Economics Lecture Two

Economics Lectures - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 - 11 - 12 - 13 - 14]

In the last lecture we introduced the fundamental concepts of economics. Now we are ready to explore several issues in greater detail.

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.

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?

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.

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.

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

The price of a company’s stock reflects the price at which people are willing to sell it (the supply price) and 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. The overall value of a company at any given time is the price per share of its stock, multiplied by the number of shares of stock. A company that has one billion shares of stock in the market, each 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.

Note that stock values, like economics in general, reflects the future rather than the past. Often a company announces a profit for the year, and yet its stock value decreases on the news. That happens when people do not expect the company to be as profitable in the future as it has been. Past profits do not matter to the price of a stock today; profits in the future do. General Motors was once the most profitable company in the world; now it is worthless, because it cannot make any profits in the future.

During the internet “dot-com” boom of the late 1990s, stock prices surprisingly increased for companies that were losing money. That was because people expected the companies to be very profitable in the future. Sometimes it even seemed like the more a dot-com company lost money, the higher its stock would go! That was very unusual, but was based on expectations about the future. As it turned out, most of these companies went bankrupt, and the internet became profitable for only a few companies like Google.

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.

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 too little a price, then there are no sellers and the stock does not trade. The transaction only occurs when SUPPLY EQUALS DEMAND.

This important principle of "supply and demand" is the most basic concept in all of economics, and next we explain it further.

Supply and Demand

The supply of a good is how much of it, 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 is made up 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.

For any given good or service, there is a supply and dem