The Economic Way of Thinking 10e ©Prentice Hall 2003 1 The Economic Way of Thinking 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Supply

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The Economic Way of Thinking 10eThe Economic Way of Thinking 10e ©Prentice Hall 2003©Prentice Hall 2003

The Economic Way of ThinkingThe Economic Way of Thinking1010thth Edition Edition

by Paul Heyne, Peter Boettke, by Paul Heyne, Peter Boettke, and David Prychitko and David Prychitko

“Supply and Demand: Issues and “Supply and Demand: Issues and Applications”Applications”

The Economic Way of ThinkingThe Economic Way of Thinking1010thth Edition Edition

by Paul Heyne, Peter Boettke, by Paul Heyne, Peter Boettke, and David Prychitko and David Prychitko

“Supply and Demand: Issues and “Supply and Demand: Issues and Applications”Applications”

PowerPoint Slides prepared by PowerPoint Slides prepared by Assistant Professor Assistant Professor

Paul HarrisPaul HarrisCamden County CollegeCamden County College

PowerPoint Slides prepared by PowerPoint Slides prepared by Assistant Professor Assistant Professor

Paul HarrisPaul HarrisCamden County CollegeCamden County College

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Chapter OutlineChapter Outline

I.I. IntroductionIntroductionII.II. Looking for an Apartment in the Looking for an Apartment in the

City? Read the obituary!City? Read the obituary!III.III. Strong Booze, Stronger Drugs: Strong Booze, Stronger Drugs:

Criminal IncentivesCriminal IncentivesIV.IV. Skim Milk, Whole Milk, and Skim Milk, Whole Milk, and

Gangster MilkmenGangster MilkmenV.V. Who Pays the tax?Who Pays the tax?

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VI.VI. High Priced Sports, Low Priced Poetry: High Priced Sports, Low Priced Poetry: Who’s to blame?Who’s to blame?

VII.VII. Do Cost Determine Prices?Do Cost Determine Prices?VIII.VIII. The Dropouts Release Their First CDThe Dropouts Release Their First CDIX.IX. ““There’s Gold in Them There Hills!” There’s Gold in Them There Hills!”

So What?So What?X.X. Even Butchers Don’t have the GutsEven Butchers Don’t have the GutsXI.XI. Why Does it Cost So Much to Change Why Does it Cost So Much to Change

Bedpans?Bedpans?


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XII.XII. More Please, Since its Free More Please, Since its Free

XIII.XIII. Cost and Ownership Cost and Ownership

XIV.XIV. Appendix: Framing Economic Questions Appendix: Framing Economic Questions CorrectlyCorrectly

XV.XV. Beware of Wrong Questions or Misleading Beware of Wrong Questions or Misleading Specifications of the ProblemSpecifications of the Problem

XV1.XV1. Beware of Data That appears to Speak For Beware of Data That appears to Speak For ItselfItself


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XV111.XV111. Beware of Academic Scribblers Beware of Academic Scribblers and Would- and Would-Be EconomistsBe Economists

XIX.XIX.The Graphic Case of Growing and The Graphic Case of Growing and Permanent Permanent ShortagesShortages

XX.XX. Once over LightlyOnce over Lightly


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IntroductionIntroduction

• The economic way of thinking is at work The economic way of thinking is at work regardless of economist’s actions.regardless of economist’s actions.– Economist have simply uncovered the Economist have simply uncovered the

principles behind economic behavior with principles behind economic behavior with respect to people’s choices, and the respect to people’s choices, and the consequences of their choices.consequences of their choices.

– Economist help us understand how individuals Economist help us understand how individuals are able to coordinate their production, are able to coordinate their production, consumption, and exchange decisions through consumption, and exchange decisions through cooperative and competitive activities in the cooperative and competitive activities in the marketplace.marketplace.

• The economic way of thinking is at work The economic way of thinking is at work regardless of economist’s actions.regardless of economist’s actions.– Economist have simply uncovered the Economist have simply uncovered the

principles behind economic behavior with principles behind economic behavior with respect to people’s choices, and the respect to people’s choices, and the consequences of their choices.consequences of their choices.

– Economist help us understand how individuals Economist help us understand how individuals are able to coordinate their production, are able to coordinate their production, consumption, and exchange decisions through consumption, and exchange decisions through cooperative and competitive activities in the cooperative and competitive activities in the marketplace.marketplace.

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IntroductionIntroduction

The forces of Supply and DemandThe forces of Supply and Demandclarify markets, not economist.clarify markets, not economist.The forces of Supply and DemandThe forces of Supply and Demandclarify markets, not economist.clarify markets, not economist.

Economist debunk popular myths,Economist debunk popular myths,and misconceptions, about marketand misconceptions, about marketProcesses. Processes.

Economist debunk popular myths,Economist debunk popular myths,and misconceptions, about marketand misconceptions, about marketProcesses. Processes.

In this chapter we consider other In this chapter we consider other examples of misconceptions aboutexamples of misconceptions aboutthe market system.the market system.

In this chapter we consider other In this chapter we consider other examples of misconceptions aboutexamples of misconceptions aboutthe market system.the market system.

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Looking For an Apartment in Looking For an Apartment in the City? Read the Obituary!the City? Read the Obituary!

• Question……Question……– Why is it so difficult to find an Apartment in Why is it so difficult to find an Apartment in

New York City?New York City?

• Answer…Answer…– Because the free market process has not been Because the free market process has not been

allowed to work. New York City allowed to work. New York City Commissioners have imposed rent controls, Commissioners have imposed rent controls, which have led to persistent housing which have led to persistent housing shortages.shortages.

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Monthly Monthly RentRent

$100$100

$200$200

$300$300

$400$400

$500$500

$600$600

100100 200200 300300 400400 500500 600600 700700 800800 900900 10001000 11001100

Quantity of Apartment UnitsQuantity of Apartment Units

Supply

DeDe

D Rent Controls

DShortageShortage

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Monthly Monthly RentRent

$100$100

$200$200

$300$300

$400$400

$500$500

$600$600

100100 200200 300300 400400 500500 600600 700700 800800 900900 10001000 11001100

Quantity of Apartment UnitsQuantity of Apartment Units

Supply

DeDe

D Rent Controls

DShortageShortage

The Below EquilibriumThe Below Equilibriumprice causes theprice causes the

shortage ! shortage !

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Strong Booze, Stronger Drugs:Strong Booze, Stronger Drugs:Criminal IncentivesCriminal Incentives


Question………Question………

Why didn’t the prohibition of the 1920’s abolish the Why didn’t the prohibition of the 1920’s abolish the supply and demand process for Alcohol?supply and demand process for Alcohol?

Answer……Answer……

People coordinated their activities through People coordinated their activities through underground market processes.underground market processes.

Prohibition affected the elasticity of supply for Prohibition affected the elasticity of supply for alcoholic drinks.alcoholic drinks.

Supply became much more inelastic, while demand Supply became much more inelastic, while demand remained stable, causing prices to surge.remained stable, causing prices to surge.

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People pursue People pursue comparative comparative advantage.advantage.

Underground Underground production and production and distribution provides distribution provides criminals with a criminals with a comparative comparative advantage.advantage.

The prohibition can be The prohibition can be compared to the war compared to the war on drugs.on drugs.Current laws do not Current laws do not demolish the demand demolish the demand or supply for illicit or supply for illicit drugs.drugs.Like other forms of Like other forms of prohibition these laws prohibition these laws have an unintended have an unintended consequence.consequence.



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Skim Milk, Whole Milk and Skim Milk, Whole Milk and Gangster MilkmenGangster Milkmen

Skim Milk, Whole Milk and Skim Milk, Whole Milk and Gangster MilkmenGangster Milkmen

• Question………Question………– What if the What if the

production, production, distribution distribution and and consumption of consumption of milk were milk were prohibited?prohibited?

• Answer…………..Answer…………..– These activities These activities

would be driven would be driven underground.underground.

– Supply would Supply would become inelastic.become inelastic.

– Prices would rise.Prices would rise.– Criminals would Criminals would

become milkmen.become milkmen.

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Who Pays the Tax?Who Pays the Tax?

• Question……..Question……..– What effect What effect

would a higher would a higher tax have on tax have on cigarettes?cigarettes?

• Cigarettes…Cigarettes…– Currently demand is Currently demand is

inelastic.inelastic.– Higher prices bring Higher prices bring

about greater about greater responses.responses.

– Further tax Further tax increases may increases may reduce tax revenue.reduce tax revenue.

The twin goals of The twin goals of deterringdeterring

smoking and raising tax smoking and raising tax revenue are not revenue are not

fully compatible..fully compatible..

The twin goals of The twin goals of deterringdeterring

smoking and raising tax smoking and raising tax revenue are not revenue are not

fully compatible..fully compatible..

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D

Spretax

Who Pays the Tax?Who Pays the Tax?P

rice

per

Po

un

d

Quantity of Soybean Oil per Time Period(billions of pounds)

0 1 2 3 4 5 6 7

.04

.08

.12

.16

.20

.24

.28

.32 Sposttax

The imposition of a nickel tax raises the price from 20 to 24 cents--buyer pays 4 cents/seller pays 1 cent.

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Who Pays the Tax?Who Pays the Tax?

Any tax reduces buyersAny tax reduces buyers and sellers ability to and sellers ability to

engage in that activity,engage in that activity,and to enjoy the mutual and to enjoy the mutual

benefits of further benefits of further opportunities foropportunities for

exchange.exchange.

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High Priced Sports, Low Priced Poetry: Who’s to Blame?

Why are our Why are our salaries so salaries so

high?high?

Because the fans Because the fans are willingare willing

to pay to seeto pay to seeus !us !

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UnfortunatelUnfortunately the demand y the demand

for poetry for poetry reading isreading is

low. low.

High Priced Sports, Low Priced Poetry: Who’s to Blame?

Why aren’t poetsWhy aren’t poets paid aspaid as

much as professionalmuch as professional athletes?athletes?

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Do Costs Determine Prices?Do Costs Determine Prices?

Sellers like for the Sellers like for the public to believe that public to believe that price increases arise price increases arise from rising costs.from rising costs.

No sellers in history No sellers in history have announced that have announced that increases in demand increases in demand caused the the price caused the the price hike.hike.

Costs depend not only Costs depend not only on supply, but on supply, but demand too.demand too.The price of a The price of a commodity depends commodity depends on its supply and on its supply and demand curves. demand curves. The position of the The position of the supply curve depends supply curve depends on its cost of on its cost of productionproduction

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The Dropouts Release Their First CD

Remember! Sunk costsRemember! Sunk costsare history. Theyare history. Theyare irrelevant toare irrelevant to

current economiccurrent economicdecisions..decisions..

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There’s Gold in Them There There’s Gold in Them There Hills: So What?Hills: So What?

Go for the Go for the Gold!!!!Gold!!!!

Current market Current market price makes price makes

it too costly to openit too costly to openthe mine. Let’s waitthe mine. Let’s wait

for demand to increase.for demand to increase.

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Even Butchers Don’t Have the Guts

Even Butchers Don’t Have the Guts

When the demand for beef increases When the demand for beef increases the butcher’s sales increase.the butcher’s sales increase.The demand for final beef products The demand for final beef products is elastic.is elastic.The supply of new cattle however is The supply of new cattle however is inelastic .inelastic .Customer’s increased demand for Customer’s increased demand for the final product cause the price to the final product cause the price to increase.increase.

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Why Does it Cost so Much to Why Does it Cost so Much to Change Bedpans?Change Bedpans?

Question……Question……

Why are Why are hospital cost hospital cost forever on the forever on the increase?increase?

InsuranceInsuranceLowers cost of Lowers cost of physicians’ physicians’ servicesservicesIncreases amount Increases amount purchasedpurchasedIncreases the cost Increases the cost of medical of medical servicesservices

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QuestionQuestion

What will patients What will patients do if their do if their payments are the payments are the same regardless of same regardless of whether they whether they receive in- or receive in- or outpatient care? outpatient care?

Care inside the Care inside the hospital is usually hospital is usually better inside the better inside the hospital than outside hospital than outside it.it.Physicians can more Physicians can more easily monitor a easily monitor a patients progress patients progress inside the hospital inside the hospital than outside. than outside.


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EmployersEmployersHave been Have been

pressuring pressuring insurers to control insurers to control costscosts

InsurersInsurersHave been Have been

pressuring pressuring doctorsdoctors

InsurersInsurersPay hospitals fixed Pay hospitals fixed

amountamountHospitals Hospitals

economize economize Demand affects cost, Demand affects cost,

rationing medical care rationing medical care services is unavoidable services is unavoidable since at a zero out of since at a zero out of pocket cost, demand will pocket cost, demand will far exceed supply. far exceed supply.


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P

Q

S

D w/outinsurance

D withinsurance


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More Please Since It’s FreeMore Please Since It’s FreeMore Please Since It’s FreeMore Please Since It’s Free

Congested highways is another word for shortages.Congested highways is another word for shortages.Shortages occur when prices are low.Shortages occur when prices are low.Public transit systems are an answer, but they loose Public transit systems are an answer, but they loose

money.money.Private auto drivers don’t pay the full cost of driving.Private auto drivers don’t pay the full cost of driving.

Motorist generate a lot of Motorist generate a lot of spillover cost spillover cost by driving.by driving.As long as we give away scarce urban street space for As long as we give away scarce urban street space for

nothing we will have congested highways.nothing we will have congested highways.

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Solution to Traffic CongestionSolution to Traffic Congestion Charge users of public Charge users of public

transit a price high enough transit a price high enough to pay for improvements.to pay for improvements.

Question……….Question………. What would happen?What would happen?

Solution to Traffic CongestionSolution to Traffic Congestion Charge users of public Charge users of public

transit a price high enough transit a price high enough to pay for improvements.to pay for improvements.

Question……….Question………. What would happen?What would happen?

More Please Since It’s FreeMore Please Since It’s FreeMore Please Since It’s FreeMore Please Since It’s Free

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Cost and OwnershipCost and Ownership

Property Rights matter.Property Rights matter.Question……..Question……..

Why will personnel tend to be Why will personnel tend to be used in wasteful ways in the used in wasteful ways in the military more often than in military more often than in civilian life?civilian life?

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Answer……Answer……Civilians are paid their opportunity cost.Civilians are paid their opportunity cost.Efficient use occurs more often when Efficient use occurs more often when

resources (both human and inhuman) are resources (both human and inhuman) are owned by someoneowned by someone

Resources tend to employed less efficiently Resources tend to employed less efficiently when the users do not themselves have to when the users do not themselves have to pay the full opportunity cost.pay the full opportunity cost.

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How does the allocation of resources occur How does the allocation of resources occur when they are owned by the government?when they are owned by the government?

With public resource ownership, planners With public resource ownership, planners impose their own evaluations to the impose their own evaluations to the alternatives.alternatives.

With private resource ownership, competing With private resource ownership, competing bids and offers generate prices that bids and offers generate prices that approximate opportunity costsapproximate opportunity costs..


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Beware of Wrong Questions orBeware of Wrong Questions orMisleading Specifications of the Misleading Specifications of the

ProblemProblemYou gave You gave me the me the wrong wrong answeranswer

No You asked theNo You asked thewrong questionwrong question

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Beware of Data That Speaks Beware of Data That Speaks Appears to Speak for ItselfAppears to Speak for Itself

With this With this data the data the answer is answer is apparentapparent

!!

Data Data never never speaks speaks

for itself!for itself!

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Beware of Academic Scribblers Beware of Academic Scribblers and Would-Be Economistand Would-Be Economist

Hey! The orange freeze is Hey! The orange freeze is going to lower supply, and going to lower supply, and

lead to higher prices, which lead to higher prices, which will lower demand.will lower demand.

The price increase will lead to The price increase will lead to a decrease in the quantity a decrease in the quantity

demanded. That will demanded. That will eliminate the shortage.eliminate the shortage.

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The Graphic Case of Growing and The Graphic Case of Growing and Permanent ShortagesPermanent Shortages

The Graphic Case of Growing and The Graphic Case of Growing and Permanent ShortagesPermanent Shortages

OutputOutputOf OilOf OilOutputOutputOf OilOf Oil

YearYearYearYear19501950 20102010 20502050

DemandDemand

SupplySupply

Surplus

Shortage

Shortage

False supply and False supply and demanddemand

curves for oil.curves for oil.

False supply and False supply and demanddemand

curves for oil.curves for oil.

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Once Over LightlyOnce Over Lightly

Rent Controls create Rent Controls create unintended unintended shortages.shortages.

Prohibition on Prohibition on alcohol and drugs alcohol and drugs drives the market drives the market process underground, process underground, and provides and provides criminal with a criminal with a comparative comparative advantage. advantage.

A taxed activity A taxed activity tends to reduce tends to reduce further further opportunities for opportunities for people to participate people to participate in that activity.in that activity.

Price is determined Price is determined both by supply, and both by supply, and demand, not simply demand, not simply cost.cost.

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Once Over LightlyOnce Over Lightly

Supply and demand Supply and demand and the market and the market process sets prices process sets prices that reflect the that reflect the relative scarcities of relative scarcities of goods and indicate goods and indicate how they can be how they can be used most used most economically.economically.

When resources are When resources are not privately owned not privately owned the rules of the game the rules of the game governing their use governing their use are unclear.are unclear.

Economic terms, and Economic terms, and concepts are often concepts are often used in misleading used in misleading ways.ways.

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End of Chapter 6

Next , Chapter 7 on Next , Chapter 7 on “Information, “Information,

Middlemen, and Middlemen, and Speculators”`Speculators”`

Documents

The Economic Way of Thinking 10e ©Prentice Hall 2003 1 The Economic Way of Thinking 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Supply