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Marginalism Steven T. Call, Metropolitan State College of Denver Students must master relationships between averages and marginals. I use this example to focus on this issue: Suppose a woman currently has 3 children, whose names and birth weights are listed below: CHILD BIRTH
WEIGHT (pounds) No. 1 Tom 8 No. 2 Dick 9 No. 3 Harry 10 The average birth weight after three births is 9 pounds. Now suppose the woman bears another child (the "marginal" child) and the birth weight is 400 pounds. Since the "marginal" observation (400 pounds) exceeds the prevailing "average" (9 pounds), it is easy for all to see that the average must rise. If the marginal birth weight is 2 ounces, the average will fall. If the marginal birth weight is exactly 9 pounds, the average is unchanged . . . If marginal > average, average is rising If marginal < average, average is falling If marginal = average, average is stable Extending this example counters a typical student error: "If the marginal falls, the average will be falling." Let the woman bear a fifth baby, weighing 399 pounds. Now the marginal is falling, yet the average is quite obviously still rising. Hence, whether the average rises or falls is not related to whether the marginal rises or falls, but whether the marginal is greater or smaller than the average. When Every Unit is the Marginal
Unit Ralph T. Byrns One concept that many students find difficult is the idea that goods or resources are often fungible, so that every unit is the marginal unit. Examples such as the following can lead students away from thinking that marginal units are uniquely identifiable: 1. If you randomly remove a bucket of water from the ocean, it is the marginal gallon of water. 2. Express outrage that you have too many students and threaten to give an automatic F to the one who drove class enrollment past 35 (or whatever.) If you are a bit of a ham, every student in your class will begin squirming, recognizing that he or she is the culprit. 3. Show a full bag of candy to your class. Ask which piece was the marginal (last?) added, raising the total to 53 (or whatever) morsels in the bag. Distribute the candy, commenting that as each piece is withdrawn, the total has been reduced by one, and so it must have been the marginal piece. When only one piece remains, state that it is now "the last (marginal?) piece". Eat it yourself, asking your class if any of them get mad when someone else takes the last piece of some delicacy. Point out that, in a sense, each piece of candy that anyone ate was the marginal piece. Rewarding Marginal Exam
Improvement Kyoo Hong Kim, Bowling Green State University Students often have difficulty with the relationship between average product and marginal product. One way to help them understand this relationship is to reward them for marginal improvements in their quiz (or exam) scores over the semester. For instance, before professors give the second quizzes, they announce that an award of, say $1 (or in my case, an oriental recipe), will be given to the student with the highest `marginal' grade (improvement). This exposes students to the notion that eligibility for the prize requires their marginal grades to be higher than their average quiz grades. (Later, of course, students who think they are in the running report their performance confidentially to the professor). Repeated computations of marginal performance gradually lead the students to a solid understanding of the relationship between any general marginal and average function. The Relevance of Marginal
Analysis Michael Behr, University of Wisconsin‑Superior Where are the terms, "margin" or "marginal", encountered apart from economics? The margin of a sheet of paper is the area between the writing and the rest of the universe; the marginal student is one who shows prospects of becoming a non-student; the marginal business is one that shows prospects of becoming a nonbusiness, etc. The commonality of all usages is "edge": The edge of the paper, the edge of academic survival; the edge of economic viability. In human affairs, as in the last of these two uses, it is at the edge where the action occurs. It is when we go over the edge that the changes occur that move us from one condition to another. It is these changes that are supremely relevant because our current conditions are consequences of past actions in that they are beyond our control. Our future condition can be determined only by considering any changes that apply to our current condition. And these changes occur with the passage of time. Thus, life itself is lived at the margin of time where decisions are made and actions taken with respect to all of life's elements. Therefore, when you hear "marginal" you should hear "change" and you need only ask what variable is changing. Normally, marginal analysis in economics proceeds in terms of the ratios of changes in one variable relative to another, e.g., DC/DY, DPQ/DQ, etc. William J. Swift, Pace University In micro principles, how do you establish the relationship between the marginal cost, average variable cost, and average total cost curves? I tell my students to consider calculating their grade point averages. Their individual semester averages are the marginal component, their cumulative is the average component. Consider a typical frosh, I say. "He starts with a 2.5, slips to a 2.0 (what happens to his GPA?), then falls in love (they like this) and slips to a 0.4, then works hard because the dean sends him a stern letter and rises to a 0.6 (nervous laughter‑‑too close to home for some), while all the time his "average" is falling even though the marginal was falling, leveled off, and is now rising." If his `cumulative' hits 1.000 and his semester average is 1.0005, what happens? How can his GPA rise?.... they now see it. P.S.: I tell them that to end his (academic) troubles, we'll get our eager beaver married, boosting his GPA to 4.0. Of course, the married students recognize the trade off of one set of problems for another. Focusing on the Appropriate
Margin Gary Galles, Pepperdine University I have used the following example in class as a way to remind students that the first step in solving any real world economic problem is identifying the appropriate margin for decision‑making. Suppose you are walking through Central Park at two in the morning and you have $200 in your wallet. Suppose further that a mugger pulls a knife on you and tells you to give him all your money. How do you respond? Do you say "I'll tell you what: I'll give you $200 if you leave me alone; $150 if you rough me up a little; $100 if you cut me a little; $50 if you put me in the hospital; but nothing if you kill me"? Of course not, because you would be focusing on the wrong margin for decision‑making; you are faced with an all or none decision, not one in which marginal adjustments can be made (i.e., the relevant marginal decision is the all or none decision of how to respond to the mugger‑‑fight or hand over the money. Once that decision is made, marginal ones may follow, like how hard to fight or how much money to try to withhold.) While this example is obvious, it makes an important point: before you can apply your analysis to a particular problem, you must correctly identify the relevant margin. It can also serve as a springboard to a discussion of types of decisions where this is crucial. This would include: a) all or none type decisions (like marriage, divorce, having a first child, declaring war, etc.); b) improper treatment of historical (sunk) costs (like refusing to sell below average cost, historical depreciation, treating average cost as if it were marginal cost, etc.); c) inframarginal external benefits (like justifying more (marginal) spending on health or education because of net external benefits in total rather than at the margin); d) indirect solutions when direct ones are better (such as a gas tax to reduce pollution); e) errors in analyzing the free rider problem (like the argument that if nobody is informed about the political arena, we will get bad government, therefore you individually should become well informed); etc. Roger W. Lizut, New Mexico Highlands University The following is offered as an aid to getting students to think in terms of increments and marginal quantities. Consider two featureless perfect spheres, one the size of the Earth and the other the size of a golf ball. Say that someone has wrapped a piece of string along the entire equator, with no space between the string and the surface, for each ball. Now comes along somebody with a lot of one inch high telephone poles and says that the entire string must be suspended one inch above the surface, and that it must be done for each ball. How much string must be added to the Earth‑sized ball and how much must be added to the golf ball sized one? The "intuitive" answer is that a lot more must be used for the Earth‑sized ball. The key concept is to think in terms of increments, regardless of the "sunk" values already given. It can be easily shown mathematically that the increment required for both balls is the same: Say the Earth‑sized ball radius is R inches and the smaller ball radius is r inches. The initial length of the large ball string is 2 P R inches and the small ball 2 P r inches. Both radii are to be increased by one inch to provide slack for the needed clearance. The new large ball length will be 2 P (R+1) and the new small ball length will be 2 P (r+1). The increment added to the large ball is then 2 P (R+1) ‑ 2 P R which is (2 P R + 2 p) ‑ 2 P R which is 2 P inches. The increment added to the small ball is 2 P (r+1) ‑ 2 P r which is (2 P r + 2 P) ‑ 2 P r which is 2 P inches. Therefore, the increment added to both balls is the same, despite "common sense." Demand Gary Galles, Pepperdine University Students often need help in distinguishing between changes in the quantity of a good demanded along its demand curve as the price changes and changes in the equilibrium price and quantity of a good demanded due to some other factor that shifted the entire curve. I ask my students why happy hour exists. Some student will reply that it occurs during periods of low demand, when regular prices would leave a bar largely empty. I then ask which of the following would increase demand the most: a reduction in the price of a complementary good (snack food?) or a reduction in the price of drinks? The first to respond almost always falls for the "trick" and says that cutting drink prices would increase demand the most. I tell him that this is incorrect, and then solicit explanations from the class as to why. Those who understand will explain (or I will) that a drop in the price of a drink does not alter the relationship between the price and quantity of drinks demanded (i.e., it leaves the demand curve unchanged)‑‑it just moves us to a different point on that relationship‑‑but reducing the price of a complementary good does change the entire demand relationship, causing more drinks to be demanded at each price. Therefore, a reduction in the price of the complementary good raises demand more, because a price reduction will have no effect on the demand for drinks. Which option is a better happy hour policy? A typical first response is that the complement good price cut will raise demand, while an own price reduction won't. I reply that while cutting complement prices boosts demand and a drink price cut doesn't, that doesn't necessarily make it the best decision. The standard answer is it depends, with further questions being: what does it depend on and how does it depend on these things? I show how it depends on demand elasticity, how complementary the two goods are, and the profit margin per drink, while I use graphical or numerical examples to illustrate these points. Then I ask why most bars give away munchies and charge for beer, rather than vice versa, to show how complementarity can be stronger in one direction than another (i.e., beer without pretzels is more enjoyable than pretzels without beer). This example has proven useful in (a) cementing student understanding of the distinction between a shift of demand and a movement along a demand curve, (b) briefly introducing them to how economics would be used in a simple business decision (i.e., how it depends is the framework around which policy decisions are made), (c) improving student understanding of complementary relationships, and (d) generating class participation and interest. The Law of Demand and a Seesaw Ki Hoon Kim, Central Connecticut State University Whenever a storefront shows a big SALE sign, what happens? The consumers buy more because of lower prices. If the same store charges higher prices, they would buy less or may seek substitutes. Thus the inverse relationship between the price (P) and the quantity demanded (Qd) of a good or service in a given time period is called the law of demand. The best way to understand the inverse or negative relationship is just like placing the P and the Qd on a seesaw. If one (say, P) goes down, the other (i.e., Qd) goes up, and vice versa, as the following diagrams show.
Figure 3-1 Changes in Demand vs. Quantities
Demanded Rudy McCallister, Truman State University Distinguishing a change in demand from a change in quantity demanded is a troublesome, yet important skill that occasionally evades even the advanced student. To help reveal the difference, I draw a graph relating the time that a student spends preparing for an exam to his expected grade (you can also use this to make other points, e.g., diminishing returns). It shows that, generally speaking, as a student studies more, he makes a better grade, i.e., one moves along the curve. Now, I ask the students what would happen if they somehow came into possession of a copy of the exam. They respond, naturally, that they would probably be able to make a higher grade than before given the same amount of study time. In other words, the function shifts. Although this is a direct function, they can usually now see the endogenous/ exogenous nature of the variables and why a price change will not shift the demand curve. Eric Steger, East Central University Too often in economics classes we stress pride and quantity relationships and deemphasize qualitative considerations due to the inherent difficulties in measuring quality accurately. However, when I relate that Honda Motor Co.'s Accord was the best selling car in the U.S. in 1989, students became interested. I explain that this was the first time a Japanese model has been number 1 in the U.S. Also, this manufacturer produces automobiles that, by most measures, are top quality. This usually communicates the price quantity and quality relationship quite well. Thomas J. Shea, Springfield College The most difficult topic in supply and demand, even for my brightest students, is the distinction between demand and quantity demanded. I have tried many clever ways to explain the difference and to warn them about the trap of saying "If the price changes then 'demand' will change." I have finally solved the problem by never really saying quantity demanded. I use the term "amount people wish to buy" in every instance where the text (any you can name) uses the term "quantity demanded." However, in writing on the board, and in the myriad of handouts, problems and quizzes, I always use the term "amount people wish to buy (quantity demanded)". The parenthetical "quantity demanded" is a sort of definitional concept that relates my lecture to the text. After seeing it written this way so many times, students coming upon the term "quantity demanded" in a text or a reading automatically know that this term means "the amount people want to buy" and not demand. They rarely if ever confuse demand with quantity demanded. Of course, I do the same with quantity supplied substituting the term "amount offered for sale" for quantity supplied. With this method it is also easier to teach equilibrium. When you ask students what will happen to the price if the amount people wish to buy is greater that the amount offered for sale you get a much greater response than if you ask what happens when quantity demanded is greater than quantity supplied. For those teachers who still wish to use quantity demanded and quantity supplied, this method still works. Constant reminders that two terms are the same allows both you and the student to use them interchangeably. The key is that they do not use demand when they mean quantity demanded and vice versa. John S. Cameron, Southwest State College This analogy is used to solidify the difference between changes in demand and changes in quantity demanded by relating these changes to the change in speed (quantity purchased) brought about by pushing the gas pedal (price) and a shift to a whole new set of possible speeds (quantities purchased) by shifting gears (demand) The axes of the graph are jointly labeled. Using the graph below the student can see the similarities. Starting in gear D0, greater MPHs (quantity per unit of time) will be obtained as the pedal (price) is depressed. If the automobile shifts to another gear, D1, greater speed (quantity purchased) can be obtained at each level of pedal depression (price). Downshifting to D2 produces the opposite effects on speed and quantity purchased.
Figure 3-2 Mnemonics for Demand
Determinants Bruce Caldwell, the University of North Carolina‑Greensboro and Phillip E. Graves, University of Colorado‑Boulder To help students remember the determinants of demand and the distinction between "changes in demand" and "changes in quantity demanded," we use the following memory (mnemonic) devices. CALDWELL: To get their attention, state "Let's see if we can figure out what sorts of things might go into determining the demand for a product in a certain marketing region (the college). For relevance, let the product be‑‑bottles of vodka." We then list (via their contributions) Px = Price
of good Pog = Prices
of other goods (noting subs and complements) Px* = Price expected for good I = Income (noting normal and inferior goods) N = Number of people in marketing region T = Tastes and preferences We then note that Px, Pog, Px*, I, N, T ‑‑spells PINT‑‑as in pints of vodka (The 3 P's allow the slurring of the word pint, as in "Give me another p‑p‑pint.") Whether teetotaler or frequent partaker, they generally remember these 6 determinants of demand. GRAVES: Alternatively, the following approach can be used. Put the following on the board:
Figure 3-3 As I do this, I introduce the demand shifters as a word near and dear to the hearts of undergraduates: PINT. I then discuss how changes in the prices of other goods, income, number of buyers, and tastes can shift demand‑‑the relation between the quantity demanded and the own price. To close this discussion, I ask, "How might this memory device handle price expectations?" The answer comes from Olde English: PYNTE (where E stands for expectations). I have found that this memory device resolves a lot of student confusion. Davis Folsom, University of South Carolina‑Aiken and Walter C. Rose, Sampson Tech. College FOLSOM: Early in any principles course we try to explain what a demand curve is, typically using some dull example like wheat or corn. To get students involved, I hand out a slip of paper and ask the question: "What is the most you would be willing and able to pay for an A in this course?" After the laughter subsides, I allow a few minutes for thought before collecting their unsigned figures. By the next class I tabulate and construct a demand curve and explain how if you said $100 you would be willing to pay $10 too. Later, when discussing demand shifters, I ask students how their income, grade expectations, and enjoyment of the course would affect their willingness to pay. After the first exam I ask if that price had changed. There are always some students who do not want to buy a grade. I use them in explaining what a market is. ROSE: In discussing how to construct demand schedules and plot demand curves, the class is asked to write down what each one is willing to pay for an "A" in the course and turn the paper in to the instructor. From this action, we develop a demand schedule and then plot it on a graph. The instructor then gives the class a sheet listing the prices at which "A"s would be supplied. From this supply schedule, the class plots a supply curve and determines the equilibrium price and quantity of "A"s. It stimulates interest and helps students understand how a price system operates and how demand/supply schedules and curves are constructed. Successful Job Interviews as
Demand Shifters Edward D. Lotterman, University of Minnesota‑Twin Cities Many students view the idea that expectations about future events are an important demand shifter as either boring or abstract and irrelevant. Texts often include some mundane example of a shopper who buys an extra sack of sugar because of rumors that the price is going up. The effects of broader economic expectations on individuals' consumption patterns are often ignored. I find the following example useful for many students. College students are often a poor down‑trodden lot who must pinch pennies to get by and often subsist for most of their college careers on oatmeal or macaroni and cheese. They have to walk around in old rags. (Playing up the poverty of students gets sympathetic attention!) They endure this extreme deprivation until the last semester of their senior year. Then they start to apply for jobs and go to interviews. You can easily tell who is doing well in the job search process, they are the students who go out for pizza and beer and who begin to sport flashy new clothes! You can also distinguish between majors, accounting and computer science majors with high expectations will go out for pizza frequently, philosophy majors perhaps once or twice! Why does this occur? It is because good interviews give students confidence that in a few months their era of poverty will draw to a close. It is not necessary to even receive their first paycheck for these students to begin to alter their consumption patterns. Most have some slight reserve of cash, and the mere expectation of fat checks in a few months is enough to loose the bands on their coffers. Those without any nest egg may be inclined to borrow a bit, knowing that repayment will be easy. Budding accountants and systems analysts can, of course, be more prodigal since the size of the paycheck they anticipate is substantially fatter than that expected by the average philosophy major. Expectations of the future are a broad and powerful demand shifter not limited to expectations of future prices of a specific good. Cable TV and the Law of Demand Eric K. Steger, East Central University (Oklahoma) Many times my students have difficulty remembering the determinants of price elasticity of demand. To help then I first ask, "How many have the basic cable TV?" (Our school is in a remote area such that most people have the basic cable service to enhance the quality of TV reception). Of those that raise their hands, I ask, "How many would not continue the service if the basic cable TV service rate rises 15%?" Very few, if any, would discontinue service. I ask them, "Why?" Most say that without the cable, the quality of TV reception is terrible. I indicate that there are few good substitutes. Antennas give poor quality reception and satellite dishes are still too expensive for many people. The demand tends to be relatively price inelastic in this price range -- based on the substitutes determinant. Others indicate that the extra money spent on the basic subscriber services isn't much for quality reception. I indicate that the smaller the percentage of a budget allocated to an item, ceteris paribus, the lower the price elasticity of demand tends to be. I indicate that the less "necessary" a good is, the more price elastic the demand tends to be. Cable TV services tend to be elastic on this count, but the other determinants overwhelm this one. I do point out that as time passes, more good substitutes may be found for cable TV services and the price elasticity of demand will tend to rise. Buying Coffee Even If You Don't
Like It Patricia L. Wiswell, Columbia‑Greene Community College One of my favorite anecdotes that illustrates how a change in demand may be caused by changing consumer expectations took place in the 1970s. My mother‑in‑law had a friend, Jack, who was in the coffee vending machine business in Metropolitan New York. He supplied the vending machines and ingredients for hotels, movie theaters, bus stations, etc. Naturally, it was important for him to follow the commodities market. One night, Jack was a dinner guest at Mom's house. Coffee had been selling for 89 cents for a one pound can for a long period of time. Over dinner Jack told Mom that coffee prices would be skyrocketing in the very near future because Colombia (or Brazil) had experienced a major coffee crop failure. The next day Mom hit every supermarket in Long Island and bought every can of coffee she could get her hands on. She had a basement full of coffee‑‑but Mom doesn't drink coffee. Variable Interval Reinforcement,
Expectations, and Demand Gary M. Galles, Pepperdine University I have often found it difficult to come up with an example of how price expectations shift demand curves that sounds both realistic and important enough for the idea to sink in with my students. Therefore, I have come up with the following "psychology" example (based on a recent Wall Street Journal article) of the auto industry. I begin by asking if any of my students has taken a psychology course. I ask one of them to explain (or I do it myself) what variable interval reinforcement is (it is rewarding behavior on a frequency that is a random variable‑‑e.g., rewarding a rat an average of once in ten times it pushes a bar, but at an uncertain interval each time) as opposed to fixed interval reinforcement (e.g, rewarding a rat exactly once after each ten times it pushes a bar). The particular feature of variable interval reinforcement I wish to examine is the question of how fast the behavior in question is "extinguished" (i.e., stopped) when the reinforcement or reward system is stopped. So I ask two questions of my students about it. First, I ask whether it would take longer to extinguish a behavior under fixed or variable interval reinforcement schedules of the same average frequency. It takes longer under the variable schedule, because it takes longer to establish that the reward system has in fact been stopped. Second, I ask which of the two cases would be more likely to lead to a resumption of the behavior if a single reward is given at a particular time once the reward schedule has been stopped. Again, the variable schedule is the answer, because a single reward may convince the subject that he had just recently had a string of bad luck (no reinforcement), but that the reward system still existed. Once the behavior is started again, it takes a while to extinguish that behavior again. Hence, once a variable interval reinforcement schedule is begun, it takes a long time before subjects are convinced it's over, so the rewarded behavior tends to persist. We then apply this result to automobile marketing in recent years. Car sales have been very low in this high real interest rate recession (you can introduce the real vs. nominal interest rate distinction here, if you have not done so already). I ask my students what an economist might suggest as a way to increase sales in such a situation. Since we will have just covered the law of demand, someone will suggest that the price be lowered. I then ask whether auto prices were effectively lowered (yes) and how. Someone will come up with rebates, discount financing, "free" extra features, etc., as ways it was done. (You can ask them about why the manufacturers didn't simply lower prices to dealers instead, as a thought question for a micro class). I also ask them whether these programs were permanent or only temporary (temporary), and whether cars sold better under them (yes). I then ask what they would expect to happen to sales when these programs ended (fall, which is what did happen). I point out that manufacturers shortly responded to the resulting sales decline with new temporary promotions that had the same effect: increasing sales under the promotion campaign but very few sales when they stopped. This happened several times, at different intervals (this is where the variable interval reinforcement comes in), with the same results each time. Car companies decided that the promotions were primarily shifting sales from periods with no promotions, not increasing sales in total (i.e., interested buyers would put off buying today because they knew if they waited long enough there would be a new promotion that would result in a better deal). This is a case where the car companies "trained" potential buyers to put off buying (shifting the current demand curve to the left) in expectation of lower effective prices later under promotion programs (shifting that demand curve to the right) ‑ a classic case of price expectations shifting demand curves over time. The story does not end here, with car companies just ending these promotions (they have continued), however, because of the variable interval reinforcement schedule involved in the promotions. Whenever the promotions have ended, people continued to wait for the next one, whether one was planned or not. This pushed down sales, distressing manufacturers and dealers, resulting in resumed promotions again. Chevrolet attempted to break this pattern by substituting straightforward lower prices without special promotion programs on their new 1983 models, hoping to convince buyers that promotions would be ended in favor of general lower prices. Buyers apparently were not convinced, and sales were not very strong (ask whether the students would have been convinced by this) as buyers waited for the inevitable promotion program (made necessary by their expectation of one) even with lower initial prices. This also devastated sales of end‑of‑the‑model‑year 1982 cars (substitutes for new 1983 cars) by lowering the relative prices of 1983 cars and the expected relative price under promotions even more. These circumstances led to promotional programs for the 1983s and even bigger ones for 1982s in an effort to sell cars. Repeated temporary promotions initiated under weak sales conditions rewarded potential buyers who put off buying until the next promotion. Initial attempts to stop the promotions were not very successful because that buyer behavior was not quickly "extinguished" under the effective variable interval reinforcement schedule. Even stronger attempts to convince buyers that promotions were over, to be replaced with lower prices, failed to work much better at extinguishing this behavior. It will take a period of lower sales than otherwise at any prices before potential customers stop holding off in hopes of a still better deal on a promotion. Not only that, but it could take even longer if some company decides to "reward" promotion waiters with a new program, and other companies follow instead of losing customers, because that will resurrect those same expectations the car companies are trying to bury. The end of these special promotional programs will probably require a general increase in the demand for cars. Differentiating Shifts From
Changes in Quantities John P. Cochran, Metropolitan State College of Denver After introducing the law of demand and the demand curve, emphasize the difference between demand and quantity demanded using graphs and verbal descriptions. The word demand always refers to the whole schedule or curve whereas the term quantity demanded refers to a single point or price‑quantity combination. Demand reflects the quantities consumers would be willing to purchase at alternative prices. Underline the "s" at the end of quantities and prices to reinforce the idea that demand refers to a whole array of price‑ quantity combinations. The definition for quantity demanded will be similar except price and quantity are in the singular. Quantity demanded is the quantity or amount consumers are willing to purchase at a given price. This distinction aids students in remembering to distinguish a change in demand (a shift of the whole curve) and a change in quantity demanded (a movement to a new point). A similar technique can be used to differentiate between supply and quantity supplied, and between changes in supply and quantity supplied. Partial Equilibrium Analysis Elephants, Blind Men, and
Partial Equilibrium Sharmi Mehta, East Tennessee State University Students often have difficulty with the partial equilibrium approach to economic analysis. The initial symptoms of this difficulty appear with the discussion of the Law of Demand and the role of a good's price in relation to demand. Students commonly express doubts about the validity of the law by pointing out some factors (other than the price) which in their judgment play an important role in changing the demand for a particular commodity. One way to cure their confusion about partial equilibrium analysis is to narrate the story of the seven blind men who, not having seen or heard about an elephant before, tried to describe the beast after touching only one part of its body. Thus, one who felt the tusk described the elephant as resembling a spear, while another who held the trunk argued that it was like a snake. Hearing the seven descriptions, it was quite clear that each man was right, but only partially so. Furthermore, no one was able to grasp the whole image of the elephant. Had they touched all its parts, they would have had a much better understanding of his whole complex figure. The Law of Demand, by focusing only on the role of the price of a commodity, illuminates only one dimension of that commodity. The other parts of demand analysis‑‑focusing on the roles of factors (other than own price) which cause a shift in the demand curve for a commodity‑‑are then introduced. The Ceteris Paribus Assumption
and Time Travel Joseph E. Pluta, St. Edward's University Many students have difficulty grasping the usefulness of the ceteris paribus assumption and argue that it is unrealistic to hold "all else constant" when other things are, in fact, continually changing. Science fiction stories about time travel implicitly use the ceteris paribus assumption. By altering relatively minor circumstances (the independent variable) and assuming that all else happens as before, the time traveler changes a number of subsequent occurrences (dependent variables). A recent example illustrates the usefulness of the ceteris paribus concept in forecasting future events. In the movie Back to the Future, 17‑year old Marty McFly is transported to the year 1955 where he becomes involved in bringing together the two teenagers who are to be his parents. Marty helps to place his talented yet spineless father‑to‑be in a situation where he must stand up to the local bully who in adulthood is destined to be the father's domineering supervisor. In this playback of history, only one variable changes: a young man attains self‑confidence. All other variables over the next thirty years are assumed to behave as before. When Marty is sent "back to 1985," he finds his parents more happily married, healthier in appearance, more financially successful, more creative, and employers of the town bully of thirty years ago. Despite the fictional fantasizing about cause and effect, the movie is a useful point of reference because so many students (and professors) have seen it. Similar "time travel" experiments may be undertaken in class to replay economic history (assuming, of course, that care is taken to hold the proper "all other things constant"). If the U.S. energy industry had taken steps during the 1960s to make the American economy less dependent on foreign oil, for example, then (ceteris paribus) the impact of the energy crises of the early 1970s would have been less severe. If the tax cut during President Reagan's first term had been geared more toward investment goods than consumer goods, then (ceteris paribus) economic growth might have been more self‑sustaining. If a student had not frivolously spent $100 on entertainment last weekend, then (ceteris paribus) the money could be used this week for necessary school supplies. And so on. If done properly, such exercises can be more than mere wishful thinking using the benefit of historical hindsight. At best, they may create greater interest in contemporary economic events (as well as the factors influencing their occurrence) and instill an appreciation for the necessity of the ceteris paribus assumption. John P. Cochran, Metropolitan State College of Denver The use and importance of ceteris paribus assumptions in economic analysis can be integrated into a lecture using the law of demand, the non‑price determinants of demand, shifts or changes in demand, and changes in quantity demanded. When presenting the law of demand, underline the all else assumed equal or parallel phrases. All of the things held constant are then presented as the non‑price determinants of demand. Shifts in demand are then easily presented as the result of changes in the factors that were assumed constant when the law of demand and the relationship between price quantity was introduced. Again the discussion can easily be adapted for supply. Some version of Table 3-1 can be placed on the board showing how changes in each category change demand. The table can also show such subcategories for groups as: substitutes and complements, normal and inferior goods, and expected price, availability, and income.
Table 3-1 Supply Nudity, Opportunity Cost, and
Market Supply William Yacouissi, Mansfield University Many professors use a class survey to illustrate demand, such as how many pizzas would you buy at prices, x, y, or z. This exercise never fails to produce the requisite negatively sloped demand schedule and related graph. However, supply is more problematic. Students don't instinctively understand why supply is positively sloped. Why should it take higher prices to call forth greater quantity? If the market price provides a profit, why isn't an unlimited supply of the good available at the market price? To teach these concepts an exercise is needed that effectively conveys the concept of opportunity cost for resource inputs. This could be done if a product could be found that all students could produce and for which the opportunity cost of production is distinctly different for each student. The concept I eventually settled on was that of nudity. Most people have an anxiety dream where they are nude in a room full of clothed people and anxiety or embarrassment is a good proxy for opportunity cost. Of course I would never suggest that students actually take off their clothes in class but it is a mind game to which virtually everyone can relate. The exercise used is very similar to the common demand exercise. I ask the students to write down on an index card how much money they would have to receive to be induced to take their clothes off in class. I also ask them how much they would have to receive to be induced to be unclothed on a nude-only beach. Sometimes a word is necessary to the students about keeping their payment demand reasonable. Realistically, most people would take their clothes off for a good deal less than a million dollars. The results are usually as expected. Some students require low payment because their opportunity cost is low and others require high payment because their opportunity cost is high. This difference produces a positively sloped supply curve. Students also always put down a lower price for being nude in the presence of other nude people than in the presence of clothed people. The second set of prices is used to illustrate how a supply curve will shift when underlying market conditions change. In this case shifting from the classroom to a nude beach is analogous to introducing a technical innovation that lowers the opportunity cost of production for each producer. The Artificial
"Shortage" of Blood Eric K. Steger, East Central University Some students are skeptical about the efficiency of the price system. This example helps illustrate my point. I explain to students that many medical facilities complain of too few blood donors and potential shortages of blood, and that a sufficient supply of blood would exist if a higher price were offered to people to supply their blood. Some students protest and say that selling blood is "barbaric" and they would never sell their blood but would give it away. I then ask, "How many have given blood?" Very few have given blood. I explain that they may never give or sell their blood but many people are more willing to endure the discomfort of needles, etc., if the reward (money) is higher. This seems to make the point Mnemonic Devices for the
Determinants of Supply Philip E. Graves, University of Colorado-Boulder and Robert L. Sexton, Pepperdine University To help students distinguish "changes in supply" from "changes in quantity supplied," we employ the following memory aid:
Figure 3‑4 After putting the preceding on the board, we illustrate its use with graphical examples of the various shifters. In understanding movements along the supply curve, these other factors are seen to be PESTs, obfuscating the effect of a change in own‑price. We have found that students exposed to this device quickly grasp the difference between change in supply and change in quantity supplied. Illustrating the Law of Supply Eric K. Steger, East Central University I often ask my principles students if they could use some extra money. Most indicate that they could. I then offer to hire each one to help me do yard work at my home, but I'm only willing to pay $1.00 per hour. Nobody is willing to work for that wage. I then offer to pay each student $3.35 per hour for the same work. Usually I get a few that are willing to work. I then offer $10 per hour to get other students to work. Immediately, I get many more students willing to do yard work. I then develop a table that contains wages and the quantity supplied at each wage. I then plot the numbers, and students easily see how the law of supply is realistic and relevant. Ralph Byrns Many people think of technological change as synonymous with progress and technological advances. Your discussion of technology as a supply shifter is an excellent place to make the point that technology is a broad term referring to anything that influences how resources are transformed into outputs (some have compared it to a magical "black box"), and that technology can move in both directions. Some examples to help make this point include: 1. Agriculture. The "technology" that underpins agriculture includes climate, weather, insect cycles (e.g., plagues of locusts), diseases of plants and animals, and the state of knowledge. Such weather changes as drought or a frost that kills citrus trees represent negative technological changes. 2. War. Vast amounts of modern capital may be wiped out during a war; this is also a negative technological change. A worldwide nuclear holocaust could yield instant and total depreciation of capital, with a nuclear winter being the ultimate example of technological regression. Mention to your students that, under a proposal offered by Assistant Secretary of State Morgenthau following World War II, Germany's devastated industrial base would not have been rebuilt, and Germany would have been denied little but agriculture as an economic base. Much technology was embodied in a highly educated and disciplined work force, however, permitting rapid recovery in the German "economic miracle" of the 1950s. Equilibrium Thomas J. Shea, Springfield College To show how the idea of equilibrium is a set of forces which result in a "state of rest", "a position to which you are forced to go" or "a position from which there is no impetus to move" (to quote from the text examples), I ask my students to visualize a man jumping from the Empire State Building without a parachute. He will be in equilibrium only when he reaches the sidewalk below. For there he is indeed in "a state of rest", "a position to which he was forced to go", and most certainly "a position from which he has no impetus to move". This gruesome example seems to set the definitional concepts firmly in their minds. The Difference between Real and
Economic Shortages Tim D. Kane, University of Texas‑Tyler Students in the introductory course sometimes have difficulty understanding that there are two kinds of "shortages" confronting the American consumer today: Those which are real and those which are economic. To illustrate the difference, I pose this question to the class: "If four people are on a sinking boat in the Gulf of Mexico‑‑too far out to swim to land‑‑and there are only three life jackets on board, how will the life jackets be distributed?" Brute force, "first‑come, first‑served," and "women and children first" are the usual replies. However, it is obvious to the students that money, or price, is not relevant and that offering a jacket to the highest bidder would not be in the self‑interest of any of the passengers. Lesson: A "real" shortage is one which cannot be resolved by the price mechanism. On the other hand, gasoline shortages under price controls, and apartment shortages under rent controls are two examples of "economic" shortages that were created when the price was arbitrarily set below its true market value. We know this is true because at higher prices the shortage disappears! Whenever the price of a good is set below its market level there will always be a "shortage" but it is an economic one rather than a real one. Lesson: An "economic" shortage is one that can be eliminated by rising prices. Shortages, Surpluses, and Price
Changes Dale Sievert, University of Wisconsin-Madison The standard approach to explaining how price changes follow demand or supply changes often assumes more student intuition than students possess. The dynamics involved in price changes need more explicit expression. I begin by stressing that both buyers and sellers, because they face scarcity, are constantly trying to maximize their welfare. If market price is below the equilibrium price, a shortage exists. Many students seem unaware of shortages, so at this point we search for them. Sold out concerts, empty store shelves for popular items, and waiting lists for classes graphically show them how to recognize shortages. Next we examine why shortages lead to price increases. There are two reasons. First, even though the low price pleases some buyers, not all buyers are pleased because some cannot buy all they want. To increase the welfare of one who faces this situation, a higher price is offered to induce the seller to cancel contracts with other buyers. This occurs at auctions, stock or commodity rallies, and sales of popular items that seem in short supply. Second, sellers soon recognize a shortage situation and realize they can raise prices and still sell all they want. It is as though their nemesis, the law of demand, didn't exist. Thus, as prices increase, so can profits. Finally, I stress that these two "forces" only tend to increase the price. Other more powerful forces could counteract them, thereby leaving prices unchanged. To dramatize this, I hold up a pencil and ask if gravity is a force acting to pull the pencil toward earth. If the students say "Yes," I ask why it isn't working. Of course, gravity is working. I'm simply overpowering it with the greater force in my finger muscles. Then I show what such similar forces are that prevent price increases during shortages. Such forces include price ceilings, sellers seeking to maintain goodwill (thereby insuring future profits), and buyer resentment (i.e., irrational refusal to become involved in an auction). Similarly, surpluses are shown to cause price declines through the efforts of buyers and sellers to maximize welfare. And there too, these "forces" can be offset by price floors, collusion, and irrational seller behavior. Ki Hoon Kim, Central Connecticut State University A comfortably balanced mix of hot and cold water makes taking a shower one of life's pleasures. (Success stimulates off‑key singing!) There are possibilities of changes in the volume or temperature of the water. Then a readjustment is necessary. Likewise, equilibrium is the state of balance between opposing forces. There is no tendency to change over time. When we roll a small ball in a big bowl, it oscillates for a while and then settles down at the lowest point in the bowl. It is in a state of rest which is an equilibrium position. Stable vs. Unstable Equilibrium Ken McCormick, University of Northern Iowa The concept of a stable vs. an unstable equilibrium is often difficult for students. Consider an ordinary mixing bowl and a ping‑pong ball. Drop the ball into the bowl, and watch it come to rest. This means that it has reached its equilibrium. Now slap the ball gently. It will roll around the bowl, but will eventually come to rest in the same spot as before, namely, the bottom of the bowl. Thus, the original equilibrium was stable. Now turn the bowl upside‑down, and balance it on top of the bowl. The ball will be at rest, so it is at an equilibrium. Tap the bowl gently and cause the ball to roll down the side of the bowl. It will be obvious to all that it will not come to rest at the same spot as before. Hence, the position at the top of the upside‑down bowl was an unstable equilibrium. Using Prices to Allocate Faculty
Gym Lockers William Lee, Saint Mary's College of California When I was a graduate student, I always enrolled in a physical activities class so I could be issued a gym locker. This entitled me to receive clean gym clothes and a towel weekly. I took full advantage of this service because I did not like to carry gym clothes in different stages of decay around in my car. Unfortunately, when I passed my qualifying exams I was no longer considered a graduate student. I was no longer allowed to enroll in gym classes and could not be issued a locker, so the aroma in my car . . . well, you knew when I was driving your way. The only alternative was to put my name on a waiting list for a "free" faculty locker. Naturally, I never got to the top of the list during the three year I worked on my dissertation and lectured. Six years after leaving the university, I returned to lecture for a term. Still enjoying tennis and jogging and not liking an offensive smelly car, I wanted a faculty gym locker. Predictably, I was still on the waiting list. That year the school, for budgetary reasons, implemented a new revolutionary policy‑‑charging $15 per term for a faculty gym locker, including fresh gym clothes weekly. With the exception of the economists, the faculty screamed "foul." They said that it was not fair to make them pay for their lockers. After about a two week transition period of emptying and reissuing the lockers of people who were unwilling to pay the $15 (some had not used them in years and some had moved from the area) I, after nearly a decade, and anyone else who was willing to pay $15 got a locker. All those who did not want to pay $15 did not get a locker. As an added benefit, with the locker fees the university even bought soap dispensers for the showers. This shows how prices allocate resources and goods, in this case lockers, to their highest valued uses. Marshallian Demands and Shortages John P. Cochran, Metropolitan State College of Denver To help students understand how markets cure shortages and surpluses, introduce the Marshallian concepts of demand price and supply price. Draw a demand curve on the board. Arbitrarily pick a quantity and ask what maximum price consumers would pay for this quantity. Repeat the process several times for different quantities until students understand the concept. (The exercise also helps students become more competent in the use of graphs). Next draw a set of market supply and demand curves and set price so that a shortage occurs. Ask students if any of the buyers who cannot acquire the good at current price would be willing to pay a higher price rather than do without. (YES) The stage is set to explain the tendency for prices to rise to cure a shortage. The concept of supply price can now be used to let students discover why prices tend to fall in markets with excess supplies. Student Population and Rental
Housing Janet M. Thomas, Bentley College Reasons for demand and supply disturbances can be construed by the student as just another laundry list to be memorized unless the presentation is lively and relevant. A shift in demand due to changes in population is one that generally does not lend itself to interesting examples, particularly if the focus is on changes in U.S. population. However, if the presentation of population shifts is placed on a more regional level, specifically the town or city in which the college is located, many instances of population‑driven demand shifts can be discussed to which the students can more readily relate. A particularly relevant one in any college town is the annual effect of returning students on local population and its impact on the demand for rental housing. Students know first‑hand the resulting effect on apartment rents and can readily accept the theory driving the result. Do Markets Really Work? A Supply
and Demand Experiment Clifford Nowell, Weber State College In order to demonstrate equilibrium and convince students that markets do actually work, I conduct the following experiment. I ask for 10 volunteers; 5 will be buyers, and 5 sellers. To create supply and demand curves I give each buyer a card similar to Card A and each seller a card similar to Card B.
Figure 3‑5 The buyer's resale value varies from $4.50 to $2.50 in $.50 increments. The seller's production cost varies from $1.50 to $3.50 in $.50 increments. The instructions I give the students at the beginning of the experiment are simple. I tell them that our market will have 4 periods, and that in each period we will auction off a fictitious product. During each period each buyer may purchase one unit of the product by bidding. Sellers may sell one unit of the product by giving offers. Each successive bid must increase in value and each successive offer must decrease. The bids and offers are written on the board and a transaction occurs when the offered price equals the bid price. The students who made the transaction record the sale price and calculate profit on their cards. I also tell them that they will be paid any profits they make during the course of the experiment. I tell the students each period will last 3 minutes, and then go through an example of how to fill out the cards. Based on the values given by the cards, the following supply and demand curves will result. B1 represents buyer #1. The maximum willingness to pay for B1 is given by his resale value of $4.50. Note that sellers 4 and 5 may not make any transactions because their costs of production are too large. Likewise, buyers 4 and 5 may not purchase any of the commodity.
Figure 3-6 The equilibrium quantity sold will be three and the equilibrium price will be between $3.00 and $3.50. Consumer surplus can be demonstrated by the amount of earnings paid out. This experiment gets students to believe in the concept of equilibrium and enables them to have confidence that the graphs I draw throughout the entire class have meaning. We conclude that markets do indeed work. Experiments in Price Discovery Steven C. Turner, University of Georgia The purpose of the experiments is to make the students aware of the difference between price determination (which evolves from underlying economic forces) and price discovery (which is short run in nature and evolves out of the structure and rules of a market). Three experiments are conducted using the different trading mechanisms of an auction, centralized private negotiation with price reporting, and centralized private negotiation without price reporting. The requirements for each experiment are as follows. Divide the class symmetrically into buyers and sellers and hand each student a card with their identifying buyer or seller number (an address label with buyer or seller and number identification information is helpful), his reservation price, and the number of units to be bought and sold. Individual reservation prices are assigned by picking off points on linear demand and supply curves in which the slope of the demand curve is the negative of the supply slope. For sellers, the reservation price represents the lowest acceptable price, while for buyers it represents the highest price to be paid. For both private negotiation trading experiments, traders are given trading cards on which they record (1) time of transaction, (2) opposite trader number, and (3) quantity (number of units) and price of the transaction. The difference between these two experiments is that in the private negotiation with price reporting, traders are required to relay transaction price to a market reporter who records the prices sequentially in clear view of all traders. In the auction trading experiments, the seller sells all of his units when the auctioneer selects his number. The auctioneer begins bidding at a certain price (he drops this price until bidding commences) and moves the price up until bidding is discontinued. All the sellers units (10 units/seller) are auctioned off and buyers can buy a maximum of 10 units. After the experiments, data are collected for two purposes. One purpose is to rank or grade the students. This is done by recording each trader's actual profit (difference between transaction and reservation price) and his expected profit (difference between equilibrium and reservation price). The difference between actual and expected profit is computed and used to rank the class, the highest rank going to the trader with the greatest positive difference. The other purpose of the experiments is to show the influence of supply and demand curves in a trading context, how average transaction prices can differ from equilibrium prices, and how different trading mechanisms can influence average transaction prices. Only a teacher's imagination limits the way these experiments may be used to convey basic economic concepts. Relaxation of the basic assumptions of a perfectly competitive market can also be explored using variations on these experiments. The Disappearing Supply and
Demand Curves Mark E. Schaefer, Georgia State University Do (revealed market‑wide) demand and supply curves always exist? No; individual buyers and sellers always have marginal benefit and cost curves, but they do not always reveal this information to others. Consequently, knowledge of market‑wide curves is not always freely available. As the number of market participants (sellers and buyers) goes from many to few, schedules of supply and demand go from being revealed in the market place to being concealed. Why? Because the person withholding information has an advantage over the person on the other side of the potential deal who gives away information in his eagerness to do business, thus losing bargaining power in the negotiations over the swap. Successfully functioning competitive markets are oiled by the provision of a FREE good, the information revealed for free by the many participants who tip their hands, i.e., who tell what quantities they are willing to buy or sell at various prices. Why do they give away this valuable information freely? Because they would be ignored in the frenzy of exchange if they stood silently with arms folded in the commodity auction pit as others shouted out their bids and asking prices. Only as the number of participants decreases (and the significance and unique individuality of each participant becomes more apparent) does the influence of each on the outcome of the negotiation increase through hype, hints, cajoling, threats of withdrawing, whining and wheedling. Why would you go to market, dilute your uniqueness in the herd of participants, and lose the power to withhold information? Because you expected the advantage of having many people on the other side of the exchange among whom you hoped to find a better swap, to more than offset the disadvantage of revealing information about your willingness to swap. Independence between Short‑Run
Supply and Demand Ralph Byrns When introducing time intervals (short run, etc.) stress that short run demands and supplies are normally independent. This helps students sort out S & D determinants. NOTE: Short run demands ultimately adjust to long run supplies, and short run supplies to long run market demands. Examples: short run supplies of computers depend on long run demands because, were demand zero, they would never have developed. Similarly, a demand for oil would not have developed without a supply; we would now use other technologies. Examples where demands exist without supplies include perfect solvents, perpetual motion machines, teleporter buttons, and other technologically unavailable goods. Supplies of tuna fish ice cream, economic poetry, incorrect mathematics formulas, or mud pies can be made available quickly, but there are no corresponding demands for them. Supplies typically exceed private demands for such things as doodles, songs by bathtub tenors or sopranos, and some professors' lectures. Demand is also far below supply in the following example. Lothario fantasizes about Miss Universe, but the prices he's able to pay for her affection are below the prices she requires. (The prices need not be monetary; he could be willing to do her laundry or take out her trash.) His demand and her supply of affection to him are shown in Figure 3‑7. This demand and supply are independent, but you may want to suggest that demands and supplies of affection are very interdependent for long term relationships.
Figure 3-7 |
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