Transcript Praxeology, Supply & Demand for Freedom University

Praxeology, Supply & Demand
for Freedom University
By Paul F. Cwik, Ph. D.
Mount Olive College &
The Foundation for Economic
Education
What is Economics?
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Economics is NOT about how to get rich or how to
invest your money.
Rather studying economics is about learning problem
solving techniques to help us understand the everyday
world around us.
Economics is a science, a social science, but a science
nonetheless.
There is a different methodology between economics
and the natural sciences.
Economic Methodology
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Scientific Method:
 Austrian Economics is
different. We use
Observe data/event
 Axiomatic Deductivism:
Recognize correlations
Doesthe
Scientific Method
Axiom
Speculate Causation
workfor
the Social Sciences?
(Construct a Theory)
Laws
Create a Hypothesis
 Theorems
So what
do we do? Give up?
(Yes/No)
 Models
Test—Controlled Remember: WeThought
need to Experiments
use
Experiment
the ceteris
Theseparibus
thoughtcondition.
experiments allow us
Revise Theory
to hold everything else constant.
Economic Methodology continued

Thought Experiments are used to hold all else equal.
Otherwise analysis becomes impossible.
 Imagine
trying to analyze oil prices by looking at all the
factors that influence the price.
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In the natural sciences nobody asks the rock or the
pen why it falls. However in the social sciences, we
can engage in introspection.
We are able to perform a self-examination and ask
ourselves, “why?”
Some Definitions:
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Methodological Individualism—people are influenced by
others, but action can only be undertaken by individuals.
Therefore, the analysis must always be centered on the
individual. Be careful of the use of collective nouns.
Axiom of Human Action—is purposeful behavior by humans
over economic (scarce) goods. To satisfy our wants and
desires, we act. However, not all goals or wants can be
satisfied at once. This is due to Scarcity.
Praxeology—is the science of human action. Economics is the
Howdeveloped
do we know
that this is an axiom?
most
branch.
An Observation: we live in a world of Scarcity.
Try to denythe
it and
what are
you doing?
Scarcity—is
condition
whereby
the resources, goods and
services
available
to individuals
and
society are limited
Purposefully
trying
to
show
that
people
relative to the wants and desires for them.
do not behave purposefully.
Economic vs. Non-economic Goods
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Economic Goods and Services are scarce.
Due to the scarcity of resources (and even time), we must choose.
Thus, we construct an Ends/Means framework. We set goals and
must choose which means we’ll apply to which ends.
Thus, we have to choose NOT to do some things.
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Non-economic goods are not scarce.
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These costs are called opportunity costs (but more on this later). They
are everywhere and unavoidable. There is even an opportunity cost
associated with time.
These are sometimes referred to as Free Goods and Services (i.e., those
goods and services that are available in sufficient amounts and provide
all the people want at zero cost).
Due to the fact of Scarcity, we are not able to enjoy all the things
that want. Therefore, we must choose.
But how?
Choice & Preference Scales
How that
do individuals
Notice
choose? ALL of these
preferences
arereally
subjective.
 We are not
concerned

with what they choose, but
we do know
things
Opportunity
Costsome
is the
next
about how people choose.
best alternative that is NOT
 Individuals create
done.
Preference Scales.
They rank preferences from
If most
you can
only do two things,
to least.
what is your opportunity
 So let’s make a Preference
cost?
Scale…

Things to do next week Friday…
A. Go to a Concert
B. Go Dancing
C. Go to a Friend’s place
D. Watch a DVD
E. Go to a play
F. …
Q.
Study
Demonstrating Diminishing
Utility
a measure
ofof
Marginal Utility
We canissee
the value
satisfaction that the
Things
nextreally
week
Friday...
However,
As
we to
adddo
what
means,
Total
matters
Value /
A.
Go to
a Concert
is Marginal
Utility
increases.
Utility, not Total Utility
B.
Go Dancing
Utility.
C.
GoUtility
to a Friend’s
Total
is the place
The
height
thebars.
bars is the
D.
a of
DVD
blueWatch
area of
the
Marginal
E.
Go to aUtility.
play
as Q increases,
F.So …
You
see that as we add
Totalcan
Utility
more,
the Total Utility
increases.
Q.
Study
increases, but the Marginal
Utility decreases.
each of the ends
on this
consumption
of goods
or
chart. yields an
services
individual. It’s a level of
happiness.
A
B
C
D
Q Quantity
The Law of Demand
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Utility is not directly observable. Price
We use price as a proxy for value. Utility
When we use price, we get the
Law of Demand:
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The price of a product or service
and the amount consumers are
willing and able to purchase are
inversely related, all other things
held constant.
When we present it graphically,
we get the Demand Curve.
The Demand Curve does not
actually exist. It is a mental tool
used to helps us think about the
world around us.
The Demand
Curve
A
B
C
D
Q Quantity
Which of these are legitimate
demand curves?
P
P
P
D
P
Yes
D
D
D
Q
P
Yes
Yes
Yes
Q
P
Yes
Q
P
No
D
D
No
D
Q
Q
Q
Q
Factors Affecting Demand
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What moves the demand curve? Or, what creates a change in demand?
Anything OTHER THAN PRICE, such as consumer income and
preferences, that determines the amount of a product or service that
consumers are willing and able to purchase.
Shift Factors:
1. Change in income;
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2.
3.
Change in Tastes and Preferences;
Changes in Related Goods;
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4.
Normal Goods
Inferior Goods
Price
Supply
P1
Po
Substitutes
Complements
D’
Demand
Expectations
Qo
Q1
Quantity
From Individual to Market Demand
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Market Demand—The total amount consumers are willing and
able to purchase of a product at all possible prices, obtained by
summing the quantities demanded at each price over all
buyers. (Summed Horizontally)
Price
D Market
D Ben
D Sheldon
D Ivan
Quantity
The Law of Supply
(Also known as the Law of Reservation Demand)

Weof
will
create
another
preference
scale,so
but
this
time
Again,
we
cannot
directly,
webe
use
pricewe
as will
a
If one
the
sacksmeasure
is lost inUtility
the night,
what
will
sacrificed?
What
we
see
here
is
The
Law
of
use
it
in
reverse.
proxy. When we do this, we get the Law of Supply.
Suppose
second
sack

Inif1886,
Böhm-Bawerk
with of sacks of
What
isa was
sack
A? is used an example
Increasing
Opportunity
Costs
grain.
So connect
if will
it’s good
him…

lost.can
Now
what
bethe enough
We
again
dots andfor
create
a Supply
Curve.
sacrificed?

We start with 6 sacks of grain.
Price
Supply Curve
Utility

Preference Scale
A.
B.
C.
D.
E.
F.
Feed Family
Feed Cow
Feed Horse
Feed Pigs
Feed Chickens
Make Whiskey
F
E
D
C
B
A Quantity
Which of these are legitimate supply
curves?
P
P
S
Yes
Yes
Q
P
P
S
P
S
Yes
Q
Yes
S
P
Q
P
No
S
Yes
Q
Q
S
Q
S
YES
Q
Factors Affecting Supply
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What moves the supply curve? Or, what creates a change in
supply?
Anything OTHER THAN PRICE, such as consumer income
and preferences, that determines the amount of a product or
service that consumers are willing and able to purchase.
Shift Factors:
1.
Changes in Production Costs
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
Technology
Input Costs
3.
Expectations
Taxes and Subsidies
4.
Change in Population Size
2.
Price
Supply
Po
P1
Demand
Qo
Q1
Quantity
S’
Economic Harmony / Equilibrium
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Market is the interaction of buyers
and sellers producing and buying
goods and services.
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The market is NOT a person;
automatic; a mechanism or machine;
or a place.
 The market is a process.
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Mechanics of Price Determination:
Suppose the price is at P1. What is
the result?
We have a shortage, QD > QS. The
price is too high.
Suppose the price is at P2. What is
the result?
We have a surplus, QS > QD. The
price is too low.
Price
Supply
P2
P1
Demand
QSD
QQSD
Surplus
Shortage
Quantity
Market Harmony
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Free markets have a tendency to
clear through the continuous
exchange between suppliers and
demanders.
Buyers compete with buyers.
Sellers compete with sellers.
Notice that buyers do not compete
with sellers.
Markets do not require
economists to make the market
clear.
Coordination and market clearing
are the unintended consequences
of each person acting in one’s
own self-interest.
Price
Supply
Pe
Demand
Qe
Quantity
What We’ve Covered so Far…
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We start with an Axiom that people act purposefully, and we
have an assumption that there is scarcity in the world.
From this starting point, we are able to deduce the Law of
Diminishing Marginal Returns AND the Law of Increasing
Opportunity Costs.
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Notice that they are the same principle. They are just coming from
different directions.
Next, we replace utility with price and create the laws of
demand and supply.
Finally, we are able to create a model of a market, where we
can maintain the ceteris paribus restriction.
Mainstream vs. Austrian
Construction of the Demand Curve
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So doesn’t this just get you to where every other basic
textbook goes?
What’s so significant about Austrian economics if they take
you to the same end?
Actually, it isn’t the same end. For example, in the Austrian
formulation, there are no perfectly elastic (or perfectly
inelastic) demand curves.
Moreover, there are also no such thing as Giffen goods.
What’s a Giffen good?
A Giffen good is one where you want less when the price falls.
More fundamentally, Austrians are marginal theorists who
place the marginality on utility, while the mainstream places
the marginality on the unit.
Neo-Classical Conception of
Demand Curves
Quantity of All
other Goods
The
Neo-Classicals
Next,
we
pick a a
First,
we
create
Where
is Marginal
are
comparing
two
second
price.
budget
constraint.
Utility
in
all ofIt
this?
levels
of our Total
changes
Utility.
budget constraint.
Price of
Good A
P1
?
Q1
Q2
The slope is the
price ratio.
U1
Indifference Curve U0
Quantity of Good A
And now we have
our first point.
P2
The Demand Curve
Q1
Q2
Quantity of Good A
Are Neo-Classicals Marginal Utility
Theorists?
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The Neo-Classical economists are looking at the Marginal Rate of
Substitution.
This is not looking at amount of additional utility the next unit of the
good provides, which is what the Austrians are looking at.
Can the Neo-Classicals claim to be heirs of the Marginalist
Revolution?
Not in the same sense that the Austrians make the claim.
For the Neo-Classical, the word “Marginal” applies to the unit, not
the utility.
Finally, the Austrians claim that a Giffen good is only possible in the
Neo-Classical framework because they are comparing one good
relative to a bundle of goods.
Austrians look at goods as means and rank the ends (uses). It is the
marginal utility of the next end that is important, not the marginal
unit of the means.
Why does picking an approach
matter?
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Suppose that an economist proposes a tax on gasoline in an
attempt to get people to reduce gasoline consumption.
This tax has two effects:
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First, people will have to pay higher prices and reduce their
consumption of gasoline.
Secondly, the consumers’ real income is damaged by this tax.
So the economist says that the money collected from the tax
will be used to reimburse the loss of income from the higher
tax.
Thus, he claims that he gets a lower rate of gasoline
consumption (via the substitution effect), but doesn’t harm any
one because he compensates everyone through the income
effect.
While this may seem like hocus pocus (and it is), it doesn’t
stop actual, real live (Neo-Classical) economists from making
this proposal.
For Further Reading:
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My “For Further Readings” list is very heavy on the praxeology side
of the lecture.
Here are the ones you should start with:
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Callahan, Gene (2002). Appendix B, “Praxeological Economics and
Mathematical Economics,” Economics for Real People: An
Introduction to the Austrian School, pp. 315-322.
http://mises.org/books/econforrealpeople.pdf
Gordon, David (2000). An Introduction to Economic Reasoning,
Chapters 1-4, pp 1-81. http://mises.org/books/EconReasoning.pdf
Rothbard, Murray N. (1993). Man, Economy and State, Chapter 1, pp.
1-66. http://mises.org/books/mespm.pdf
Selgin, George A. (1990). Praxeology and Understanding: An Analysis
of the Controversy in Austrian Economics. http://mises.org/books/praxand-understanding.pdf
Smart, William (1891). An Introduction to the Theory of Value, pp. 1-34
& 47-66. http://mises.org/books/value.pdf
Taylor, Thomas C. (1980). An Introduction to Austrian Economics,
Chapter 4, pp. 40-51. http://mises.org/books/introtoaustrian.pdf
Praxeology, Supply & Demand
By Paul F. Cwik, Ph. D.
[email protected]