market made it difficult to censor and suppress this Bible.
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In the graph above, P<sup>*</sup> and Q<sup>*</sup> are the price and quantity at which the good is sold: the equilibrium price and quantity.
  
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Supply and demand comprise a very powerful force, stronger than any individual or government.  Over time, supply and demand prevail, and ultimately all authorities endorsed the idea of an English translation of the Bible, leading to the printing of the magnificent King James Version in 1611.  But the unstoppable effect of supply and demand did not occur soon enough to help Tyndale himself; he was executed as a heretic in 1536 after he refused to recant his beliefs.
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The point where supply equals demand can be found either by graphing the two curves and seeing the point of intersection or, if you have the equation for each curve, by solving the equations algebraically.  For example, if the supply curve is P = 100 + Q and the demand curve is P = 500 - Q, then the point of intersection can be found by solving these two simultaneous equations as follows.  When the P in the first equation equals the P in the second equation, then 100 + Q = 500 - Q, thus 2Q = 400, and thus Q = 200.  From there you can solve for P by plugging Q back into one of the two original equations: P = 500 - 200 = 300.  You can check this answer by plugging Q into the other original equation to confirm that you get the same P = 100 + 200 = 300.  So the final answer -- the point where supply equals demand -- is this: P=300, Q=200.
  
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== What is Irrelevant to Supply and Demand? ==
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=== Changes in Supply and Demand ===
  
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Many things that you might think are important to the pricing of a good or service in the market are actually irrelevant.  Supply and demand by many people determine the price, and thus the preferences of any single individual are irrelevant.  The wealthiest person in the world cannot affect supply and demand any more than the poorest person can, in a free market.  Supply and demand transcends and is above the views, preferences, and buying habits of any individual or small group of people.
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The above model for supply and demand helps us consider the effect of changes or shifts in supply and demand.  First consider an increase in demand by the public for a particular good, from demand curve 1 (D<sub>1</sub>) to demand curve 2 (D<sub>2</sub>):
  
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Note also that supply and demand do not care who a person is or what his background may be.  The store owner sells a chocolate candy bar for the same price to the richest man in the world as to the poorest man in the world.  The President pays the same price as the most disliked person in town.  Supply and demand, and the free market, treats everyone fairly and equally.  Someone who walks into a candy store and offers to buy '''''all''''' the candy bars in the store may receive a slightly better price per candy bar because he is paying so much, but he won't receive any better treatment than anyone else, even the most disreputable person in town, who might also offer to buy all the candy bars in the store.  The free market responds to powerful economic forces above any possible prejudice, gossip, or personal preferences.
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[[Image:Demand_curve_shift.gif]]
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An increase in demand causes the price to rise from P<sub>1</sub> to P<sub>2</sub>.  The new equilibrium is at a point with higher price and greater quantity than before.  What could cause an increase in demand?  For gasoline, more people driving would cause an increase in demand.  For heating oil, a colder winter would cause an increase in demand.  For sports entertainment, a close rivalry (as in a close pennant race between the Yankees and Red Sox) can cause an increase in demand (spectators).  In all these cases, price and quantity tend to rise.  Conversely, if there is a decrease in demand by the public, then the opposite is generally true:  prices and quantity decrease.
  
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The "market price" set by supply and demand often is often unrelated to the historical cost of the good.  Someone may have paid $300,000 for his house in 2006, when houses were relatively expensive, but the market price of that house in 2009 may be only $150,000.  When that person tries to sell his house in 2009 it does not matter what he paid for it in 2006.  All that matters is what the supply and demand for that house is when he tries to sell it.
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Next consider an increase in supply by the producers.  Suppose farmers have better weather, for example, causing more crops at the harvest.  Or suppose there is discovery of huge new oil reserves underground.  Or suppose a new invention, such as Eli Whitney’s cotton gin, increases the production of a good (cotton).  This curve shows what happens when there is an increase in supply, from supply curve S<sub>1</sub> to supply curve S<sub>2</sub>:
  
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==Equilibrium & Information==
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[[Image:Supply_curve_shift.gif]]
  
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===Consider these three basic principles of economics:===
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Can you interpret that?  When the supply curve shifted to the right as supply increased, the price decreased but the quantity increased.  The new equilibrium is at a lower price and greater quantity than before.  Consumers are happier as supply increases.  The discovery of new oil reserves, or inventions like the cotton gin, make consumers (the public) better off.
  
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# When demand exceeds supply at a given price, the price tends to rise. Likewise, when supply exceeds demand, the price tends to decrease.
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Laws exist to encourage greater supply, because it is good for the public. Antitrust laws, for example, make it illegal for companies to agree with each other to reduce supply.
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# A rise in price tends to increase supply and decrease demand. Conversely a fall in price tends to decrease supply and increase demand.
 
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# Price tends to move towards the amount at which the quantity in demand is equal to the quantity in supply: SUPPLY EQUALS DEMAND.
 
  
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Note the use of the verb “tend” in the laws of economics cited above.  Companies that consistently lose money “tend” to go bankrupt and out of business.  But it does not happen immediately, especially if the company is large.  It takes time for the market to come to equilibrium.  Ultimately supply does equal demand, but only after enough time and activity passes for the conditions to attain equilibrium.
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== The "Free Market" ==
  
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“Equilibrium” is “where things are going” or where they have already arrived.  The equilibrium for the universe is complete disorder and chaos, with every creature extinct.  A constant increase in entropy is what drives situations to their equilibrium. (Devolution is the process, not the so-called evolution.) Economic equilibrium is when all the imbalances in selling and buying prices have disappeared and there are no more trends to different price levels.  Randomness and profit-making pressures drive pricing towards equilibrium.
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The interaction of supply and demand is what we call the "market".  The "free market" is the interaction of supply and demand without any interference or control by government.  The dictionary definition states that the "free market" is "an economic market operating by free competition."<ref>Merriam Webster's Collegiate Tenth Edition (1994).</ref>
  
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The ultimate equilibrium when there is perfect competition occurs when the marginal revenue to the seller equals its marginal cost of the product.  In other words, the supplier keeps producing more and more goods until its marginal profit on each extra good falls to very close to zero.  That profit decline may be because the goods are not selling as quickly or due to unsold goods.  For example, the first SUV produced by Ford may sell at a high price, but its last SUV in a given year will have to be discounted heavily.  Ford doesn’t want to make any more SUVs in a given year that it might have to take a loss on.  It produces just enough so that marginal revenue falls to marginal cost, as best as can be predicted.
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The free market drives down prices, which helps the poor enormously.  It is the free market that makes the Bible and food and communications inexpensive for the poor, and which helps bring Christian missionaries to serve the poor in faraway places.  The following example illustrates how the free market has made air travel available to the poor, and available to others in order to help the poor.
  
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Imbalances in information are a reason for the delay in pricing to reach equilibrium.  Buyers do not immediately realize when they can obtain the same good more cheaply another way.  For many years people continued to pay high costs for renting telephones after it became legal to buy inexpensive ones. The effects of competition are not often felt overnight. A lower-priced competitor has to educate the public of the availability of its goods, and that takes time.
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In the 1960s and 1970s, government set the prices for airline tickets, and only the wealthy could afford to travel by plane.  Then, in 1978, Congress "deregulated" the airplane industry, which allowed the free market to set the prices based on supply and demand.  The benefits were tremendous in enabling far more Americans to be able to afford air travel:<ref>http://www.econlib.org/library/Enc/AirlineDeregulation.html (emphasis added, citation omitted).</ref>
  
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There is also a more permanent imbalance in information between the buyer and seller of a good. The seller always knows more about his good than the buyer does. The seller does not want to disclose the disadvantages, weaknesses, defects, and outright dangers of his good. The buyer has to beware in paying money to the seller for a good: caveat emptor (Latin for “let the buyer beware”).
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:Airfares, when adjusted for inflation, have fallen 25 percent since 1991, and ... are 22 percent lower than they would have been had regulation continued. Since passenger deregulation in 1978, airline prices have fallen 44.9 percent in real terms according to the Air Transport Association. ...  [W]hen figures are adjusted for changes in quality and amenities, '''passengers save $19.4 billion dollars per year from airline deregulation'''.  
  
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Tobacco companies did not want to disclose that cigarettes cause cancer.  [[Abortion]] providers do not want to disclose that [[abortion]]s cause breast cancer, infertility, and severe psychological problems.  There would be far fewer abortions if full disclosure of their harm were made prior to performing the service, and if taxpayer money was not used to fund the service.   
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The above analysis was written five or more years ago.  Airline fares have fallen even more since then.  That is because the free market lowers costs for everyone.  Poor people can buy airline tickets now, when they could not before.   
  
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Disclosure of harm is a problem for used car dealers who do not want to tell buyers that a car is a lemon (i.e., constantly needs fixing).  Food manufacturers do not want to disclose all the fat and artificial ingredients in their products.
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Wal-Mart is another example of this, as it provides goods at lower and lower prices for everyone.  This is very helpful to the poor.  Someone can have no money, or lose all his money, and yet if he tries then he can live nearly as well as the wealthiest man in the nation -- '''''if''''' the free market is allowed to exist to drive down prices and provide equal opportunity. Where the free market does not exist -- as in many countries of the world -- then the poor may suffer, because prices are too high and opportunities are too limited for the poor to improve their lives.  Thus one of the best ways to help the poor is to provide them with the free market in order to lower prices and increase opportunities for them.
  
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Governmental regulations require some of these disclosures (but not for abortion in New Jersey, which is one reason why New Jersey has more abortions than other states that do require full disclosures).  Mandatory disclosure about goods and services may be the best and only effective type of governmental regulation.  Food packaging now must state what the ingredients are and how much fat is contained.  The buyer doesn’t have to guess about this information.  The buyer must still beware, but can do so with more information than before.
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The free market can have a politically beneficial effect also.  The free market is a powerful force against tyranny.  Government cannot easily control and limit free market supply and demand.   
  
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==Price Discrimination==
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So the next time you're flat broke without any job and facing a hopeless economic situation, remember this:  in the United States you still have the free market on your side, the most powerful tool of all.  Put it to work for you.  The free market is a hardworking servant.
  
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The term “price discrimination” sounds ugly, but it means selling the same good or service at different prices to different people.  It is an attempt by a seller to capture additional money from buyers who are willing to pay more.
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== What Supply and Demand Are '''''Not''''' ==
  
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Airline tickets are an example.  Businesses are willing to pay more for airline tickets for their employees to travel to business meetings than tourists are.  Why?  Because the businessmen are traveling to make more money for their company, and the airline ticket can be paid out of their profits.  If they are flying to do a deal worth $100,000, then they’re willing to pay many thousands of dollars for the airline ticket.  Not so for tourists who fly.
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In learning what something '''''is''''', it sometimes helps to learn what it is '''''not'''''.
  
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The airline wants to sell the same seat at a price low enough for the tourist to pay, and then at a different, much higher price for the businessmen.  This is price discrimination, because it distinguishes or discriminates based on who the buyer is.  “Perfect price discrimination” sells each unit of a good at the maximum amount each individual buyer is willing to pay.
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The preference of any single individual, such as yourself, is nearly irrelevant to the overall supply and demand.  You may dislike the Yankees, but your own view is less than a "drop in the bucket" compared to the view of the public.  Similarly, the opinion of the wealthiest person in the world does not affect supply and demand any more than the opinion of the poorest person can, in a free market.  Wealthy people may avoid Wal-Mart, but that did not keep it from becoming the richest and most successful store in the world.  '''''Supply and demand transcend and are above the views, preferences, and buying habits of any individual or small group of people.''''' Supply and demand are like a massive ocean that's not going to change based on what a few people do.
  
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There are laws against price discrimination, but most sellers find clever ways to do it anyway.  Airlines distinguished between business customers and tourists by its “Saturday night stay-over” rule.  If the traveller reserves the return flight to include staying over at least one Saturday night, then he is likely a tourist.  If he flies out and back in the same week without staying through the weekend, then he is likely a businessman.  So the airline tickets were then priced much more cheaply for those who stay over at least one Saturday night.
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Notice also that the free market treats everyone fairly and equally.  Supply and demand do not care about someone's status in society.  The free market is independent and above prejudice.  A restaurant owner makes the same amount of money from the most disliked person in society as from the most popular person in town.
  
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In general, price discrimination depends on the existence of obstacles to prevent buyers from reselling their goods to other buyers.  If the same good is sold at $X to person A and $Y to person B, and X<Y, then person A could buy an extra good and sell it to person B at less than $Y.  The price discrimination would collapse due to the resale market.
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Notice this too: the "market price" set by supply and demand is often unrelated to the historical cost of the good.  Someone may have paid $300,000 for his house in 2006, when houses were high in value, but the market price for that same house in 2009 may be only $200,000.  When that person tries to sell his house in 2009 it does not matter what he paid for it in 2006.  All that matters is what the supply and demand for that house is at the time he tries to sell it.
  
−
But some goods cannot be resold.  Goods that are personal to the buyer, like a tailored suit or dress, cannot be resold.  Price discrimination works fine for personalized goods or exclusive markets, because there is not a resale market to destroy the discrimination.
+
The free market and supply and demand are similar to a sports competition.  It really doesn't matter how many trophies one team may have won in prior years, or who likes which side better, or who thinks which side should win.  All that matters is which team is better on game day.  Likewise, all that matters to setting the price in a free market is the supply and demand at the time of sale.  That may seem harsh if it causes someone to lose money, just as it can be sad when someone trains extremely hard to win a match, but is defeated in an upset by someone nobody likes.  But in other ways this is fair, because it gives full opportunity for someone to do well no matter who he is and no matter where he comes from.
−
 
−
==Minimum Wage and Price Controls==
 
  
−
So far we have been talking about economic exchanges in the absence of government controls.  But the government does interfere in many ways in our economy.  America enjoys more free enterprise than any other large country, but we are still heavily regulated.
+
==Equilibrium==
  
−
During World War II, the government imposed controls to prevent companies from raising prices during the war.  The needs of our military for goods increased demand that would ordinarily shift the demand curve and increase prices.  But the government prohibited this from happening by limiting price increases.
+
The important concept of “equilibrium” arises frequently in economics.  It is similar to the concept of equilibrium as in chemical reactions.  The term “equilibrium” means a state of balance between opposing forces.  It is a settling down.  In a tug of war between opposing teams, “equilibrium” would be where the rope is stationary with each side pulling an equal amount on it.  But usually one side wins in a tug of war, so that is not the best example.  A better example of an “equilibrium” is when you have eaten just enough to satisfy your hunger, and not too much to make you feel bloated or nauseous.  You are then in “equilibrium” between hunger and overeating.  If you're still hungry then you eat more; once you are "full", you stop eating until later.
  
−
Controls on prices (and also wages) were also imposed to control inflation in the early 1970s.  A war in the Middle East, and assistance in that war by the United States of Israel, caused the Arab nations to reduce their supply of oil to us.  That created gasoline shortages and increased energy costs, which then drove up inflation.  Price controls were designed to limit the increases.
+
“Equilibrium” is “where things are going” or where they have already arrived.  Economic equilibrium is when all the imbalances in the forces of selling and buying have disappeared and a perfect balance between the sellers' desire to make more money (that's like hunger) and the buyers' desire to pay as little as possible (that's like not eating).  When the market has reached a balance between these two powerful, opposing forces, then it is equilibrium.  The opposing forces of the sellers trying to make money and the buyers trying to keep money are what "drive" the price to its equilibrium level, like a tug of war.
  
−
Today, the government prohibits employers from paying wages below a certain amount per hour, called the “minimum wage.”  It is now $7.15 per hour in New Jersey, but only $5.15 per hour nationwide.  If you work 40 hours a week for 50 weeks, or a total of 2000 hours, then that translates to a yearly salary of $10,300.  It is nearly impossible to support a family that amount in most areas of the country, and many politicians are constantly demanding an increase in the minimum wage.
+
When there is perfect competition in the sale of a good or service, then the equilibrium is when the marginal revenue to the seller (the extra dollar that he charges and receives as revenue) equals his marginal cost in producing the good (the extra dollar he paid to produce the good). At that point the seller's marginal profit (the extra amount that he can keep after paying his costs) has fallen to zero and he has no incentive to produce any more goods.  In other words, the supplier keeps producing more and more goods only until his marginal profit on each extra good falls to zero such that he does not make any more money by trying to sell additional quantity.  The seller does not want his marginal revenue to fall below his marginal cost, because then he is losing money.
  
−
Unfortunately, it is even more difficult to survive without a job at all, which is what happens to many people (particularly teenagers) when the minimum wage is increased.  Employers who would hire someone to work at $4 per hour might not be able to hire them at $5.15 per hour.  Isn’t a job at $4 an hour better than none at all?
+
Here is an example.  How long does the owner of a store keep it open at night?  As long as the flow of customers into his store pays him more money (marginal revenue) than it costs him to keep the store open (marginal cost).  As it gets later at night, the flow of customers declines, the owner makes less, and eventually his costs of keeping the store open will exceed the money that is being paid to him by new customers.  As soon as the owner realizes that he is paying more to his workers to keep the store open than he is getting from new customers, he closes his store for the night. After a few weeks of this, the owner realizes that he usually makes money before a certain hour (perhaps 9pm), and loses money afterward.  Then he puts a sign on his door telling everyone that he closes at 9pm every night.  Marginal revenue exceeds marginal cost before 9pm for him (so he makes a marginal profit by staying open), while marginal costs exceed marginal revenue after 9pm (so he avoids losing money and closes his store for the night).
  
−
Moreover, illegal aliens find a wage of even $2 an hour better than what they could make in their homeland.  Companies move operations offshore to take advantage of places that do not have minimum wages as high as ours.  Alternatively, workers enter this country illegally to work at low wages and displace American workers, according to several lawsuits.
+
==Example: Health Care==
  
−
== Minimum Wage and Dropping Out of School ==
+
By far the single biggest industry in the United States is health care (medical care).  It represents a massive one-sixth of our entire economy -- including annual expenditures of more than $2.2 ''trillion'' --  and costs are increasing each year.  It has three major components: government-controlled (Medicare and Medicaid), insurance-controlled, and private pay or uninsured.  Though many are unhappy with our system, it is the finest in the world and foreigners travel to the United States to have their medical problems treated.  The survival rate for the most prevalent form of cancer in men -- prostate cancer -- is 92% in the United States, but the survival rate for that same disease in England is only 51% under its government-controlled system.
  
−
Researchers have found that one effect of raising the minimum wage is that more students drop out of school, or do not go on to college, because they can make more money working at jobs than they could before.  This can be understood as follows:
+
Most other countries have some form of government-controlled, or socialized, medicine.  In the countries of Canada, North Korea and Cuba, it is actually illegal to pay money to a doctor to see you.  You can see only a doctor paid by the government in those countries.  In England, there is a two-tiered system: good care is provided to the few who can afford to pay for it, and free but inferior care is provided by the government to the vast majority who cannot afford it.
  
−
:Suppose that "x" number of students quit school to work at jobs when the minimum wage is $6 per hour.
+
In the United States, under the free market, anyone can pay his own money for medical care at any time.  But in Canada, someone with an illness is typically put on a waiting list and, depending on his age and likelihood of survival, may not see a doctor for months.  In some cases, patients pass away before they obtain the treatment they need.  The Canadian government sets limits on wages and prices for medical care, and that causes shortages because there is always less supply when the price is artificially lowered by government control.  (Look again at the shape of the supply curve:  at lower P, there is lower Q).
  
−
:If the minimum wage is raised from $6 per hour to $7 per hour, then jobs appear more attractive to students and even more will leave school than before.
+
Lowering wages and prices prevents supply from rising to satisfy demand.  Then demand is much greater than supply, and patients have to wait a long time to see a doctor.  There is a lower survival rate for cancer in Canada than the United States because of the delays in diagnosis and treatment in Canada.  In Buffalo, which is on the Canadian border, doctors treat many Canadians who come over the border to pay for immediate American medical care rather than wait for it in Canada.
  
−
:Therefore raising the minimum wage causes more students to leave school in order to work at jobs.
+
This limiting of supply by government-set pricing causes what is known as "rationing".  More people want the service (a medical operation or treatment) than is available.  A waiting list is created to handle the surplus in demand over supply.  But when someone has a cancer growing inside of him, delay by being placed on a waiting list can be agonizing and deadly.  Quick treatment helps improve survival from cancer.  In the United States, where government does not set all prices and there is not any rationing yet, the survival rate for five common forms of cancer is over 90%.  Thanks to the powerful benefits of the free market, the rate of survival continues to improve in the United States.
  
−
Other studies show, however, that the more education that someone has, the higher their average income is.  Students who complete four-year colleges make more money on average than students who completely only two-year colleges, for example. Students who complete two-year colleges likewise have higher average incomes than students who end their education after high school.
+
But in Scotland, the birthplace of Adam Smith and his theory of the invisible hand that he wrote about in 1776, the survival rate from cancer under government-controlled medicine has fallen to "the worst in Europe, lagging behind countries such as Poland and Slovenia. ... Cancer experts blamed ... long waiting lists for the poor results."<ref>http://www.highbeam.com/doc/1P2-12923478.html</ref>
  
−
Raising the minimum wage thus entices students to take advantage of a "short-term" benefit of the higher wage, but they are worse off in the "long-run".  They would make more money by staying in school and not being enticed by the increase in the minimum wage.
+
A free market in health care benefits children too.  The life expectancy for a child born with cystic fibrosis in the United States is 37 years, but only 27 years in Ireland under its government-controlled (or nationalized) health care.
  
−
==Socialized Medicine==
+
==Assignment==
−
 
 
−
The single biggest industry in the United States is health care, and it is sharply increasing in expenditures each year.  It has three major components: government-controlled (Medicare and Medicaid), insurance-controlled, and private pay or uninsured.  Each year, the demands for the government to take over the field grow louder, as insurance costs sky-rocket.
 
−
 
 
−
Most other countries have some form of socialized medicine.  In the countries of Canada, North Korea and Cuba, it is actually illegal to pay money to a doctor simply to see you.  The government control there is so great that you can only see a doctor paid by the government in those countries.  In England, there is a two-tiered system: good care is provided to those who can afford to pay for it, and free but inferior care is provided by the government to those who cannot.
 
−
 
 
−
The Canadian government destroyed free enterprise in medicine there, and took over the health care system.  The government now sets limits on wages and prices.  Lowering the wages and prices prevents supply from rising to satisfy demand.  Because demand is much greater than supply, patients have to wait a long time to see a doctor.  There is a lower survival rate from cancer in Canada than the United States because of the delays in diagnosis and treatment there.
 
−
 
 
−
If an elderly Canadian is vacationing in Florida and falls and breaks his hip, which is very painful, the Canadian system of health care will not even reimburse the patient for surgery at the nearest hospital.  Instead, the patient must fly back to Canada in excruciating pain to be operated on by a government-controlled doctor there.
 
−
 
 
−
In the United States, where health care still includes free enterprise, a patient can enter a doctor’s office or hospital at any time and receive services based on a promise to pay for them by check or cash.  Prices vary, and it is worth shopping around.  Immediate care always remains available at some price.
 
−
 
 
−
Medical care in the United States has the highest survival rates for cancer and the most advanced procedures.  People from all over the world come to the United States to obtain the best care possible.  The life expectancy for a child born with cystic fibrosis in the United States is 37 years, but only 27 years in Ireland under its government-controlled (or nationalized) health care.
 
−
 
 
−
In the summer 2009, the President Obama and the Democrats in control of Congress proposed a bill calling for a partial government takeover of health care.  Their proposal included a "public option," which would be a government-controlled health insurance program like Medicare and yet available to persons of all ages.  Their proposal includes many other controversial features, including:
 
−
 
 
−
*a “public option” that will define which treatments will be allowed and which will not, with a goal of limiting costs.
 
−
*mandatory insurance requiring people to buy what they do not currently want, and which may not cover what they need.
 
−
*requirements that "self-insured employers" provide insurance for their employees, even if the small business cannot afford it.
 
−
*government-defined health benefits, like abortion or sex-change operations, that must be included by insurance as a condition of being able to participate in a government managed "Health Insurance Exchange."
 
−
*"home visits" by government agents to "improve immunization coverage" (require proof of vaccination).
 
−
 
 
−
Sarah Palin, the Republican Vice Presidential candidate in 2008, criticized this plan as follows:
 
−
 
 
−
:The Democrats promise that a government health care system will reduce the cost of health care, but as the economist Thomas Sowell has pointed out, government health care will not reduce the cost; it will simply refuse to pay the cost. And who will suffer the most when they ration care? The sick, the elderly, and the disabled, of course. The America I know and love is not one in which my parents or my baby with Down syndrome will have to stand in front of Obama’s “death panel” so his bureaucrats can decide, based on a subjective judgment of their “level of productivity in society,” whether they are worthy of health care. Such a system is downright evil.
 
  
−
Thomas Sowell is an African American economist who consistently supports free market solutions to health care and other challenges.
+
Read the lecture, and reread any section that you did not fully understand.  Complete the homework assignments through the level in which you choose to participate in this course.  You can post your answers for prompt grading here:
 +
http://www.conservapedia.com/Economics_Homework , or hand them in next class.  These questions are for a "free market" (when government does not control the prices and quantities).
  
−
In America children having cystic fibrosis live an average of 37 years, but under nationalized health care in Ireland the life expectancy for children with this condition is only 27 years.  Government-run health care does not cover many special-needs conditions, and once everyone is in the government system there is not enough of a free market to fund proper care for special needs persons.
+
1.  Fill in the blanks in the following sentence: The supply and demand for a good determine both the _________ and ___________ at which the good is sold.
  
−
==Tariffs and Quotas==
+
2. Suppose the price demand curve for a particular good is P = $30 - Q, where P is the price and Q is the quantity.  Also suppose the price supply curve is P = $6 + Q.  At which price and quantity will the good be sold?
  
−
"Imports" are goods shipped into our country by a foreign country, for sale in our country.  China imports many goods that are sold in the United States by Wal-Mart, for example.
+
3. When the '''''supply''''' of a good or service increases, such as increasing the number of oil wells, what happens to the market price of oil?  Explain.  When the '''''demand''''' for a good or service increases, such as more people driving cars that need gasoline (refined oil), what happens to the market price of oil?  Explain.
  
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There are valid reasons to discourage the sale of imports and encourage sale of goods made domestically (made in the United States). The money paid for imports goes to the foreign companies, and support the foreign countries.  The sale of imports do not help Americans as much as the sale of made-in-America goods do.
+
4. Why do grocery stores lower the price of their fruit (such as grapes) when they have an oversupply of ripened fruit? Explain by citing the downward slope of a demand curve, and describe what happens to this fruit after the grocery store lowers its price.
  
−
There are two approaches to disfavoring imports. The primary way in history was to impose a tariff on imports. A tariff is a tax on imports.  A tariff raises the price of imported goods, and the supplier must then reduce its received price to attain the same level where supply meets demand.  This has the effect of reducing supply.  Goods made domestically (in the United States) increase their sales due to the decrease in sales by the imports.  A tariff on a foreign-made car like the "Honda" would reduce the supply of Honda cars in the market.  American car companies would benefit from that, but consumers who want to buy more Hondas might not.
+
5. When the New York Yankees built their new $1.5 billion ballpark, they made a decision about how many "obstructed view" bleacher seats to include.  Due to the design of this new stadium, people sitting in these "obstructed view" bleacher seats would not be able to see all of the field because stadium walls or poles or other fans would block part of their view.  An economist studied the "supply and demand" in the market, and developed this table:
−
   
 
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The other approach to limiting imports is the use of quotas.  Instead of imposing a tariff on Hondas, our government could set an upper limit (quota) on the total number of Hondas that may be sold in the United States each year.  Quotas also reduce supply, but without generating any revenue to the government.  Instead, quotas have the effect of increasing the price of the good (Hondas in this case) with the higher price going to the company that sells the Hondas.  The government does not obtain any revenue from a quota, while it does obtain revenue from tariffs.
 
−
 
 
−
Prior to the passage of the Sixteenth Amendment that legalized the income tax in 1913, and even long afterward, the major source of revenue for our national (federal) government in Washington, D.C. was tariffs.  But tariffs have long been controversial, and dividing the North (which liked them because they "protected" the northern manufacturers against competition from imports) and the South (which disliked them because it increased the prices of goods they purchase and caused foreign nations to retaliate by placing tariffs on cotton and other exports from the South).  Tariffs were a major cause of the Civil War.
 
−
   
 
−
Today tariffs are rarely used and the government relies almost entirely on the income tax for funding.
 
−
 
 
−
==Assignment==
 
−
 
 
−
Read, and reread, the lecture.  Complete the homework assignments through the level in which you choose to enrol in this course:
 
−
 
 
−
1.  The supply of a good, and the demand for that good, determine both the ______ and ______ at which the good is sold, at least in a market free from interference or control by government.
 
−
 
 
−
2. Suppose the price demand curve is P = $30 - Q, where P is price and Q is quantity.  Also suppose the price supply curve is P = $6 + Q.  At what price and quantity will the good be sold?
 
−
 
 
−
3. When the supply of a good or service increases, such as increasing the number of oil wells, what happens to the market price of oil?  Explain.  When the demand for a good a good or service increases, such more people driving cars that need gasoline (refined oil), what happens to the market price of oil?  Explain.
 
−
 
 
−
4. Suppose 500 persons in a town each have the following weekly demands for gas, and the gas stations have the following weekly supplies:
 
  
 
{| class="wikitable"
 
{| class="wikitable"
 
|-
 
|-
−
|Gallons
+
|'''Price/Ticket for an "Obstructed View" seat'''
−
|Demand Price/Gallon
+
|'''Supply quantity at that price'''
−
|Supply Price/Gallon
+
|'''Demand quantity at that price'''
 
|-
 
|-
−
|10
+
|$30
−
|$5
+
|1000 (the high sales price => high supply)
−
|$1
+
|300 (the high sales price => low demand)
 
|-
 
|-
−
|20
+
|$25
−
|$4
+
|800
−
|$2
+
|450
 
|-  
 
|-  
−
|30
+
|$15
−
|$3
+
|600
−
|$3
+
|600
 
|-  
 
|-  
−
|40
+
|$8
−
|$2
+
|300 (the low sales price => low supply)
−
|$4
+
|1200 (the low sales price => high demand)
 
|-  
 
|-  
 
|}
 
|}
  
−
(A) What is the price and overall quantity of gas sold each week?
+
(A) Given the above supply and demand (you might find it easier to graph it), how many "obstructed view" bleacher seats did the New York Yankees build, and how much does the team make from sales of "obstructed view" tickets at each game?
−
<br>(B) Suppose Congress declares war and imposes a price control of $1 per gallon.  At what price and overall quantity will gas sell each week?
+
<br>(B) Suppose the City of New York passed a law for a maximum price (a "price control") of $2 per "obstructed view" bleacher ticket, because politicians felt that fans should not pay more if they do not get a full view of the field.  Will the obstructed-view seats sell out under this law, and will people have to wait in line in order to buy them?  Would you oppose or support such a law, and why?
−
 
 
−
5. For most of our nation's history it used tariffs rather than taxes on income in order to provide money for the national (federal) government in Washington, D.C.  What is the effect on the supply curve for a good imported from China if the U.S. government imposed a $1 tariff on it?  Would that cause more or less of that good to be purchased?  Why?  Now suppose the government uses quotas rather than tariffs.  By limiting the amount of a foreign good that can be sold in this country, Americans who make the same good have an easier time selling their good with less competition.  What effect does a quota have on the supply curve and the equilibrium price for an imported good?  Who makes more money because of a quota, and who loses the most from it?
 
  
−
6.  "Time is money." Explain.
+
6.  Suppose you own a restaurant, and your average customer spends $10.  Suppose further that your marginal cost for each customer is $5.  But in addition you have costs of $20 per hour in electricity and wages. From 6-7pm each night, you usually have about 40 customers, but then it decreases by 50% each hour thereafter as it gets later in the evening.  At what time do you close your store for the night? Explain your answer.
  
−
7. Suppose you work for a store and its owner arrives one day and tells you that wants to set new prices for every good in the store.  He declares that he is the owner, and he should be able to sell his goods and whatever price he chooses.  Will he succeed in this strategy, or is there another force outside the control of the owner that will determine the sales prices?  Explain to the owner what your opinion is of his approach.
+
7. Explain ''why'' waiting lists develop in countries (like Canada) where the government prohibits anyone from charging more than fixed prices for medical services, assuming that these fixed prices are lower than what the prices would be under supply and demand in the free market.  (Hint: the reason is related to the effect of price controls on the ''supply'' of a good or service.)
  
 
===Honors===
 
===Honors===
Line 227: Line 171:
 
Write an essay of about 300 words total on one or more of the following topics:
 
Write an essay of about 300 words total on one or more of the following topics:
  
−
8.  Discuss the effect of supply and demand and the Tyndale Bible.
+
8.  "Time is money."  Explain.  Or, as an alternative, improve on our definition of a "free market." Or, as a third alternative, explain how the free market is so much powerful than even the wealthiest people in the world.
−
 
 
−
9.  Is there a supply and demand curve for homeschooling, or homeschooling courses?  Discuss.
 
  
−
10.  Explain your opinion of the Democratic health plans proposed in the summer of 2009.
+
9.  Relate the supply and demand curves to the basic economic concept of scarcity.  For a good that has no scarcity, such as air, are there any supply and demand curves that are meaningful?  Discuss.
  
−
11.  How does supply and demand and the free market help someone who might be an outcast in a community?
+
10.  Discuss any aspect of the economics of health care.
  
−
12.  What is your view of the minimum wage?  Should it be increased?
+
11.  How are the forces of supply and demand and the free market helpful to someone who might otherwise be an social outcast and victim of prejudice in a community?  In addition or alternatively, discuss the social benefits of a "free market" more generally.
  
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13.  Should providers of abortion services be required to fully disclose the harm that abortion causes to those considering abortion?
+
12.  Compare "equilibrium" in economics to "equilibrium" in other fields (such as chemistry or physics) or in life itself (such the flow of traffic on highways), using specific examples.
  
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==References==
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== References ==
  
 
<references/>
 
<references/>
−
 
 
[[Category:Economics lectures]]
 
[[Category:Economics lectures]]
 
{{DEFAULTSORT: Economics Lecture 02}}
 
{{DEFAULTSORT: Economics Lecture 02}}

Latest revision as of 14:53, July 16, 2014

You can post answers here: Economics Homework 2 Answers
Economics Lectures - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 - 11 - 12 - 13 - 14]

One miracle is mentioned in all four Gospels of the Bible: the multiplication of the loaves and fish by Jesus to feed the crowd of thousands. It illustrates God easily overcoming a scarcity in food. Similarly, the devout Puritans overcame scarcity and created wealth under harsh conditions in New England in the early 1600s. Scarcity is no problem for God, but it can be a huge problem for those who turn away from God.

Economics is the study of the transfer of goods and services. What determines the price and quantity of goods transferred? How much must a buyer pay in order to acquire the good (the price), and how many units of the good (the quantity) will the seller be able to sell at that price?

Let's take an example. Suppose you own a candy store, and you sell chocolate candy bars. What price should you use to sell those candy bars? If you sell them for $1 each, many people will buy them. But if you charge $5 per candy bar, fewer will buy them at that price. You will not be able to sell as many candy bars at the price of $5 each. If, on the other hand, you sell the candy bars for only 10 cents per bar, you'll sell out quickly as people rush to buy the bars at that low price. It might seem like you'd be happy at selling so many, but you make much less money overall at 10 cents per bar than at $1 per bar. As the candy store owner you're worse off if you set the price at only 10 cents per bar, because you receive too little for each bar, and you're worse off if you set the price at $5 per bar, because you sell too few bars. The price at which you make the most money is probably around $1 per bar.

The above example is the sale of a good (a candy bar). The same analysis applies to the sale of services (such as a car mechanic repairing cars). People sell their time as much as they sell what they own. In this sense, "time is money" because time can be converted into money by spending that time working. You could convert 8 hours of time into about $60 by working at minimum wage.

Price of Stocks

The price of a company’s stock is a compromise between (i) the price at which people are willing to sell it (the supply price) and (ii) the price at which other people are willing to buy it (the demand price). A "sale" of the stock occurs only when the supply price equals the demand price.

Specifically, stock prices on the New York Stock Exchange and NASDAQ (the stock exchange for new and often high-tech companies) are determined entirely by the “bid” and “ask” prices of the buyers and sellers. Someone will “bid” a certain amount to buy a stock, and a seller will “ask” for a higher price. When the bid and ask prices are equal, then a sales transaction occurs. Prices can move very quickly and unpredictably when millions of people are involved. When the overall trend of most stocks from day-to-day is an increase in their prices, then it is known as a "bull market"; when the overall trend of stocks from day-to-day decreases in price, then it is known as a "bear market." You can remember that by thinking of how bears are scary, and stock markets that crash in their prices are scary things.

As explained above, the price that a stock trades on the exchange is where the “supply” by sellers equals the “demand” by buyers. When a seller of stock asks too high a price, then there are no buyers and the stock does not trade. When a buyer of stock offers to pay too little a price, then there are no sellers at that low price and the stock does not trade. The transaction (trade) occurs only when SUPPLY EQUALS DEMAND.

This is the most basic concept in all of economics: transactions occur only where "supply meets demand." Let's discuss this further.

Supply and Demand

The supply of a good is how much of it (the quantity), and at what price, is provided by a seller of the good. Grocery stores, factories, malls, amazon.com, and candy stores all supply goods. Services, like entertainment, are supplied by Hollywood, Major League Baseball, the NFL and also doctors, lawyers, accountants, and so on. The supply side consists of the producers, providers and sellers of goods and services.

The demand for a good is how much of it, and at what price, is wanted by the public seeking to buy it. Shoppers, moviegoers, baseball and football fans, and people needing medical care, are on the demand side. Often buyers of goods and services are called "consumers".

For any given good or service, there is a supply and demand. The supply can be described in terms of the possible production of different quantities at different prices. The demand can be described separately as the willingness of the public to purchase different quantities at different prices. The price is the key to both the supply and demand side; it is the price that determines the quantity transacted.

No company can afford to build cars (supply them) if the sales price is only $1. But at a sales price of $30,000, a vast number of cars can be built. The cause is price, and the effect is quantity: the higher the market price for something, the more that manufacturers will want to make and sell it.

 
Impress the girls with this Lamborghini sports car, at a cost of $350,000. Not a high demand at that price!

The demand for a good is also described in terms of price and quantity. At a given price, there is a specific quantity demanded by the public for the good. A billion people might buy a car if the price were only $1 (unrealistic). At a much higher price of $30,000, the demand drops to a quantity of millions sold (realistic). At a still higher price of more than $100,000, the demand falls much further to the range of only a few thousand that can be sold (these are the very luxurious cars, like the Lamborghini sports car shown at the right).

Because supply and demand can both be expressed in terms of price and quantity, they can be plotted on the same graph. Price (P) is on the y-axis, and quantity (Q) is on the x-axis. This is in alphabetical order: "p" for price is lower in the alphabet than "q" for quantity, and "p" appears first on the graph as one reads from left to right. Put another way, the graph is of "Ps and Qs," in that order from left to right (P on the y-axis to the left, and Q on the x-axis to the right).

The supply curve is always upward sloping: the higher the sales price, the higher the quantity that companies will produce for sale. That is because higher sales prices bring in greater revenue -- and greater profits -- to provide the incentive to increase the supply quantity.

The demand curve is always downward sloping: the higher the sales price, the lower the quantity the public is willing to buy. Few people will buy a candy bar if it costs $5: if that price is lowered to $2, then more people will want to buy it, and if its price is lowered to $1, then even more will want to buy it, and if its price is lowered to 50 cents, then the demand by the public for that candy bar will be even greater. As the price for something goes down, the demand goes up. That results in a downward-sloping demand curve: as the price goes down the slope of the curve, the quantity demanded (sought) by the public goes up (see the curve labeled "Demand" on the graph below).

The supply and demand form the most basic relationship in all of economics. They are independent of each other, but are placed on the same graph so that it becomes easy to find "equilibrium": the point where supply and demand have the same value for their price, and the same value for their quantity (the point of the intersection of their curves).

If the price is higher than the equilibrium price, then there will be unsold goods due to fewer people wanting to pay the higher price. The sellers then need to lower their price in order to sell these leftover or unsold goods, and that forces the price downward to the equilibrium price. Conversely, if the price is lower than the equilibrium price, then the sellers will not have enough goods to satisfy the higher demand by the public. The sellers will then increase their price (and their revenue) to take advantage of the higher demand. These market forces both above and below the equilibrium price are what push the final price to the point where the supply curve intersects the demand curve. At this point the price and quantity for the supply are precisely equal to the price and quantity for the demand.

The supply and demand curves usually look like this:

 

In the graph above, P* and Q* are the price and quantity at which the good is sold: the equilibrium price and quantity.

The point where supply equals demand can be found either by graphing the two curves and seeing the point of intersection or, if you have the equation for each curve, by solving the equations algebraically. For example, if the supply curve is P = 100 + Q and the demand curve is P = 500 - Q, then the point of intersection can be found by solving these two simultaneous equations as follows. When the P in the first equation equals the P in the second equation, then 100 + Q = 500 - Q, thus 2Q = 400, and thus Q = 200. From there you can solve for P by plugging Q back into one of the two original equations: P = 500 - 200 = 300. You can check this answer by plugging Q into the other original equation to confirm that you get the same P = 100 + 200 = 300. So the final answer -- the point where supply equals demand -- is this: P=300, Q=200.

Changes in Supply and Demand

The above model for supply and demand helps us consider the effect of changes or shifts in supply and demand. First consider an increase in demand by the public for a particular good, from demand curve 1 (D1) to demand curve 2 (D2):

 

An increase in demand causes the price to rise from P1 to P2. The new equilibrium is at a point with higher price and greater quantity than before. What could cause an increase in demand? For gasoline, more people driving would cause an increase in demand. For heating oil, a colder winter would cause an increase in demand. For sports entertainment, a close rivalry (as in a close pennant race between the Yankees and Red Sox) can cause an increase in demand (spectators). In all these cases, price and quantity tend to rise. Conversely, if there is a decrease in demand by the public, then the opposite is generally true: prices and quantity decrease.

Next consider an increase in supply by the producers. Suppose farmers have better weather, for example, causing more crops at the harvest. Or suppose there is discovery of huge new oil reserves underground. Or suppose a new invention, such as Eli Whitney’s cotton gin, increases the production of a good (cotton). This curve shows what happens when there is an increase in supply, from supply curve S1 to supply curve S2:

 

Can you interpret that? When the supply curve shifted to the right as supply increased, the price decreased but the quantity increased. The new equilibrium is at a lower price and greater quantity than before. Consumers are happier as supply increases. The discovery of new oil reserves, or inventions like the cotton gin, make consumers (the public) better off.

Laws exist to encourage greater supply, because it is good for the public. Antitrust laws, for example, make it illegal for companies to agree with each other to reduce supply.

The "Free Market"

The interaction of supply and demand is what we call the "market". The "free market" is the interaction of supply and demand without any interference or control by government. The dictionary definition states that the "free market" is "an economic market operating by free competition."[1]

The free market drives down prices, which helps the poor enormously. It is the free market that makes the Bible and food and communications inexpensive for the poor, and which helps bring Christian missionaries to serve the poor in faraway places. The following example illustrates how the free market has made air travel available to the poor, and available to others in order to help the poor.

In the 1960s and 1970s, government set the prices for airline tickets, and only the wealthy could afford to travel by plane. Then, in 1978, Congress "deregulated" the airplane industry, which allowed the free market to set the prices based on supply and demand. The benefits were tremendous in enabling far more Americans to be able to afford air travel:[2]

Airfares, when adjusted for inflation, have fallen 25 percent since 1991, and ... are 22 percent lower than they would have been had regulation continued. Since passenger deregulation in 1978, airline prices have fallen 44.9 percent in real terms according to the Air Transport Association. ... [W]hen figures are adjusted for changes in quality and amenities, passengers save $19.4 billion dollars per year from airline deregulation.

The above analysis was written five or more years ago. Airline fares have fallen even more since then. That is because the free market lowers costs for everyone. Poor people can buy airline tickets now, when they could not before.

Wal-Mart is another example of this, as it provides goods at lower and lower prices for everyone. This is very helpful to the poor. Someone can have no money, or lose all his money, and yet if he tries then he can live nearly as well as the wealthiest man in the nation -- if the free market is allowed to exist to drive down prices and provide equal opportunity. Where the free market does not exist -- as in many countries of the world -- then the poor may suffer, because prices are too high and opportunities are too limited for the poor to improve their lives. Thus one of the best ways to help the poor is to provide them with the free market in order to lower prices and increase opportunities for them.

The free market can have a politically beneficial effect also. The free market is a powerful force against tyranny. Government cannot easily control and limit free market supply and demand.

So the next time you're flat broke without any job and facing a hopeless economic situation, remember this: in the United States you still have the free market on your side, the most powerful tool of all. Put it to work for you. The free market is a hardworking servant.

What Supply and Demand Are Not

In learning what something is, it sometimes helps to learn what it is not.

The preference of any single individual, such as yourself, is nearly irrelevant to the overall supply and demand. You may dislike the Yankees, but your own view is less than a "drop in the bucket" compared to the view of the public. Similarly, the opinion of the wealthiest person in the world does not affect supply and demand any more than the opinion of the poorest person can, in a free market. Wealthy people may avoid Wal-Mart, but that did not keep it from becoming the richest and most successful store in the world. Supply and demand transcend and are above the views, preferences, and buying habits of any individual or small group of people. Supply and demand are like a massive ocean that's not going to change based on what a few people do.

Notice also that the free market treats everyone fairly and equally. Supply and demand do not care about someone's status in society. The free market is independent and above prejudice. A restaurant owner makes the same amount of money from the most disliked person in society as from the most popular person in town.

Notice this too: the "market price" set by supply and demand is often unrelated to the historical cost of the good. Someone may have paid $300,000 for his house in 2006, when houses were high in value, but the market price for that same house in 2009 may be only $200,000. When that person tries to sell his house in 2009 it does not matter what he paid for it in 2006. All that matters is what the supply and demand for that house is at the time he tries to sell it.

The free market and supply and demand are similar to a sports competition. It really doesn't matter how many trophies one team may have won in prior years, or who likes which side better, or who thinks which side should win. All that matters is which team is better on game day. Likewise, all that matters to setting the price in a free market is the supply and demand at the time of sale. That may seem harsh if it causes someone to lose money, just as it can be sad when someone trains extremely hard to win a match, but is defeated in an upset by someone nobody likes. But in other ways this is fair, because it gives full opportunity for someone to do well no matter who he is and no matter where he comes from.

Equilibrium

The important concept of “equilibrium” arises frequently in economics. It is similar to the concept of equilibrium as in chemical reactions. The term “equilibrium” means a state of balance between opposing forces. It is a settling down. In a tug of war between opposing teams, “equilibrium” would be where the rope is stationary with each side pulling an equal amount on it. But usually one side wins in a tug of war, so that is not the best example. A better example of an “equilibrium” is when you have eaten just enough to satisfy your hunger, and not too much to make you feel bloated or nauseous. You are then in “equilibrium” between hunger and overeating. If you're still hungry then you eat more; once you are "full", you stop eating until later.

“Equilibrium” is “where things are going” or where they have already arrived. Economic equilibrium is when all the imbalances in the forces of selling and buying have disappeared and a perfect balance between the sellers' desire to make more money (that's like hunger) and the buyers' desire to pay as little as possible (that's like not eating). When the market has reached a balance between these two powerful, opposing forces, then it is equilibrium. The opposing forces of the sellers trying to make money and the buyers trying to keep money are what "drive" the price to its equilibrium level, like a tug of war.

When there is perfect competition in the sale of a good or service, then the equilibrium is when the marginal revenue to the seller (the extra dollar that he charges and receives as revenue) equals his marginal cost in producing the good (the extra dollar he paid to produce the good). At that point the seller's marginal profit (the extra amount that he can keep after paying his costs) has fallen to zero and he has no incentive to produce any more goods. In other words, the supplier keeps producing more and more goods only until his marginal profit on each extra good falls to zero such that he does not make any more money by trying to sell additional quantity. The seller does not want his marginal revenue to fall below his marginal cost, because then he is losing money.

Here is an example. How long does the owner of a store keep it open at night? As long as the flow of customers into his store pays him more money (marginal revenue) than it costs him to keep the store open (marginal cost). As it gets later at night, the flow of customers declines, the owner makes less, and eventually his costs of keeping the store open will exceed the money that is being paid to him by new customers. As soon as the owner realizes that he is paying more to his workers to keep the store open than he is getting from new customers, he closes his store for the night. After a few weeks of this, the owner realizes that he usually makes money before a certain hour (perhaps 9pm), and loses money afterward. Then he puts a sign on his door telling everyone that he closes at 9pm every night. Marginal revenue exceeds marginal cost before 9pm for him (so he makes a marginal profit by staying open), while marginal costs exceed marginal revenue after 9pm (so he avoids losing money and closes his store for the night).

Example: Health Care

By far the single biggest industry in the United States is health care (medical care). It represents a massive one-sixth of our entire economy -- including annual expenditures of more than $2.2 trillion -- and costs are increasing each year. It has three major components: government-controlled (Medicare and Medicaid), insurance-controlled, and private pay or uninsured. Though many are unhappy with our system, it is the finest in the world and foreigners travel to the United States to have their medical problems treated. The survival rate for the most prevalent form of cancer in men -- prostate cancer -- is 92% in the United States, but the survival rate for that same disease in England is only 51% under its government-controlled system.

Most other countries have some form of government-controlled, or socialized, medicine. In the countries of Canada, North Korea and Cuba, it is actually illegal to pay money to a doctor to see you. You can see only a doctor paid by the government in those countries. In England, there is a two-tiered system: good care is provided to the few who can afford to pay for it, and free but inferior care is provided by the government to the vast majority who cannot afford it.

In the United States, under the free market, anyone can pay his own money for medical care at any time. But in Canada, someone with an illness is typically put on a waiting list and, depending on his age and likelihood of survival, may not see a doctor for months. In some cases, patients pass away before they obtain the treatment they need. The Canadian government sets limits on wages and prices for medical care, and that causes shortages because there is always less supply when the price is artificially lowered by government control. (Look again at the shape of the supply curve: at lower P, there is lower Q).

Lowering wages and prices prevents supply from rising to satisfy demand. Then demand is much greater than supply, and patients have to wait a long time to see a doctor. There is a lower survival rate for cancer in Canada than the United States because of the delays in diagnosis and treatment in Canada. In Buffalo, which is on the Canadian border, doctors treat many Canadians who come over the border to pay for immediate American medical care rather than wait for it in Canada.

This limiting of supply by government-set pricing causes what is known as "rationing". More people want the service (a medical operation or treatment) than is available. A waiting list is created to handle the surplus in demand over supply. But when someone has a cancer growing inside of him, delay by being placed on a waiting list can be agonizing and deadly. Quick treatment helps improve survival from cancer. In the United States, where government does not set all prices and there is not any rationing yet, the survival rate for five common forms of cancer is over 90%. Thanks to the powerful benefits of the free market, the rate of survival continues to improve in the United States.

But in Scotland, the birthplace of Adam Smith and his theory of the invisible hand that he wrote about in 1776, the survival rate from cancer under government-controlled medicine has fallen to "the worst in Europe, lagging behind countries such as Poland and Slovenia. ... Cancer experts blamed ... long waiting lists for the poor results."[3]

A free market in health care benefits children too. The life expectancy for a child born with cystic fibrosis in the United States is 37 years, but only 27 years in Ireland under its government-controlled (or nationalized) health care.

Assignment

Read the lecture, and reread any section that you did not fully understand. Complete the homework assignments through the level in which you choose to participate in this course. You can post your answers for prompt grading here: http://www.conservapedia.com/Economics_Homework , or hand them in next class. These questions are for a "free market" (when government does not control the prices and quantities).

1. Fill in the blanks in the following sentence: The supply and demand for a good determine both the _________ and ___________ at which the good is sold.

2. Suppose the price demand curve for a particular good is P = $30 - Q, where P is the price and Q is the quantity. Also suppose the price supply curve is P = $6 + Q. At which price and quantity will the good be sold?

3. When the supply of a good or service increases, such as increasing the number of oil wells, what happens to the market price of oil? Explain. When the demand for a good or service increases, such as more people driving cars that need gasoline (refined oil), what happens to the market price of oil? Explain.

4. Why do grocery stores lower the price of their fruit (such as grapes) when they have an oversupply of ripened fruit? Explain by citing the downward slope of a demand curve, and describe what happens to this fruit after the grocery store lowers its price.

5. When the New York Yankees built their new $1.5 billion ballpark, they made a decision about how many "obstructed view" bleacher seats to include. Due to the design of this new stadium, people sitting in these "obstructed view" bleacher seats would not be able to see all of the field because stadium walls or poles or other fans would block part of their view. An economist studied the "supply and demand" in the market, and developed this table:

Price/Ticket for an "Obstructed View" seat Supply quantity at that price Demand quantity at that price
$30 1000 (the high sales price => high supply) 300 (the high sales price => low demand)
$25 800 450
$15 600 600
$8 300 (the low sales price => low supply) 1200 (the low sales price => high demand)

(A) Given the above supply and demand (you might find it easier to graph it), how many "obstructed view" bleacher seats did the New York Yankees build, and how much does the team make from sales of "obstructed view" tickets at each game?
(B) Suppose the City of New York passed a law for a maximum price (a "price control") of $2 per "obstructed view" bleacher ticket, because politicians felt that fans should not pay more if they do not get a full view of the field. Will the obstructed-view seats sell out under this law, and will people have to wait in line in order to buy them? Would you oppose or support such a law, and why?

6. Suppose you own a restaurant, and your average customer spends $10. Suppose further that your marginal cost for each customer is $5. But in addition you have costs of $20 per hour in electricity and wages. From 6-7pm each night, you usually have about 40 customers, but then it decreases by 50% each hour thereafter as it gets later in the evening. At what time do you close your store for the night? Explain your answer.

7. Explain why waiting lists develop in countries (like Canada) where the government prohibits anyone from charging more than fixed prices for medical services, assuming that these fixed prices are lower than what the prices would be under supply and demand in the free market. (Hint: the reason is related to the effect of price controls on the supply of a good or service.)

Honors

Write an essay of about 300 words total on one or more of the following topics:

8. "Time is money." Explain. Or, as an alternative, improve on our definition of a "free market." Or, as a third alternative, explain how the free market is so much powerful than even the wealthiest people in the world.

9. Relate the supply and demand curves to the basic economic concept of scarcity. For a good that has no scarcity, such as air, are there any supply and demand curves that are meaningful? Discuss.

10. Discuss any aspect of the economics of health care.

11. How are the forces of supply and demand and the free market helpful to someone who might otherwise be an social outcast and victim of prejudice in a community? In addition or alternatively, discuss the social benefits of a "free market" more generally.

12. Compare "equilibrium" in economics to "equilibrium" in other fields (such as chemistry or physics) or in life itself (such the flow of traffic on highways), using specific examples.

References

  1. ↑ Merriam Webster's Collegiate Tenth Edition (1994).
  2. ↑ http://www.econlib.org/library/Enc/AirlineDeregulation.html (emphasis added, citation omitted).
  3. ↑ http://www.highbeam.com/doc/1P2-12923478.html
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