Economics for Politicians Lesson 2: Introduction to Microeconomics - Why Prices Matter
Welcome to lesson II of "Economics for Politicians"! In the first lesson we explained who the government's money belongs to (the people), and now we move on to Lesson 2 - a basic introduction to Microeconomic Theory. Hey! Stop - don't get up and leave! Contrary to what you may have heard economics in not necessarily boring, and this lesson will be a huge help in your crafting policy that will get you re-elected!
Ah, I knew that magic word would get your attention. As I was about to say, the most fundamental building block of understanding economics is the classic supply and demand curve. You probably remember seeing something like this in one of the classes you slept through early on in your undergraduate days:
OK, we've put a bunch of points on a graph and plotted them out. So what does all of this mean? Like any problem it's easier to understand if you break it down piece by piece. Let's make the discussion more interesting by talking about a good or product that you will find interesting - bottles of whiskey. Back in the early days of your career before you had lobbyists to provide you with bottles of your favorite blend, you had to actually pay for them with your own money. What drove your decision as to what to buy? Probably lots of factors, such as the quality of the brand, how far you may have had to travel to get it, and of course, cost. To simplify this lesson we'll use a term that factors out externalities, or what economists call caterus parebus, "All other things being equal" to only focus on price. Assuming that every store carries your favorite whiskey where you buy and how much will only depend on price for now.
Let's assume that the local shop has ten bottles of whiskey on the shelf, and they are giving them away for free! If it's your favorite brand, it's a no brainer - you take all ten. Now let's say the price goes up to $10 per bottle - still a very good deal, and these could make great stocking stuffers for your cohorts. But you don't want to or can not buy all ten bottles, so you buy only nine. When the price increases to $20 you buy only eight, and so on until the price reaches $100 where you decide that whiskey is too expensive for your tastes right now and you decide to buy some vintagely challenged wine instead. Plot all of the points, and you get a demand curve that looks something like this:
Keep in mind that these curves will not perfectly predict your buying behavior, but this is a short lesson so we have to speak on a general level. On a large enough scale and when you compile enough actual data from real world examples, these graphs hold pretty true to actual behavior.
Now let's look at the other side of the aisle, the supply curve. Where as we just looked at whiskey from the buyer's perspective, the supply side looks from the seller's perspective. If you are selling your whiskey you are willing to supply more if you will get paid more for it. If you have your ten bottles of whiskey to sell at $100 per bottle you will gladly sell all ten! Now as we drop the price you are not willing to sell as many since you can not make as much profit on each bottle. Your willingness to sell them drops until we get to giving them away for free, and you are unwilling to offer any on your store's shelves. Plot the points and you get something like this:
An obvious question is that if you're only able to charge $40 per bottle why you would order ten in the first place when you are only willing to sell four of them? The answer is that your awareness of this lower market price leads you to only order four bottles since more are not worth your trouble. Consider this your introduction to why price controls are an excellent way to cause shortages and rationing.
Plot both lines together and we see a magical point where both lines meet - buyers and seller have found the point where we have maximized how many will sell with how many will buy, also known as equilibrium - voila!
Going back to a strictly buyer's perspective, when the price of a good increases less of it gets consumed, while as the price drops more of it gets consumed. To some degree you already understand this - think of when you pass "sin taxes" to encourage people to consume less of goods that they want but that groups who fork over truckloads of cash into your reelection campaign you deem a bad choice, such as cigarettes or oil. On the flip side, when you want people to consume more of a good that they would not willingly choose at the market price you introduce subsidies to bring costs down and increase demand, such as with electric cars or "green" energy.
Now you see how your decisions and the laws you impose on us help to modify people's behavior and distort marketplaces where prices are the measurement of what people will freely choose to buy or not buy. Think of the sum of all of the legislation that you pass designed to affect markets as the biggest anti-choice initiative ever created. Prices do matter!
Now that we've seen how to understand the economics of individual decisions, next up will be an introduction to Macroeconomics, or how how we measure the sum of all of this economic activity!
Ah, I knew that magic word would get your attention. As I was about to say, the most fundamental building block of understanding economics is the classic supply and demand curve. You probably remember seeing something like this in one of the classes you slept through early on in your undergraduate days:
OK, we've put a bunch of points on a graph and plotted them out. So what does all of this mean? Like any problem it's easier to understand if you break it down piece by piece. Let's make the discussion more interesting by talking about a good or product that you will find interesting - bottles of whiskey. Back in the early days of your career before you had lobbyists to provide you with bottles of your favorite blend, you had to actually pay for them with your own money. What drove your decision as to what to buy? Probably lots of factors, such as the quality of the brand, how far you may have had to travel to get it, and of course, cost. To simplify this lesson we'll use a term that factors out externalities, or what economists call caterus parebus, "All other things being equal" to only focus on price. Assuming that every store carries your favorite whiskey where you buy and how much will only depend on price for now.
Let's assume that the local shop has ten bottles of whiskey on the shelf, and they are giving them away for free! If it's your favorite brand, it's a no brainer - you take all ten. Now let's say the price goes up to $10 per bottle - still a very good deal, and these could make great stocking stuffers for your cohorts. But you don't want to or can not buy all ten bottles, so you buy only nine. When the price increases to $20 you buy only eight, and so on until the price reaches $100 where you decide that whiskey is too expensive for your tastes right now and you decide to buy some vintagely challenged wine instead. Plot all of the points, and you get a demand curve that looks something like this:
Keep in mind that these curves will not perfectly predict your buying behavior, but this is a short lesson so we have to speak on a general level. On a large enough scale and when you compile enough actual data from real world examples, these graphs hold pretty true to actual behavior.
Now let's look at the other side of the aisle, the supply curve. Where as we just looked at whiskey from the buyer's perspective, the supply side looks from the seller's perspective. If you are selling your whiskey you are willing to supply more if you will get paid more for it. If you have your ten bottles of whiskey to sell at $100 per bottle you will gladly sell all ten! Now as we drop the price you are not willing to sell as many since you can not make as much profit on each bottle. Your willingness to sell them drops until we get to giving them away for free, and you are unwilling to offer any on your store's shelves. Plot the points and you get something like this:
An obvious question is that if you're only able to charge $40 per bottle why you would order ten in the first place when you are only willing to sell four of them? The answer is that your awareness of this lower market price leads you to only order four bottles since more are not worth your trouble. Consider this your introduction to why price controls are an excellent way to cause shortages and rationing.
Plot both lines together and we see a magical point where both lines meet - buyers and seller have found the point where we have maximized how many will sell with how many will buy, also known as equilibrium - voila!
Going back to a strictly buyer's perspective, when the price of a good increases less of it gets consumed, while as the price drops more of it gets consumed. To some degree you already understand this - think of when you pass "sin taxes" to encourage people to consume less of goods that they want but that groups who fork over truckloads of cash into your reelection campaign you deem a bad choice, such as cigarettes or oil. On the flip side, when you want people to consume more of a good that they would not willingly choose at the market price you introduce subsidies to bring costs down and increase demand, such as with electric cars or "green" energy.
Now you see how your decisions and the laws you impose on us help to modify people's behavior and distort marketplaces where prices are the measurement of what people will freely choose to buy or not buy. Think of the sum of all of the legislation that you pass designed to affect markets as the biggest anti-choice initiative ever created. Prices do matter!
Now that we've seen how to understand the economics of individual decisions, next up will be an introduction to Macroeconomics, or how how we measure the sum of all of this economic activity!