Crossposted from Brother Bobs Blog
Welcome to lesson II of “Economics for Politicians”! In the first lesson we explained who the government’s money belongs to (the people), and now we move on to Lesson 2 – a basic introduction to Microeconomic Theory. Hey! Stop – don’t get up and leave! Contrary to what you may have heard economics is not necessarily boring, and this lesson will be a huge help in your crafting policy that will get you re-elected!
Ah, I knew that magic word would get your attention. As I was about to say, the most fundamental building block of understanding economics is the classic supply and demand curve. You probably remember seeing something like this in one of the classes you slept through early on in your undergraduate days:
OK, we’ve put a bunch of points on a graph and plotted them out. So what does all of this mean? Like any problem it’s easier to understand if you break it down piece by piece. Let’s make the discussion more interesting by talking about a good or product that you will find interesting – bottles of whiskey. Back in the early days of your career before you had lobbyists to provide you with bottles of your favorite blend, you had to actually pay for them with your own money. What drove your decision as to what to buy? Probably lots of factors, such as the quality of the brand, how far you may have had to travel to get it, and of course, cost. To simplify this lesson we’ll use a term that factors out externalities, or what economists call caterus parebus, “All other things being equal” to only focus on price. Assuming that every store carries your favorite whiskey where you buy and how much will only depend on price for now.
Let’s assume that the local shop has ten bottles of whiskey on the shelf, and they are giving them away for free! If it’s your favorite brand, it’s a no brainer – you take all ten. Now let’s say the price goes up to $10 per bottle – still a very good deal and these could make great stocking stuffers for your cohorts. But you don’t want to or cannot buy all ten bottles, so you buy only nine. When the price increases to $20 you buy only eight, and so on until the price reaches $100 where you decide that whiskey is too expensive for your tastes right now and you decide to buy some vintagely challenged wine instead. Plot all of the points, and you get a demand curve that looks something like this: 
Keep in mind that these curves will not perfectly predict your buying behavior, but this is a short lesson so we have to speak on a general level. On a large enough scale and when you compile enough actual data from real world examples, these graphs hold pretty true to actual behavior.
Now let’s look at the other side of the aisle, the supply curve. Whereas we just looked at whiskey from the buyer’s perspective, the supply side looks from the seller’s perspective. If you are selling your whiskey you are willing to supply more if you will get paid more for it. If you have your ten bottles of whiskey to sell at $100 per bottle you will gladly sell all ten! Now as we drop the price you are not willing to sell as many since you cannot make as much profit on each bottle. Your willingness to sell them drops until we get to giving them away for free and you are unwilling to offer any on your store’s shelves. Plot the points and you get something like this:
An obvious question is that if you’re only able to charge $40 per bottle why you would order ten in the first place when you are only willing to sell four of them? The answer is that your awareness of this lower market price leads you to only order four bottles since more are not worth your trouble. Consider this your introduction to why price controls are an excellent way to cause shortages and rationing.
Plot both lines together and we see a magical point where both lines meet – buyers and seller have found the point where we have maximized how many will sell with how many will buy, also known as equilibrium – voila!
Going back to a strictly buyer’s perspective, when the price of a good increases less of it gets consumed, while as the price drops more of it gets consumed. To some degree you already understand this – think of when you pass “sin taxes” to encourage people to consume less of goods that they want but that groups who fork over truckloads of cash into your reelection campaign you deem a bad choice, such as cigarettes or oil. On the flip side, when you want people to consume more of a good that they would not willingly choose at the market price you introduce subsidies to bring costs down and increase demand, such as with electric cars or “green” energy.
Now you see how your decisions and the laws you impose on us help to modify people’s behavior and distort marketplaces where prices are the measurement of what people will freely choose to buy or not buy. Think of the sum of all of the legislation that you pass designed to affect markets as the biggest anti-choice initiative ever created. Prices do matter!
Now that we’ve seen how to understand the economics of individual decisions, next up will be an introduction to Macroeconomics, or how we measure the sum of all of this economic activity!
A fine lesson.
Thanks.
While I cook with alcohol like vodka, wine, sherry, brandy, whiskey and a few others, I only drink the stuff a bit.
So, when throwing it in to have the flavor, not the alcohol, I go more for flavor than price.
BUT meat.
Yikes!
I was taking with a butcher the other day.
Beef has skyrocketed up and now it sits on the supermarket shelves until two days before its ”last day to sell” date.
Then it gets cut in price and sells quickly.
Also supermarkets (in my area) have gone down in quality of beef.
No Prime.
No Choice.
They only sell Select grade beef.
I sometimes get a yen for beef steak so I go to one of those shops that carries Prime.
It isn’t that much pricier to get Prime because all beef is so high.
Economics is weird.
@Nan G:
That’s the only brand of beef I buy these days: expired. I figured it’s just “well aged”. I really wonder what they do with those $65 prime ribs when they expire, though. I’ve never seen one marked down.
We have a discount supermarket in our town which specializes in about-to-expire food of all kinds. I shop there a lot.
@Nan G: @John Cooper:
Beef prices, along with chicken and every other meat sold, has gone up in price due to many different factors, including the price of fuel(which affects transportation costs of everything), and the price of corn(which has gone up due to ethanol usage).
Brother Bob could have gone into much greater detail concerning microeconomics, such as the factors affecting a seller’s(producer’s) willingness to supply a good, including the cost of manufacture of that good, and then what is included in that cost to manufacture a good, such as one’s workers’ labor costs, which can be affected by such things as minimum wage increases, or the above mentioned tranportation costs and price of the raw materials.
Generally, though, the lesson is simple enough that most people can understand it, although I would assume that many liberals would still complain that the seller is being “greedy”.
@johngalt – Great observations. Stay tuned for subsequent posts where I address those – this is the second in a series of nine posts. Stay tuned!
On your supply vs demand lesson (retailer and consumer) there is another point of view, that of the manufacturer and investor. I understand for simplification purposes you presented the slope of these graphs as straight lines. In real life they aren’t straight but more parabola shaped. The point here is that the demand/supply line is an exponential curve, not a straight line and therefore not a geometric proportional response. While most liberals would understand your straight line slope explanation, they don’t understand the curve and that’s were the problem lies. Liberals automatically assume profiteering when in fact in times of shortage high prices not in proportion are needed to draw capital investment to quickly correct the supply imbalance.
Example: As the demand for gasoline increases, the closer you come to a supply imbalance, the faster the price rises out of portion to supply. This is what is called a seller’s market, where competition is non existant. When demand is so high that a shortage develops, prices skyrocket exponentially to limit demand (capitalistic consumption rationing.) Higher prices inturn stimulate production as producers (oil drillers) get more profit and naturally want to maximize their profits on the volume. Over time the supply imbalance starts favoring the consumer where producers are competing against each other, a buyer’s market, for market share. When this happens, prices drop minimally according to the low end of the exponential curve since production is a fixed cost per unit unless some technological breakthrough occurs allowing one of the producers to undercut the others to grab market share.
During times of shortages, investors flock to the producers to sink more oil wells since a high rate of return is forecasted. This is especially true when there are limited high return investments from other industries. (yes, there is a competition between investors and manufacturers as well) During times of glut, where the return on investment is minimal, investors shun that sector and in the process works to limit production which has the effect reducing the supply imbalance of a buyer’s market. This is especially true of the oil and gas producers since the wells that are drilled age very quickly and start declining in production after the first two years in service, necessitating more wells to be drilled to offset the declining production of existing wells. This explains the cyclical nature of oil and gas supply. Your example again because of simplification purposes eliminates the time lag between investment and production to give the illusion of a proportional instanteous response. This also confuses liberals.
@Dan Scott – That was a terrible comment! Do you expect a politician to understand that?!?
jk… Good intermediate micro comment! =8^)
@Brother Bob:
I will most definitely “stay tuned”! I used to vote more on the social issues rather than fiscal, but have since moved to a position that I believe the social issues kind of take care of themselves if the fiscal problems are addressed. And in my previous job, which essentially was running my own business where I had to deal closely with economic issues on a daily basis, I obtained a “school of hard knocks” type education on economics and had to do so in order to make my “business” thrive.
Another big influence in my move to fiscal conservatism was a reading of Atlas Shrugged which made clear to me ideas that I was fumbling around with before. Levin’s Liberty and Tyranny was also a big influence in my moving into Constitutional Conservatism.
@dscott:
All that is well and good, however, when people don’t even understand the basic of the basics, so to speak, then any detailed explanation is useless. That is where Brother Bob’s post here is worthwhile. I, for one, am looking forward to his future postings, particularly in the hopes that some of our liberal/progressive “friends” here will engage in the conversation, so that they may learn why their ideas are so damaging to business.
@Brother Bob:
And we wonder why we are in trouble? There is no cure for stupidity, the only solution is to vote them out!