G. Mick Smith, PhD: Honors Business Economics: 3 December 2010

Thursday, December 02, 2010

Honors Business Economics: 3 December 2010

Prayer
Current Events:
Cf. http://www.bloomberg.com/video/64960242/

Dec. 2 (Bloomberg) -- Robert Eisenbeis, chief monetary economist at Cumberland Advisors, discusses the Federal Reserve's report on users of its $3.3 trillion in emergency programs. Eisenbeis speaks with Erik Schatzker on Bloomberg Television's "InsideTrack." (Source: Bloomberg)

1 December 2010: The Federal Reserve bailed out foreign entities with $3.3 Trillion.

1 December 2010: US Ready to Back Bigger EU Stability Fund: Official

Delaying Tax Vote Could Crash Stock Market, 12/15

The Chapter 2 Make-Up Test is today.

Cf. http://shanawiki.wikispaces.com/Honors+Business+Economics+Chapter+2+Test+Prep+Page+Fall+2010

The Ch. 2 Sec. 3 American Free Enterprise Make-Up Quiz is today.

New feature:

The electronic edition of the Philadelphia Inquirer is available. We have the Sunday edition, available on Mondays, in addition to the Tuesday through Friday editions on the other days.

Please follow the steps below:

URL: http://nie.philly.com
Click on the words "Access e-Inquirer" located on the gray toolbar underneath the green locker on the opening page.
Login:
Username: bshsinky@shanahan.org
Password: 10888

The electronic editions will be archived at the site for 30 days only.

The Supply and demand game is helpful in applying the basics we have learned about supply and demand.

Cf. http://www.shmoop.com/supply-demand/game-D623795642C84F09A486C99993F88056

Vocabulary eFlashcards
Show Business is the Federal Reserve Bank of Boston's learning activity on economics and the entertainment industry. The goal is to provide an additional tool for teaching and learning about basic economic concepts, with some economic history snuck in.

Cf. http://www.bos.frb.org/entertainment/index.htm

A music video from School House Rock on investing and Wall Street.

Cf. http://www.shmoop.com/corporations-stocks/botw/resources?d=http://www.gamequarium.org/cgi-bin/search/linfo.cgi?id=3797

Prices and Markets

Chapter 4 Demand

(Supply and) Demand

In-class assignment: in your own words, summarize and explain supply and demand. Draw an individual (each student) sample Supply and Demand Curve as it is described in the video. What is the relationship between prices and quantity demanded? What does it mean in Economics to move towards equilibrium? What is the consumer surplus? What is a producer surplus?

Supply and Demand Screen shot 1

Supply and Demand Screen shot 2, Equilibrium

Supply and Demand Screen shot 3, Consumer Surplus

Supply and Demand Screen shot 4, Producer Surplus

Why It Matters

The Big Idea

Section 1 What is Demand?

ceteris paribus ([key-te-rees pah-ri-boos] other things being equal

Guide to Reading

Section Preview

Content Vocabulary

demand

microeconomics

market economy

demand schedule

demand curve

To get a better picture of demand, economists construct graphs. They try to find out how many people are willing to buy an item at various prices, and then plot that information on a graph like this.

You should note a couple of things about demand curves: 1) price is always plotted along the vertical axis and quantity is always plotted on the horizontal axis, and 2) demand curves always slope downward from left to right.

By now you should understand the primary reason demand curves always slope downward from left to right—as price falls, demand increases. But a second economic principle plays a role as well. The law of diminishing marginal utility tells us that individual demand for a good will decrease each time that good is purchased or consumed.

Deriving the Demand Curve

In-class assignment: if asked to explain to a friend who knew nothing about the demand curve, how would you explain it? Where does the demand curve come from?

Income influences demand. As our income changes, our willingness and ability to buy a product changes. When you were working for the minimum wage, you may have been willing and able to pay only 75¢ for a donut. But after your wage was doubled, your willingness and ability changed. Now you are willing and able to pay $1.25 and maybe $1.50 for a donut. And if for some reason income levels rise or fall more generally—say during a depression—the entire demand curve will shift. During good times the demand curve for donuts might look like this.

But suppose the bottom fell out of the stock market, the unemployment rate shot up, and the national average income dropped 15%. Our demand curve would shift to the left and look like this.

Want a good indicator of the income effect? How about yacht sales. Yachts are nice, of course. But they're not exactly necessities (for most of us, anyway).
Yacht sales are thus highly sensitive to the income effect.
In the first half of 2008, before the bottom fell out of the economy, 4,157 sailboats were sold in America.
In the first half of 2009, with the economy a mess and incomes falling, sales were 28% lower.

The Law of Demand

Okay—let’s start with a basic and simple fact: as the price of something falls, demand for it rises; and as the price of something rises, the demand for it falls. This is the law of demand and every kid who has ever sold lemonade, baseball cards, or Beanie Babies understands it. If the price of a good is cut in half, more people will buy it. If the price doubles, fewer people will buy it.

But the concept of demand is a bit more complicated than the law of demand. (Or at least economists like to make it sound more complicated.) So to make sure you don’t embarrass yourself at a cocktail party filled with economists (yeehaw), memorize this definition. Demand refers to the amount of a good or service that people are willing and able to buy at a specified price.

Demand refers to the amount of a good or service that people are willing and able to buy at a specified price.

There are a couple of key phrases in this definition—willing and able and specified price. To accurately gauge demand for a particular item we need to eliminate the willing but unable and the able but unwilling—in other words, there may be plenty of people with interest in our item but no money. And there may be people with plenty of money but absolutely no interest in the good. They should not be factored into our calculation of demand. Moreover, identifying a vague interest in a product is meaningless unless we can link that interest to a specific price. Sure, you may like what we are selling, and you may be willing and able to buy our product—but are you willing and able to pay $3? $4? $5?

Demand, therefore, means more to economists and businessmen than some vague, desire for something—it refers to the amount of a good or service that people are willing and able to buy at a specified price.

Consumer tastes may affect demand. Consumers may clamor for an item one year and ignore it the next. The clothing industry is particularly vulnerable to quickly changing tastes. How ready was the clothing industry for the abandonment of the polyester bell bottom complemented by a form-fitting butterfly collar shirt? How ready was the industry for the revival of these ridiculous clothes thirty years later?

Mott The Hoople, 1974

Every Christmas season, it seems, there is that one must-have item that everybody just needs to have under the tree. Manufacturers just can't make enough, stores run out of inventory, and desperate shoppers trample each other on Black Friday trying to get their hands on the precious, the precious.
Here are the best-selling must-haves of recent holiday shopping seasons:

Best Selling Christmas Items
2009	Nook eReader (Barnes & Noble)
2008	Elmo Live (Fisher Price)
2007	iTouch (Apple)
2006	Playstation 3 (Sony)
2005	Xbox 360 (Microsoft)
2004	RoboSapiens (WowWee)
2002-3	Beyblades (Hasbro)
2001	Bratz Dolls (MGA Entertainment)
2000	Razor Scooters (Razor USA)

market demand curve

marginal utility

diminishing marginal utility

Diminishing Marginal Utility, 4:15

In-class assignment: define diminishing marginal utility based on the video and its explanation.

What makes us happy? Is Jim happy? Is there a difference if Jim is hungry, or not? Is there a difference between cookie #1 and cookie #2, and thereafter etc.? What happens as he eats cookies? What do we discover according to this experiment? What is the Law of Diminishing Marginal Utility? Is there a point Jim should have stopped eating cookies?

Economists use the word utility to describe the ability of a good or service to satisfy some want we possess. A donut has utility if it can satisfy our hunger; a movie has utility if it satisfies our desire for entertainment. Economists also recognize that the ability of a product to satisfy our want or need may diminish the more frequently it is consumed. The first donut you buy may do a great job of satisfying your hunger, the second may as well. But the third may be less satisfying to you, and you may be totally uninterested in the fourth. The once invaluable donut has lost much of its seductive appeal. We might call this the law of diminishing seductive appeal. But economists are a stodgy bunch, so they call this the law of diminishing marginal utility.

Now given our law of demand, we realize that if the donut vendor cuts his price, we may recover some interest. At half price, we might muscle-up for one more 417 calorie chocolate covered cholesterol enhancing treat. But even at a reduced price, utility will eventually diminish until prices drop again and then again and again.

The laws of demand and diminishing marginal utility combine to produce demand curves that predictably flow downward from left to right. The actual market price for a good may change, and that will trigger a change in the number of units sold, but the relationship between demand and price will remain constant—prices and demand will shift in sync with one another along the demand curve.

Economists refer to this sliding along the demand curve as movement. Movement occurs when changes in the market price for a good causes demand to slide up or down the curve—or when a change in the demand causes

prices to slide up or down the curve.

But economists also recognize the existence of certain factors that will cause the entire curve to shift—move either to the left or the right. Changes in income, consumer tastes or preferences, and in the price of substitution goods and complementary goods will prompt not just movement along the curve but a shift of the curve in one direction or the other.

Imagine you've been lost in the desert, wandering around in the blistering heat without water for days. Somehow you finally stumble into a roadside oasis, a gas station and mini-mart that has sweet, delicious water for sale. You'd probably give your left... leg for a bottle. Your demand for water is off the charts.

So you enjoy that first bottle of water. You no longer feel like you're about to die. Your lips are no longer cracked and dry, your throat no longer parched.

You're thinking about maybe buying a second bottle of water. But you don't need it. You'd pay a few bucks for it, sure, but it's no longer of nearly priceless value to you.

That's diminishing marginal utility.

Equilibrium Price

As useful (and fascinating) as supply and demand curves are on their own, they become even more valuable (and for economists, truly sublime) when combined. When we plot supply and demand for a product on the same graph, we discover how producers and consumers will interact in the marketplace—and where exactly they will converge.

Remember the demand curve looked like this.

And the supply curve looked like this.

Now look at what happens when we combine these graphs (and add a little curviness).

They intersect a t a certain point. They intersect at the price where the amount producers are willing and able to supply converges with the amount consumers are willing and able to purchase. This point of convergence is called the equilibrium price. Theoretically it is where supply and demand meet and prices settle. If suppliers ignore demand, and continue to produce units and price them too high, they will not be purchased. Instead they will sit in the warehouse. If they produce too few, demand will go unmet and consumers will clamor for more.
This clamoring for more goods might encourage new suppliers to enter the market. And as we noted above, the entrance of new competitors will increase supply. And when this occurs the market will settle on a new equilibrium price.

If factors such as the introduction of new technology or decreasing production costs shift the supply curve to the right (S2) or if other factors such as new government regulations or increasing production costs shift the supply curve to the left (S3) the market will produce a new equilibrium price.

Similarly, if demand shifts for any reason (the changing price of substitution or complementary goods, changing income, etc.) the market will generate a new equilibrium price.

What's the equilibrium point for an iPhone? Each time a new model comes out, it seems, Apple ends up with production shortages. That implies that the sticker price Apple is charging may be too low. But the company may have other reasons for selling below the equilibrium price... such as not wanting the price for the phones end up too high a few months later, once the initial frenzy has worn off.

Academic Vocabulary

prevail

inversely

Reading Strategy

Products in the News

Wrist Watch

An Introduction to Demand

Main Idea

Economics and You

Demand Illustrated

The Individual Demand Schedule

The Individual Demand Curve

Reading Check

Interpreting

How do you react to a change in the price of an item? How does this illustrate the concept of demand?

The Law of Demand

Main Idea

Economics and You

Why We Call It a "Law"

The Market Demand Curve

Reading Check

Explaining

How does the market demand curve reflect the Law of Demand?

Demand and Marginal Utility

Main Idea

Economics and You

Reading Check

Describing

How does the principle of diminishing marginal utility explain the price we pay for another unit of a good or service?

HW email to gmsmith@shanahan.org or hand in hard copy.

The Chapter 2 Test Test Prep page.

Cf. http://shanawiki.wikispaces.com/Honors+Business+Economics+Chapter+2+Test+Prep+Page+Fall+2010
Santa Claus Is Laying Off His Reindeer, 1:34