Transcript Just for Perspective: A Note on Adam Smith

Introduction to Supply and Demand
S. Folland
The Law of Demand:
When price falls, and if everything else stays the same,
then the quantity demanded will increase.
In latin, “everything else stays the same” is stated as
ceteris paribus.
Discussion questions: Why would families want more milk
just because the price fell?
Would all families buy more milk? Would some?
What happens to you if you break the law of demand?
Just for Perspective: A Note on Adam Smith
1. The concept of the demand curve was not developed fully until
the 1880s by the “Austrian” economists.
2. The father of economics, Adam Smith, wrote his famous
book The Wealth of Nations in 1776, long before the concept
of demand was fully understood.
3. Smith thought the price of every good compared to other
goods just depended on the amount of labor in each.
4. He said “if it takes two hours to catch one beaver, and just one
hour to kill a deer, then one beaver will trade for two deer.”
(This turned out to be not so good an idea).
5. Hundreds of Smith’s ideas did turn out to be good and are still
used today.
Adam Smith, 1723-1790
Demand Shifters:
1. Personal income
a. normal goods (demand increases with income)
b. inferior goods (demand decreases with income)
2. Prices of related goods
a. substitutes (demand for tea increases
when the price of coffee increases)
b. complements (demand for sugar decreases
when the price of tea increases)
3. Tastes (Can mean ordinary tastes changing or
can refer to something abstract, like age.
4. Expectations (e.g. if you believe housing prices
will rise even further, you may buy now.
5. Population.
Discussion questions on demand shifts:
Which way would demand for ___ shift if?
1. Apples, if the engine plant doubles salaries?
2. Cigarettes, if the Surgeon General states they
are hazardous to your health?
3. Used clothing, if the engine plant doubles
salaries?
4. Mustard, if hot dogs double in price?
5. Mercedes Benz’s if BMWs double in price?
6. Exxon stocks, if an Exxon oil tanker runs
aground in Alaska?
7. Land suitable for residential housing, if an
Interstate Highway is built to the property.
Supply Curve
Study questions:
1. Would diary farmers offer every last drop
of milk at say $1.00 so they could not
possibly offer more than 45k at $1.50?
2. If not, where would the extra milk come from?
Supply Shifters:
1. Technological change. E.g. robots improve productivity
on the auto assembly line.
2. Number of Sellers. E.g. more firms start up; U.S.
Loosens up the immigration laws.
3. Input price changes. E.g. price of chicken feed affects
the supply of eggs.
4. Expectations
5. Weather. Applies mainly to agricultural products.
Study questions regarding equilibrium:
a. What if the market price was above
PE?
b. Would there be pressures for the price
to fall?
c. During the time that the price is
above equilibrium, which would be
greater, quantity supplied or
quantity demanded?
d. What do we call the difference between
those two quantities? What if the “good”
were human labor, then what would we
call the difference between these two
quantities?
Comparative Static Analysis:
Compares two static equilibria.
(“Static” equilbrium: a snapshop of an
equilbrium for a given time period.)
Examples:
Suppose that Brazil, which grows a
large share of the world’s coffee crop,
suffers bad growing weather--a sudden
deep freeze killing many plants, what
will happen to the market for coffee in
the Rochester area?
You Try It:
1. The effect on the market for rental apartments in Atlanta when
the Summer Olympics came to town.
2. The effect of the Black Plague on the labor market in a typical
European city back in 1436.
3. The OU faculty goes on strike and gets double their salarie, what
effect on the market for student credit hours.
4. What happens to the market for Pentium III computer chips
when the “Pentium IV” is invented.
5. The effect of an increase in the price of flour on the market
for bread.
6. Marijuana is legalized, what happens to the market for
marijuana.
7. The Russian ruble collapses in value, what effect on our
domestic market for imported Russian furs.
8. When the price of CDs in general drops, what if anything
happens to the market for CDs.
Market Intervention: When the government intervenes
in the market.
1. Equilibrium can become unattainable.
2. Disequilibrium can cause unexpected and unwanted results.
3. There are two kinds of intervention:
a. Price floors: e.g. minimum wages, crop price supports.
b. Price ceilings: e.g. rent controls, the Irish potato famine
story.
Points to notice: 1. AB is unemployment caused by the minimum wage,
2. LE- LD is the loss of jobs; 3. WE*LE is labor income before the MW;
4. MW*LE is labor income after the MW is in place (Whether the MW
is good for labor or bad for them depends on whether labor income is
larger before or after the minimum wage is put in place.
Average Weekly Full Time Equivalent Workers at Fast Food Restaurants
Before and After An Increase in the Minimum Wage in New Jersey
New Jersey
Before
After
37.2
Change
Pennsylvania
Before
After
Change
0.41
42.5
-0.12
BLS data
Feb-Nov
1992
37.6
42.4
Card &
Krueger data
Feb-Nov
29.8
30.0
0.19
33.1
30.9
-2.23
1992
Source: These data are from an article by Card and Krueger, published by the National
Bureau of Economic Research, 1998, entitled, "A Reanalysis of the Effect of the New
Jersey Increase in the Minimum Wage."
The Card-Krueger study shook up the standard model it
seemed because apparently there was no real world
drop in the average employment level.
A competing study by David Neumark
from our sister university at MSU,
disputed this result for some pretty
good reasons.
Also, we have a history of minimum wage
studies, and a good majority of these agree
with the standard theory. So, economists
generally favor the standard theory.
However, this latest challenge turns out, we
economists have been sternly reminded
that the real world data rules, always.
Question: If there were a potato famine,
and if the government were to rule that
the price of potatoes must be frozen at
the price of the previous, good year:
Who would this favor? Who would this
policy hurt?