Comment Cards 08

September

1. I think there must have been some kind of regulation on the subsistence economy because people in the olden days were governed by kinship (some kind of exchange rules must have guided them).

R: Subsistence economies were not without rules and traditions. Economies such as the northwest Indians developed rather elaborate means to distribute the output in ceremonies such as the potlatch. The chief would give away crops to neighboring tribes after feasts and ceremonies that lasted for days and would determine how the harvest would be divided among the families within the clan. Elders would have greater power in determining distribution in these traditional economies. But they did not use means of exchange and in many such societies they shunned the appearance of exchange altogether, preferring, for example, to drop furs, fish and crops at the edge of a clearing and, after meeting with the other tribe, pick up what the other tribe left on their side of the clearing. Moreover, since a true subsistence economy lacks sufficient productivity to produce beyond its own bare needs it has no excess to exchange, i.e., there is no specialization. Even after populations reached a size in which economies of scale could allow for specialization and exchange, the market was not considered a virtuous place or activity. Earning ones living by exchanging goods for other goods (barter) was tantamount to cheating. You had to be clever and somewhat devious to do well. The higgling and haggling (don't you love these terms) of the market place was considered a lowly trade. Buying cheap and selling dear or as David Ricardo put it "profit by alienation" was not a socially acceptable activity. That's why it was confined to certain parts of the city, cordoned off from civil society. Read the book  Trade and Market in the Early Empires: economies in history and theory edited by Karl Polanyi, et al.

2. Is there an equation for, or a way to calculate, the supply and demand function?

R: There is no one equation to describe the relationship between price and quantity in a supply or demand function because every market is different. Fundamentally, we know that price and quantity-demanded are inversely related and price and quantity-supplied are positively related. That relationship however can be linear or non-linear. So, a single set of equations doesn't exist to describe all markets. If it were a perfectly linear function (unlikely) then it would be like every other one, taking the form X = a - bY where X is quantity-demanded, a is the vertical intercept (or the price when Qd is zero), Y is price and b is the slope of the function (or in other words the relationship between a given change in price and a resulting change in quantity-demanded in the opposite direction.  But I can't tell you any more. I can't give values to b or a without knowledge of a particular market which by the time we write them down will have changed before our eyes. We can always write two equations for supply and demand and solve for the equilibrium position but given the caveat that markets are constantly shifting there would be little point to the exercise. 

3. What is the difference between equilibrium and market-clearing equilibrium?

R: They are interchangeable terms. In both cases we are referring to a price at which quantity-demanded is equal to quantity-supplied. In other words, the market is cleared of products offered for sale -- the amount consumers want to buy at the equilibrium price is exactly the same as the amount sellers want to offer at that price. If price is above the equilibrium then more product will be offered than the amount consumers want to buy -- a surplus -- and the market has not cleared. If price is below the equilibrium then consumers want more products than sellers want to offer and, in that sense, consumers are still around (perhaps literally standing around) demanding more at that price, so the market has not cleared.

3. If a producer wants to make something more difficult to get, thus decreasing the quantity while increasing price, what would happen to the supply and demand curves?

R: Nothing would happen to the demand curve. If it is a competitive market then we can assume that a seller who reduces the amount she offers on the market will have no effect on price because her competitors will simply fill the vacuum by producing more. Only if the seller has a certain degree of market power or colludes with her competitors will she be able to set price by controlling the market supply. This is why Microsoft, the grain-producing industry and the petroleum industry are able to accumulate such enormous profits. They have a significant amount of monopoly power.

4. What is the difference between microeconomics and macroeconomics.

R: Microeconomics is the study of the consumer and the firm while macroeconomics is the study of the entire economy. The introductory course in macroeconomics studies market economies almost exclusively.

5. Can you explain, in particular, the process by which excess demand is eliminated and equilibrium produced?

R: Imagine a retail electronics store and a line-up of consumers waiting outside to buy the latest Nintendo Gameboy or Xbox (I have no idea what these are, so bear with me). Imagine further that there is a big sign with a price of say $400 for one Xbox (again, bear with me, I have no idea what price they sell for). The store owner looks out and sees 100 people in line. He counts his inventory and finds he has only 75 in stock. He hasn't opened his store yet so he crosses out $400 on the sign and writes $450. As a result of the increase in price, 15 people leave the line but he is still 10 short in his inventory. He crosses out $450 on the sign and writes $460 and 10 people walk away. The price of $460 is the market-clearing equilibrium price. The amount in inventory is just equal to the amount consumers are willing to buy at $460 (we're assuming each consumer wants only one). That is one way to show how markets work their way to equilibrium. Remember, however, the producer of the Xbox might eventually increase production to capture the profit the retail seller is earning from the shortage. In fact, many such producers of popular products prohibit retailers from raising price above the MSRP (manufacturers suggested retail price) because they want to realize the greatest share of profits from the sale. Producers can discipline retailers by simply refusing to sell their products to those who violate their pricing policies.

6. Why did you draw a non-linear (curving) supply curve while the demand curve was linear (a straight line)?

R: I don't recall the problem but supply and demand can be either linear or non-linear. It is most likely that the functions are non-linear -- it would be unusual if demand or supply were perfectly linear.

7. (Many students wrote comments about how much they enjoyed the double-oral auction). One student thought that in actual auctions buyers and sellers would have a better idea of the price at which a transaction could be made.

R: That may be true. Run the game long enough and both buyers and sellers would likely become somewhat more organized in how they go about trading the commodity. They would learn the constraints each other is operating under (the schedule of marginal utilities of the consumer and the schedule of marginal cost of the seller). But those constraints constantly change just like in the stock market. So, our game in which the schedules remain fixed through numerous iterations is unlikely to be found in most markets.

8. [In the shaving cream and straight razor example]... did the demand for shaving cream shift left because there are other options for shaving (i.e., electric razors).

R: No. The demand for shaving cream decreased (the demand curve shifted left) because the demand for straight razors that require the use of shaving cream decreased. Shaving cream and straight razors are complements. Whatever it was that caused the demand for straight razors to fall is only the indirect cause of the fall in demand for shaving cream. The real cause is that fewer people are using straight razors.

9. Do you want the homework assignments typed?

R: Homework assignments do not have to be typed. Writing clearly is very important however.

10. Does a rise (or fall) in income always cause the demand curve to shift and (second question) would a rumor about a probable shortage cause an increase in demand and a rise in price.

R: Since there must always be a willingness and ability to purchase before a purchase will occur, anything that affects ones ability to buy (a change in income for example) will affect demand for a commodity. However, the degree of change may be great or small depending on the income elasticity of demand for the product. Second question: Yes, a rumor of a pending shortage (consumer expectations) could cause people to rush to buy the product causing price to rise. An interesting recent example is the shortage of gasoline in the Gulf Coast. There have been very long lines at gasoline filling stations as people try to stock up, but strangely there has been no significant rise in price in that region compared to the rest of the country. Here is my cynical guess -- The oil companies want to keep oil prices down to help the political party to which they owe the greatest allegiance and have supplied the largest campaign contributions. In normal times, the petroleum companies would never fail to take the opportunity to raise petroleum prices and there is certainly nothing on either the demand side or supply side that would prevent them from raising prices now. Look for gasoline prices to rise after the election -- no matter who wins.

11. What is the difference between substitutes and complements and (second question) why did the government let Lehman Brothers file for bankruptcy -- why didn't the administration provide relief to the company?

R: Substitutes are goods that can be used for a similar purpose -- train transportation is a substitute for automobile transportation. Complements are goods that are purchased as a pair -- automobiles and tires. Perfect substitutes would be two nickels for one dime. Perfect complements would be right shoes and left shoes (you always buy one of each). 

Your second question is a lot more difficult to answer. I don't know why the government didn't assist Lehman Brothers instead of allowing them to go bankrupt. One might imagine that Lehman Brothers' failure did not pose as great an impact on the financial system as that of the collapse of Merrill Lynch or AIG. There is an interesting report in the New York Times indicating that J.P. Morgan may have caused the collapse of Lehman Brothers by freezing their assets ($17 b.) on the Friday before they filed for bankruptcy. Here is the story: http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4882281.ece. You may have to obtain a name and password to access the story -- it is free.

12. Illustrate a change in quantity-supplied and a change in quantity-demanded on a graph.

R: Draw a supply curve with price on the vertical axis and quantity-supplied on the horizontal axis. Any movement of price will cause a change in the amount sellers are willing to supply. The slope and position of the supply curve shows that change. That is a change in quantity-supplied -- a movement along a particular supply curve. It's the same for a change in quantity-demanded -- it is represented by a movement along the demand curve caused by a change in price. 

13. Is it more effective to prevent the bankruptcy of small businesses and the home foreclosures of ordinary people or to wait and bail out the lending institutions when a massive numbers of defaults and foreclosures put them in jeopardy?

R: If the regulatory agencies that had the authority to oversee lending institutions had actually done their job then the bad loans and creation of unwise financial products like derivatives, credit swaps and debt backed obligations might never have occurred. Treasury Secretary Henry Paulson is straight from Wall Street and works for an administration that thinks the free market operates just fine without any regulation. What is amazing to me is that these folks are still telling themselves the same fairy tales about the wonders of the free market. George Will stated this morning (Oct. 5, 2008) that it wasn't the lack of regulations but over-regulation that caused the financial collapse. So I suppose the FDIC is just another socialist plot to derail the free market. George Will knows perfectly well that without government the market process would collapse like a house of cards. Imagine if the court system (a creature of government) didn't exist? How would businesses be able to engage in any contracts with full faith in the other party's trustworthiness? The question isn't regulation or no regulation. The question is regulation for whom or, more specifically, for whom does government work?

14. Can the survival of the fittest attitude the government has toward small businesses be a kind of Social Darwinism?

R:  Herbert Spencer, the guy who developed the idea of Social Darwinism, was referring to the notion that a market society sorts out the wheat from the chaff or the deserving from the undeserving. So, if you succeed (meaning earn vast wealth) in a free market society then it must be that you are that much more brilliant and talented than those who are penniless. This harkens back to the individualism of Jeremy Bentham. But what if a market society is built on the notion that great wealth is a product of great poverty, that the cause of such severe inequality is systemic? Once you establish a society on the basis of the private ownership of the means of production then you create the likelihood that success is judged on how much you own. Whether you came of it fairly, inherited it or gained it by foul means, you are a success within the parameters of the system.

15. Could both the Republican and Democratic ideas of causing a recovery work or would one be better than the other?

R: I do not think there is a significant difference in the two parties regarding the plan to rescue the economy. There is more a difference of rhetoric than  substance in the positions of the two parties. For example, Rep. Peter Welch, a liberal Democrat from Vermont, first voted against the bailout because it didn't have a plan to allow homeowners to restructure their loans or place a moratorium on foreclosures. But when the second vote was taken (Obama made a few phone calls) Welch voted yes. Sen. Bernie Sanders from Vermont, arguably the most progressive member of the Senate, voted no on the bailout plan proposed in the Senate but never undertook a filibuster -- something he could have undertaken if he had real courage of his convictions. Ralph Nader recently said that the only difference between Republicans and Democrats is the velocity with which their knees hit the floor when corporations come knocking at their door. He may have a point.

16.  How do you tell if a given situation affects supply or demand?

R: You can tell by knowing whether the change is in a non-price determinant categorized as one that affects demand (changes in: income, expectations, prices of substitutes or complements or a change in taste) or one that affects supply (changes in: technology, #sellers, factor costs, expected profits).

17. If wages rise and technology improves which factor will affect supply more?

R: They may offset one another, or the increase in wages may be stronger or the improved technology may be stronger. Any particular case may differ from any other.

18. Have the comment card questions been posted on the website yet?

R: Yes.

19. Regarding the economic crisis -- How do we make sense of the real world with thought experiments and theories?

R: Abstracting from concrete reality is essential if we are to make sense of the world and act in some way to affect conditions. Everyone operates on the basis of a theory of how the world works. Theory informs practice. Milton Friedman was an economist who fervently believed in a free market system and built beautiful mathematical models to explain economic reality (His most famous book was Free to Choose). John Maynard Keynes believed a market society would inevitably suffer economic collapse and recovery and he built an elegant set of theories to show that government must be relied upon to save capitalism from self-destructing. We will study Keynesian economics in Macroeconomics.

20. What are economic actors?

R: People who take on the roles of consumer, worker or capitalist.

21. Please explain more about factors which affect price elasticity.

R: A good may exhibit elastic demand if it is a luxury good (people can do without it, so they are more sensitive to price changes) or the good has many good substitutes (if prices rise, consumers will simply buy the substitute) and so on. A good may exhibit inelastic demand if it is a necessity (you cannot do without it, so you will pay almost any price) or it has few good substitutes and so on.

22. Go over the formula for price elasticity again.

R: Ed = [(Q2-Q1) / avg Q] / [(P2-P1) / avg P]. avg P = (P1 + P2) / 2 and avg Q = (Q1 + Q2) / 2.

Example:

Ed = [(10-2) / 6] / [(5 - 10) / 7.5 = (8/6) / (5/7.5) = 1.33 / .67 = 6.65

Note: The sign is ignored in determining the size of the change, so 5-10 is simply read as 5. As well, it is always assumed that the sign is negative (price changes always cause quantity-demanded to change in the opposite direction), so the sign is usually left out of the equation. Q2 is the quantity to which consumers switch and Q1 is the initial quantity. P1 is the initial price and P2 is price after the change has occurred. 

23. What is the use to which the elasticity coefficient is put?

R: Sellers will know whether their revenue will rise or fall when they raise or lower price if they know the elasticity coefficient. Pretty important, eh?

October

1. Rent control and classical economics -- we need to change the market system.

R: Yes, change we can believe in. The first premise should be that we recognize the degree of consolidation in the ownership of property. Once we accept that we will begin to understand why government interference can make markets work to put the consumer and worker in the sovereign positions Adam Smith argued they were.

2. Do homework assignments have to be typed?

R: No, as long as they are legible. Great art work by the way.

3. I think I defied the substitution effects of a price change according to income. I essentially make no money (less than $2,000 a year at most) and I travel as much as possible. Last summer I worked just enough to cover the cost of the flight. What would this be considered?

R: The savvy traveler? Income effects and substitution effects are different. The income effect simply means that as income rises (falls) you spend more (less) on all goods you normally buy. The substitution effect occurs when the price of a commodity you normally buy increases (decreases) and you tend to buy less (more) of  that good and more (less) of a substitute good. But there is also an income effect of a price change. An increase in the price of a commodity you normally buy causes a decrease in your real income (the purchasing power of a given money income) resulting in a decrease in the amount you buy of normal goods and an increase in the amount you buy of inferior goods. But the substitution effect is stronger than the income effect so it is argued that if price goes up for an inferior good, you would still buy less of it even though your real income has declined. So, assume that the price of air travel increased over the last year, which it did, and assume further that your income remained exactly the same. Under these circumstances we would have expected you to reduce the amount of travel you usually undertake (travel being at least a normal good). Let's say you traveled just as much as you usually do over this last year. The question is, have you contradicted the income effects of a price change? Not if you examine your statement carefully. If airfares went up from last year (they did) and you worked just enough to cover the cost of your flight then your money income either must have gone up (but you claim it was about the same) or you didn't spend as much on your trip as you did the year before, i.e. you reduced the amount of spending on the good whose price increased, conserving the truth of the income effects of a price change. 

Great question!

4. I don't understand why people wouldn't buy an expensive car if their income increased. Does that mean the car is an inferior good?

R: They might very well have bought a more expensive car as their income rose. A car is a normal good. People increase the amount they buy of normal goods as their incomes rise. 

5. Explain the effect on total revenue of a change in the price of a good with an inelastic demand and elastic demand.

R: If a good like air travel increases in price then we would assume that consumers would decrease the amount they spend on that good proportionately more than the increase in price. For example, if airfares rise by five percent we might expect travelers to reduce the amount they spend on air travel by six or seven percent. Air travel is a luxury good to many. If we accept that premise then total revenue in the airline industry would decline which it has. In other words, the fact that air travel was five percent more expensive was more than offset by the decline in the number of tickets purchased by six percent. Remember we must assume ceteris paribus conditions; If incomes, the desire for travel (getting away from your troubles might have intensified) and the price of substitute goods (domestic car travel etcetera) all stayed the same. The opposite would occur for a good with an inelastic demand. If prices go up for water (bottled, tap etc) we would expect a considerably lower percent reduction in the amount of water purchased. So a five percent rise in the cost of bottled water and tap water (provided by a municipality) would result in a decrease in the use of water by say three percent. Total revenue would then rise for the purveyors of water. That's why certain companies are rushing to secure exclusive access to drinking water in many countries. 

November

1. Why does average cost fall and then rise again?

R: It is connected to the assumption of the short run period of time when some inputs are fixed. As the producer adds variable inputs (like labor) to the production process she is adding to total cost an amount equal to the wages of the worker but since another worker after some point begins to add less to total output than the previous worker, marginal cost (the cost for another unit of output) begins to rise. As long as marginal cost (addition to total cost) is less than the average cost, average cost will keep falling. However, once marginal cost rises above average cost then average cost must also rise. It's like the batting average example. If the batter's average is .500 then the batter gets two hits for every four times at bat (a very high average). If during the next game the batter gets three hits out of four times at bat then the batter's average rises (notice how I cleverly avoided a gender bias -- I'm batting a thousand!). 

2. What does it mean to have marginal cost equal price? It is still a little confusing.

R: If the perfectly competitive producer earns more in additional revenue (price) than the additional cost to produce the next unit (marginal cost) then a profit will be earned from producing and selling that next unit. For example, if it costs $4 to produce the next unit but it can be sold for $5 then price exceeds marginal cost and a profit can be made. Once the additional cost rises to just equal price then the producer has maximized profits. Since we know marginal cost keeps rising in the short run and we assume price is constant in perfect competition in the short run, MC will be higher than P for the unit of output just beyond where P = MC.

3. Why is the third market structure called monopolistic if it doesn't share monopoly qualities?

R: But it does have monopolistic qualities. A monopolistic competitor has a certain amount of product differentiation that implies some market control however slight. So, for example, a 24-hour convenience store within walking distance of your home at two a.m. on a rainy night when you are out of cigarettes has an almost complete monopoly on your business. You have heard the Steven Wright bit? A guy walks up to a convenience store on which a sign hangs "open 24 hours" and the manager is locking it up. The guy asks the manager, "I thought you were open 24 hours." The manager responds, "Not in a row!" Tah-dum.

4. Why is marginal revenue less than price for an imperfect competitor?

R:  Because an imperfect competitor enjoys a down-sloping demand curve (as the firm lowers price, it can sell more units) and when the firm lowers price they will lower them for all units sold. So, take the following example, when price is lowered from $5 to $4, sales increase from 10 to 18 units. Before the price change the firm sold all ten units for $5. After the price change the firm sells ten units for $4 (losing $1 on each of 10 units) and eight extra units for $4 (bringing in an additional $32). So, the firm lost $10 because it sold the first ten units for $1 less but gained $32 from the additional eight units it sells at the lower price. The additional revenue for each extra unit sold is not $4 (the price) but $32 - $10 = $22 and $22/8 = $2.75. Price is now $4 but marginal revenue is only $2.75.

5. I think there should be an outside presentation of Nike -- the presentation that Nelson's group did. It's a heated topic.

R: Okay, you organize it. Has anyone ever wondered how it is that Nike's brand is everywhere? Why do college teams (particularly Division I) and pro golfers predominately display the Nike swoop? The answer: Because they pay the colleges and the pro athletes to wear and use only Nike brand athletic clothing and gear. When asked by Michael Moore why Nike has no shoe manufacturing facilities in the U.S., Phil Knight said, "Americans don't want to make shoes." So, Michael Moore found 500 unemployed workers in his home town of Flint, Michigan to stand outside a shuttered General Motors plant and testify that they would make Nike shoes for the prevailing wage for unskilled labor. Knight refused to even consider the idea.

6. My presentation clarified any question regarding [diminishing] marginal productivity. [The airplane assembly line]

R: I love it when that happens.

7. Can you explain deadweight loss and consumer surplus?

R:  When a tax is imposed or an imperfect competitor sets price at the output level where MR = MC the amount sold will be less than the equilibrium position in a competitive market. In this instance the reservation price will exceed the marginal cost of producing every unit from the current output level to the equilibrium output level. Exactly half the area of the deadweight loss triangle will be foregone consumer surplus and half will be foregone producer surplus. Nobody gets it. Consumer surplus is the excess of reservation price over the price the product sells for. The reservation price is how much the consumer is willing to pay for the product.