WEBVTT

NOTE The Determination of Prices

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There are a few things I want to say about elasticity of demand left over from yesterday.

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And one is that

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businessmen

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know this concept very well, though they don't necessarily use the term.

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Especially if they're interested in

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informing cartels or getting government help informing cartels.

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Let me give you an example.

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Back in 1981, the U.S. auto industry was in dire trouble.

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they had continued to make large cars that consumed quite a bit of gas

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gas prices had shot through the roof by the late nineteen seventies as I mentioned yesterday

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and so instead of and the Japanese by the way began to export to the U.S.

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subcompact and compact cars and people were beginning to shift the man to those automobiles

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U.S. auto industry

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was beginning to lose money

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they were selling their products below

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cost of production

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Okay, which is an implication of losing money.

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Instead of attempting to compete with the Japanese imports,

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what they did was they turned to the Reagan administration

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and they put pressure on the Reagan administration

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to impose what are called voluntary export restraints, VERs,

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which are nothing of the sort, they're not voluntary at all.

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Basically what the U.S. did was to blackmail or actually extort

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The Japanese government said, look, if you don't agree to these voluntary export restraints, which will restrict imports of Japanese cars into the U.S. to about 1.65 million units per year, I believe it was, then, well, Congress is going to pass a much stricter or much more restrictive import quota, official import quota.

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So the Japanese government agreed and it forced its manufacturers to restrict the export of autos to the U.S.

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What do you think happened? Well, certainly with Japanese cars more scarce, their price went up by about $2,500 per car.

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And then that permitted the U.S. auto companies to raise their prices by about the average of $1,500.

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These V.E.R.s stayed in effect through 1985. In the years 1984 and 1985, they cost U.S. buyers of new cars about $25 billion.

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So in effect what the U.S. government did was to set up a cartel very similar to OPEC.

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At the same time that we were criticizing OPEC for restricting the supply of oil and forcing Americans to pay high prices for oil,

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we were doing the exact same thing, or the Reagan administration was doing the exact same thing, with automobiles, okay?

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Well, let's look at what happened, or what the analysis of this program is, okay?

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Okay, using elasticity of demand.

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If you take a look at the D1, the Flatter Demand Curve, let's assume for the moment that prices are $10,000 per auto, for U.S. auto, for let's say an intermediate-sized family sedan, let's say the four Taurus.

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And they're currently selling at $10,000, 100,000 units. You see that? 100,000 units.

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Now, they know if they attempt to raise price, let's say that they're losing $1,000 a car,

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so they'd like to raise their price so that they cover their costs and have a nice tidy profit.

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If they raise price in the absence of a voluntary export restraint, they move up along this demand curve.

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So if they raise the price from 10,000 to 12,000, American consumers cut back sharply from 100,000 units back to 40,000 units because it's very easy to substitute.

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There are a lot of Japanese cars available in that price range that are substitutable for the American cars.

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However, if they approach a Reagan administration and force them to restrict the supply of Japanese cars, what does that do?

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What does that do? That raises the prices substantially of Japanese cars, as we saw by $2,500, so it takes substitutes out of that price range.

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Guess what happens to the demand curve? It's forcibly rotated to become more steep, meaning Americans are no longer as responsive to an increase in the price of U.S. autos.

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Now, instead of cutting back to $40,000, they cut back to $95,000.

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Let's look at the total revenue situation.

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Total revenue was initially $1 billion when Ford was selling the Taurus, let's say, at $10,000 per car.

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They were selling 100,000 units.

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So they were making a total income, we're not talking about profit now, we're talking about total revenue, of $1 billion.

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Had the program, the VER program, not been put into effect,

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Their demand curves, as we saw, would have been extremely elastic for the Taurus, and if they raised the price, their total revenue would have actually been cut in half.

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Okay? These are hypothetical figures, but total revenue falls along an elastic demand curve as you raise the price.

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And they would have been earning 480 million dollars, less than half of what they were before.

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And it very well might not have been profitable to raise price, because total cost would not have fallen off that much.

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Well, what they did, as I said, was they got these VERs imposed through pressure of the United Auto Workers and of the firms themselves on the Reagan administration.

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The man curve became more inelastic or less elastic, as we saw, and now they were selling at $12,000, 95,000 units.

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Okay, again, hypothetical figures. That is, the drop-off in demand was not very great because people couldn't substitute the lower-priced or equivalently-priced Japanese cars, which now had much higher prices.

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So what happened? Well, now they only had to produce 95,000 instead of 100,000, so their costs went down, and at the same time, their total revenue went up from a billion to 1.14 billion.

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What happened to their profits? Well, if your costs go down, your total revenue goes up, your profits go up.

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Okay? So as we'll see later on, we talk about cartels. A purely voluntary cartel is inherently unstable, okay? There are internal pressures and external pressures that will cause it to break down.

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But when you get the government coming in and forcibly restricting the supply of a competitor, then you can coercively change the shape of your demand curve.

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This change in demand curve would have been fine if it was the result of people's value scales purely changing towards American cars.

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But that's not what occurred. This is a coercively manipulated demand curve.

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It was forced to be more inelastic by the restriction of foreign competition.

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So that's one important application of elasticity of demand.

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Once again, people in business don't necessarily use that term, but they're very familiar with the concept that it denotes.

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And that concept is, the less competition we have, the easier it is to raise our price, because the less available are substitutes for our product.

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And if we have recourse to government, if government is amenable to implementing a policy that permits us to raise our price, we'll do so under those conditions.

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Now, it could have been the case that the demand curve didn't become much more inelastic.

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So even with that government program, if the demand curve stayed much flatter, it may not have paid still to raise the price.

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But in this case, it certainly did as we saw because American consumers had to pay $25 billion more in higher prices for automobiles in 1984 and 1985.

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What is also interesting is, guess where a lot of that money went to, or to what firms that money went to?

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Well, not only did the American firms raise their prices, but because of the restriction of the number of units sent to the US, the Japanese auto firms raised their prices.

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So they accrued about $10 billion of that $25 billion, and the other $15 billion went to American auto firms.

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Okay, now let's talk a little bit about sin taxes and elasticity.

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That is, the government claims to tax things like cigarettes, alcohol, gasoline, and so on,

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in order to discourage their use and to help us to lead healthier lives.

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In the old days, when they taxed things like cigarettes and alcohol,

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before World War II, it was done to improve people's spiritual well-being,

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to have people stop these bad habits.

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Now, since health is a great new god, since the 1960s, 1970s, they're doing it to help us become a healthier nation.

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And there's been talk about taxing the fat content in foods and the sugar content in soft drinks.

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That may not come about because of elasticity of demand.

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Why, in fact, does the government tax cigarettes, alcohol and gasoline?

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Well, because the demand for those products are very what?

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They're very, very inelastic. People will not cut back much.

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So the government tends to tax products that will yield a higher revenue.

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That is, it will increase the taxes on these products because people will cut back much

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and therefore total revenue and their tax revenues will increase.

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What's interesting was that in 1991 or so, the US government attempted, Congress passed a law that imposed a luxury tax as part of a way of reducing the deficit.

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And that luxury tax was a 10% tax on luxury automobiles, yachts, boats, over $100,000.

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And what was interesting was that the demand for luxury goods, unlike the demand for things like cigarettes and alcohol, tend to be very, very elastic.

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People can substitute other things and can easily abstain from purchasing and applying substitutes.

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What happened was that it almost completely, I come from New Jersey, it almost completely destroyed the yacht industry in New Jersey.

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Many yachts are a large part of the yachts built in the U.S. or built in New Jersey and a number of small firms build these yachts.

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In any case, one firm in the year after the tax was imposed cut back on its workforce from 350 to 50.

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Another firm cut back from 1,400 to 300 employees.

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The industry as a whole, which isn't very big, lost 7,600 employees in one year.

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Now, for some reason the demand for yachts is sort of cyclical, and it could fall by as much as 20 or 30 percent in a given year.

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In the year after the tax it fell off by 90 percent, so they almost completely destroyed the industry.

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And the government claimed, they estimated that the luxury tax on boats, aircraft and jewelry, okay, there's a tax for any of those things over $100,000.

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And it was also on automobiles, I believe, would raise $5 million in taxes a year.

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Instead, the Treasury lost $24 million through lost income tax revenues because all these companies went out of business and these employees lost their incomes.

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So they lost much more than, well, they lost rather than gaining.

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The reason was the demand for these luxury goods were highly elastic, so people cut back to a great extent.

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A couple of other points I want to make.

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Coming from the Northeast and the New York area, there tend to be a lot of government transportation that I and others that live in the area deal with.

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deal with for example you know we have to and we have to pay for these things we

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have to pay for tunnels bridges trains are owned by by government obviously in

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New York subways what's very interesting though is that every time they there's a

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fair increase total revenue increases tremendously okay why is that why would

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total revenue increase tremendously when they have fair increases that is they

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don't total revenue doesn't fall off which means that they're always pricing in an

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The area of their demand curve that a profit-maximizing entrepreneur would never price in, that is, the lower part of a linear demand curve, which is the inelastic portion of the demand curve, meaning that if they simply raise their price, they would get a higher total revenue.

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Now, why don't they raise their prices? Why do they keep their prices relatively low?

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I'm not in favor, necessarily, of governments raising their tolls and getting more total revenue.

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But the reason why they do do this has to do with the fact of political pressure.

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For example, there's a lot of lobby groups that lobby, let's say, the commuter railroads in the Northeast.

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Every time they try to raise prices, they have a group that gets together and can exert some influence.

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A lot of people commute into New York, so these people vote and they contribute to campaigns.

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So that tends to set a lid on prices and fares and tolls. Same thing with bridge and tunnel tolls.

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The reason why we have, as we'll see when we talk about supply and demand together,

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the reason why we tend to have traffic jams, at least in urban areas, is because of pricing below equilibrium.

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equilibrium, that is pricing so that there's a shortage of road space. So if a road can accommodate, a certain stretch of road can accommodate, let's say, 10,000 cars in an hour, the road is either free or the price is below the equilibrium so that there may be 30,000 cars trying to use the road at that point in time, or during that period of time.

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And what that does bring about is a traffic jam. A traffic jam is a shortage of road space, pure and simple.

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And people that commute into New York City every morning by automobile have to use tunnels or bridges.

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And there tend to be a high, a long wait rather, excuse me, for tunnels and bridges.

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And one of the, there's a study that was done in France, and I'll talk more about this when I talk about weight and price controls, but a study was done in France, and in that study, it was found that by raising prices on roads into Paris by a few dollars, just during the rush hour period, you could clear up traffic jams.

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So a study was done for New York and it turned out that imposing a $1 premium on drivers who use the tunnels during peak periods would cut traffic delays by about 17% during rush hour.

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So, but of course that, and if you raise it by $2, which is 33%, you would cut traffic delays by 31%, so you know, you'd go from something like 30 minutes to 20 minutes delay, okay, at the tunnels, but one of the reasons why that is done is because of pressure, so when you have a freely operating price system, you don't have this problem, okay, you have entrepreneurs who want to earn profits, who will price in the elastic range of their demand curves, okay.

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Also, I want to mention one other, or give you a few other examples regarding elasticity and what happens when you ignore elasticity.

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Non-profit organizations tend to ignore elasticity. There was an interesting case in Macon, Georgia, in fact, right near here.

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The Macon Telegraph newspaper is the principal sponsor of the Macon Labor Day road race.

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The entry fee for the race in 1990 was $12 per runner. The fee was raised to $20 per runner for the 1991 race. It was raised by $8, and they believed that they could increase revenues by simply raising the price.

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Prior to the race, there were complaints that the fee was too high for that kind of race and that many families would not be able to participate and so on, but they ignored that.

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So the price went from $12 to $20.

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Well, in 1990 when the price was $12 for an entry into the race, the race attracted 1,600 runners.

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And so the total income that they generated was $19,200, which they donated to charity.

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Then, in 1991, with the same weather conditions as it turns out, the race only attracted 900 runners.

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That's another example.

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There's one other I want to just bring out.

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Oh, yeah.

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There's an example in Texas.

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Texas, like other states, sells vanity license plates.

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And they charge a fee for that.

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Fee for vanity plates used to be $25 in 1986.

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And then it was raised, in 1986, then it was raised to $75, it was tripled, okay?

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Before the price increase, about 150,000 cars in Texas demanded these license plates, okay?

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After the increase, only 60,000 people ordered the license plates, all right?

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So that was more than cut in half.

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But remember, the price was tripled from $25 to $75.

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So the head of the Texas DMV, not knowing anything about elasticity of demand, and at the time not having the final income figures, claimed that, well, because we had a reduction, a huge reduction in the number of people, that demand of vanity license plates, you know, we're losing a lot of revenue.

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Well, of course, the demand curve tended, in this case, to be inelastic. That is, people cut back, but the price was triple.

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So it turns out that the revenue, after the price increase, revenue rose from $3,750,000 to $4,500,000.

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So 60,000 people paying $75 generated a higher revenue than 150,000 people paying only $25.

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So there it was rational to raise price.

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Murray Rothbard, when he was alive, one of his pet peeves was that when you went into a movie theater, a movie matinee, you would see, you know, in the afternoon, and you would see maybe five people in there beside yourself.

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And all of these seats were unfilled. And he always used to complain to me, he says, don't they know about elasticity of demand? You know, they should lower the price even more.

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Okay, so let's say that a normal price is, you know, seven, back then the normal price is five dollars and they would cut the price to three dollars for an afternoon showing of the movie during the week and he thought it should be like one dollar or something like that so you get more people in there.

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But I thought more about that and I think there's a special pleading on his part because he's a college professor, he had some days off, he didn't teach until late in the afternoon so he could go to movies in the early afternoons and so on.

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The point is, of course, afternoon movies for some groups, for seniors and teenagers and so on, are, teenagers who cut school or are off, are substitutable for Friday night and Saturday night movies.

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So you would be, in a sense, reducing demand for peak hour movies.

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Okay, however though, however, why do we have, let's say, special rates for seniors, special rates for teenagers and so on?

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Well, since you can identify this group as a separate group, okay, from others, okay, they're easily identifiable, they can show an ID,

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you can separate, it's called price discrimination, we'll talk maybe a little bit more about that later,

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later. You can separate groups out according to the elasticity of demand. People that have low incomes tend to have a more elastic demand for goods than people with higher incomes for certain goods.

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So that's why you see, for example, big sales on rock CDs, but no sales advertised on classical CDs. Older people with higher incomes tend to buy classical CDs. Their demand tends to be inelastic.

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Younger people, there's a lot of substitutes for their very, very scarce dollars, they don't have very high incomes, so they respond greatly to a cut in price.

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That's why, that explains these special deals at the movies, sales on things that teenagers buy, okay?

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So that's another application of elasticity of demand.

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Recently, for example, I went to see, a few years ago, I went to see Paul McCartney in concert

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and then I went to see Rod Stewart in concert, two classic rock acts

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and I paid $125 for the Paul McCartney ticket and $80 for the Rod Stewart ticket.

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My son had a hemorrhage. He couldn't believe I would pay this much money.

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He goes to punk rock concerts for $15 to $30. He never pays more than $30.

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But again, the point is that money is much more scarce for teenagers, they have part-time jobs, they have allowances or whatever it is.

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So you would expect to see the prices being lower because their demand curves are much more elastic.

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Okay, that sums up the elasticity topic.

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What I want to do now is move on, we've been assuming up to this point, prices are somehow given.

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Now I want to move on and show how prices are determined on the free market, okay?

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And the short answer, I mean, you can teach a parrot the correct answer to how prices are determined

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by teaching them to say three words, right?

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What are those words?

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Supply and demand, okay?

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So people talk about economics, you sound reasonably erudite if you just respond,

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well, that's supply and demand, okay?

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And that's true, okay, that on the face of it, supply and demand determines the prices.

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Now let's look at what's behind it and let's look at the mechanics of how it works.

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Okay, I'm going to have a few, more than a few diagrams here to illustrate supply and demand.

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Supply and demand is one area of economics where diagrams are especially useful.

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But as we saw before, you have to be very, very careful with how you use those diagrams.

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You don't want to mislead. You want to use a straight line demand curve as an illustration,

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This is an illustration, but you want to realize that in the real world, demand curves can never be straight-lined, as we talked about.

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Alright, we've gone over demand and where demand comes from. It emerges from people's value scales.

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Let's now talk for a moment about supply. At any moment in time, supply of every good in the economy is given.

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Right now, there's a certain stock of goods available on the market to be sold.

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There's a certain stock of automobiles, there's a certain stock of oranges,

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there's a certain stock of rock CDs and iPods, and we can go on and on and on.

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But they're fixed. Now, they'll change over time, just as demand changes over time.

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But because at the moment of choice, people's value scales and demands are fixed,

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You must have a supply curve that is comparable in its time dimension.

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That is, the supplies of all goods are fixed.

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Now, that means that in terms of the shape of the supply curve,

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it's a straight vertical line, unlike the demand curve.

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The vertical line fixed, in this case it's coffee.

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There's a certain 10 million pounds of coffee available to be sold in the market at this point in time, let's say.

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Now, what we are ignoring here is the fact that sellers can and do withhold some of the good, if it's a durable good,

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off the market in speculating on a higher price down the road, okay?

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But in the long run, speculation tends to drop out, okay?

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And in this course, we're going to abstract, at least in the initial discussion of supply and demand, from speculation.

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That is, at lower prices, people can withhold some of the available stock.

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Sellers can withhold some of the available stock.

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And they do do that, especially on retail markets.

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But let's assume that there is no speculation that at any given market period or point in time, there's a fixed stock of every good.

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So, we represent it, as I said, as a vertical line. Now, why don't we use the upward-sloping supply curve in which supply increases, or the quantity supply, excuse me, increases as prices increase?

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Well, because production takes time. So it takes a while for production to adjust to higher prices.

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It certainly does adjust the higher prices over time, all other things given.

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In most textbooks, you will see an upward sloping supply curve,

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supply curve that slopes upward to the right,

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indicating that the higher the price, the more of the good that is produced

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and sold and available for sale on the market.

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But that supply curve is not comparable to the demand curve.

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The demand curve is a momentary phenomenon.

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It appears at the moment of choice.

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So the only supply curve that is relevant to price determination is the vertical supply curve.

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Now that's not to say, and I'll show you how we do this, that there is not something that's useful in an upward sloping supply curve.

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This is called the long-run supply curve. We'll discuss that later today.

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That supply curve, however, can only be used when we're talking about changes in demand and responses of the economy to a change in demand.

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That is, it's a temporal phenomenon, or it's a temporal supply curve.

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This supply curve exists at a moment in time, okay?

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It doesn't, it isn't something that exists as a process over time.

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Okay, so having said that, and then you'll see what I mean in more detail when I talk about the moment supply curve.

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Having said that, let's go to the determination of price, okay?

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It's fairly straightforward.

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As I said, it's supply and demand that determines price.

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We illustrate this determination, we can illustrate it reasonably straightforwardly, with a supply and demand schedule.

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So let's say this is the number of gallons of milk available on a given day.

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So you have quantity supplied of milk, 13 million gallons on that day in the market.

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and the middle schedule represents or the middle list of number represents the quantity demand of milk per day, okay, or on that given day.

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So note, if sellers of milk attempted to get a price of $10, you would have what we call an excess supply or a surplus, okay.

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That is, there'll be many sellers out there who had gallons of milk for which they could not find buyers, okay.

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And the only way that they could sell those gallons of milk would be to lower the price.

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They would underbid current sellers or other sellers and they would begin to lower the price.

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As the price fell as a result of this pressure of excess supply on the market,

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notice what would happen.

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The law of demand would kick in and people would begin to increase the quantity demanded at the lower prices.

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It would go from two to five million at nine dollars.

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But you would still have an 8 million gallon excess supply, and prices will continue to fall, okay?

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As long as there are sellers who cannot find willing buyers for their product, they will have an incentive to cut the price.

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And because the lower price is better than a zero price, because if you can't sell it, you're getting, in effect, a zero price.

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So the price will continue to fall until we reach $5.

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Note, at $5, every seller of a gallon of milk can find a willing buyer.

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So, there is no excess supply at $5.

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We can start low and show why prices will be bid up if they started at, let's say, $2.

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At $2, there are frustrated sellers out there, okay?

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They want 12 million more gallons of milk than are available on the market.

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They're lining up, the milk's running out early in the day.

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The sellers recognize this and see that milk is selling more rapidly and that they'll be out before the end of the day or the week, if we're talking about a week time period.

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And what they'll do then is raise the price because they'll say, hey, you know what, I can still sell out but at a higher price.

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So there's a profit incentive to raise the price when there's a shortage.

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So this excess demand or shortage results in the price being bid up.

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The price is finally bid up, even at $4, it doesn't suffice to clear the market of the shortage.

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There's still 5 million gallons of milk that people would like to have that they can't find.

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They're frustrated, so they're willing to pay higher prices and sellers recognize this and raise the price.

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So $5 is what we call in economics the equilibrium price.

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Equilibrium has a number of connotations.

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The first, from the physical sciences, is that it's at rest.

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That is, there is no reason for this price to go up or down.

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Everybody who wants to buy a gallon of milk can easily find one.

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Also, if the price was displaced from $5, if it went slightly above or slightly below,

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it would immediately return to $5 because of the surplus or shortage that was generated.

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Equilibrium also denotes balance, a balance of forces operating on a body in the physical sciences.

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If you were to, the example to use, if you were to have a bowl and you roll a ball, let's say, not an orange, a ball into the bowl,

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it would go up and down until eventually it would come to rest right in the middle of the bowl,

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as the forces of physical forces operating on the ball or bring it to rest, okay?

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All right, so now there's another term we use, market clearing price.

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It's a market clearing price of $5 because it clears the market of all surplus and all shortages, okay?

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So it's a market clearing price also.

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Now, we can show this graphically using what we call supply and demand curve, okay?

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This is the curve, this is the graph of the schedule that I just showed you, okay?

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Note that where there's an intersection with supply and demand is where we have the equilibrium price, okay?

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At that point, quantity supplied is $13 million, quantity demanded is $13 million.

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Now, at any point above $5, as you begin to rise above $5, note the demand curve,

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demand is further and further to the left of supply indicating a greater and greater surplus.

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That is, supply is greater than demand and therefore you have a surplus.

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The further the price is away from equilibrium, the greater the surplus.

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and the more likely it is for the price to fall towards equilibrium.

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On the other hand, below equilibrium, demand is to the right of supply.

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You have a shortage. Right on this graph indicates greater and greater quantities.

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So when demand is to the right of supply, the quantity demanded is greater than the quantity supplied.

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And the lower the price, the further to the right, the greater the shortage is.

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and the greater the pressure, the upward pressure on prices.

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Okay, so that's the illustration of demand and supply.

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Let me put this up here for a moment.

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And how they interact to determine the equilibrium price.

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So you have people's value scales as represented by demand interacting with product, the fixed supply,

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which is the result of past production decisions, okay?

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And it's on the market today.

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So you have value scales interacting with the stock of supply to determine the equilibrium price.

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So price determination isn't purely subjective.

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It's subjective value scales interacting with objective quantities of the good.

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Which, by the way, themselves were the result of earlier subjective decisions on the part of entrepreneurs about how much to produce.

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Now, we'll talk about whether this price is above or below cost of production, canopy below it, or must it always be above it, and so on.

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So let's talk, in other words, about some of the properties of the equilibrium price.

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First of all, the equilibrium price serves an important rationing function.

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No matter what the good is, the market will always find the price in which no one walks away dissatisfied,

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meaning everybody who wants to sell a unit will find a willing buyer,

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And everybody who wants to buy a unit will find a willing seller.

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So right now, let's say somebody wants a flat screen television, a 32-inch plasma TV.

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Anybody who wants it can find one.

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And anyone who wants to sell it is able to sell it.

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And if they can't sell it at the price that they're asking, they'll have a sale and cut the price.

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So the equilibrium price ratios a scarce stock of a good, determines who gets it.

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And who gets it? Who gets the gallons of milk? Those people who rank one or more gallons of milk above $5 are the ones that walk away with the milk.

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Those people who rank it below $5 because at $5 a gallon they'd rather drink lemonade or tea without milk or whatever, those people do not get it.

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So it ensures that those people who put the highest value on the good get the stock of the good.

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And I gave you some examples yesterday. As I mentioned, there was only one copy, original copy obviously, of John Lennon's I Am The Walrus lyrics.

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sold at auction for $129,000. Anyone in the world who wanted that set of lyrics for their putting them on the wall in their den or whatever they wanted it for could have it by bidding a higher price.

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The point is that there was one and only one copy of those lyrics and the person who got it was the person who put the highest value on that good.

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Also, the baseball card we talked about of Honus Wagner, it sold for over $600,000, okay?

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Super Bowl tickets, everyone says, oh, you're never able to get Super Bowl tickets, but of course you are, okay?

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As scarce as they are, I mean, if you want to see the Super Bowl, you can get the tickets, okay, if you're willing to pay the price.

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An example I have here is when the New York Giants played in 2001, Super Bowl, a big fan of the Giants, anyway, the tickets were officially priced at, I think the highest priced ticket was $300, some ridiculous price like that.

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The stadium was played at Tampa Bay Stadium and its capacity was 72,000.

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So you had a fixed supply at 72,000 and you had a demand curve based on people's value scales, okay?

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That is ranking the experience of seeing the Giants in the Super Bowl against other ways of spending their money.

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Well, obviously at $300 you were down over here someplace. I mean, there's a massive shortage.

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There may have been, at $300, there may have been hundreds of thousands of people,

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maybe a million people that wanted to go to the Super Bowl, okay?

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I guess the tickets ran from, I think, 100 to 300.

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So, you know, at $100, there may have been millions of people that would like to see the Super Bowl.

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In any case, there was only 72,000 seats.

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So what happened? Well, what happened was, of course, that these tickets were bought and then resold at much higher prices that reflected the equilibrium price.

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So, for example, newspaper advertisements and internet sites were offering tickets a few days before the Super Bowl in the price range of $1,800 for end zone tickets to $5,500 for preferred seating, okay?

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Now, were there lines? Were the people that walked away frustrated? No. Yes?

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My question is, why don't the leagues, in general, set the prices for these championship games? Why don't they just set a higher price from the get-go?

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Well, think of it this way. That's also true of movies that come out on their first weekend, okay?

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You see people lining up around the corner. There's a number of...

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And the movie theater could easily set a higher price.

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Instead of setting the New York price of $9 now for a first-run movie that comes out.

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Why don't they set it at $20 for a movie that people really want to see?

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At least for the first weekend or the first week, okay?

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They could do that, but they would lose goodwill that's worth even more than that, okay?

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That is to say, they don't want to be charged with price gouging.

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Hey, people say, you know, why do I have to pay a higher price for the movie today than I do later in the week?

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Well, why do I have to pay a higher price for a Mets game when they're in the playoffs than I do during the summer?

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The costs are the same. People have cost of production mentalities in their heads.

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Costs are the same. Why do I have to pay a higher price?

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They're gouging me. They're taking advantage of my great demand to see this, okay?

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So they lose goodwill, okay? So it's sort of costly to vary your prices like that.

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Secondly, it's good to see the huge lines and people desperate to get tickets.

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That's good advertising, okay? Broadway theater shows, for example.

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You see, you know, the opening, people lined up around the block for tickets and, you know, so on.

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That's where the heroic scalpers come in, okay?

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The scalpers come in and they do what?

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They buy the tickets up at these low prices.

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They're people who, that might be their full-time job.

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So they can get there early and wait,

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and then they sell them at the higher price.

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So what scalpers do is move the price

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towards equilibrium price and make sure

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that those people who value the ticket to that event,

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whatever it may be, highest are those people

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that get the tickets, okay?

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So, and that's also true with colleges by the way, especially colleges, they're non-profit organizations.

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What would happen if they began to really charge, like let's say, you know, what's a big rivalry in college football?

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Auburn plays Alabama, right? What if, you know, they're playing in Auburn and they double the price of tickets?

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Or maybe even, you know, they could probably even get more, way more. I don't know what scalpers would get, okay?

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But everyone would say, this is, you know, an educational institution.

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They should be giving us, you know, they shouldn't be, you know, trying to maximize their profit by raising prices.

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The school where my son goes, the big basketball school, Villanova, right outside of Philadelphia,

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and they got to Sweet 16 this year in the NCAA tournament.

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But they're sort of a liberal, they have a liberal Catholic ideology in the sense that they believe it.

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Everything has to be egalitarian.

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So, what they do is, they don't charge the students anything, they charge them zero for basketball tickets and you have to go into a lottery and then some people get the tickets, other people don't get the tickets.

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Well, of course, as my son pointed out, even charging five or ten dollars to the students will discourage a lot of them that are frivolous, that are just going to go for a half and then walk out, okay?

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and, of course, or sell them at a much higher price.

377
00:43:13.480 --> 00:43:18.480
So what happens is that, you know, basketball fanatics like my son who belongs to the basketball club there and all this other stuff,

378
00:43:18.480 --> 00:43:22.480
they are, they're shut out of a lot of games because of this stupid lottery.

379
00:43:22.480 --> 00:43:32.480
And there's a conservative newspaper on campus that wrote, there was an editorial attacking the policy and saying, why don't you simply charge, you know, five or ten dollars.

380
00:43:32.480 --> 00:43:36.480
This would discourage the less than serious fans from getting the tickets.

381
00:43:36.480 --> 00:43:49.480
They claim to be the only school that charges nothing for their basketball tickets, or the only major school, and we're going to stick to this policy.

382
00:43:49.480 --> 00:44:00.480
In the meantime, kids that are desperate to see the team are not getting tickets, and kids that could care and last would show up maybe for a quarter or two are the ones that get the tickets.

383
00:44:00.480 --> 00:44:14.480
So, some of the students were so desperate to see them that they, you know, that they hire buses and, again, my son went out to Notre Dame to see them play in Indiana, okay, because they can't see them at home, you know, it's absurd.

384
00:44:14.480 --> 00:44:19.480
Well, anyway, that's what happens when you don't price correctly, okay.

385
00:44:19.480 --> 00:44:28.480
Not that it's, I mean, again, there are reasons for firms not to raise their price every day depending on what they believe the demand will be, okay.

386
00:44:28.480 --> 00:44:32.680
Okay, there is a real loss in goodwill that is worth something. Yes, Patrick.

387
00:44:32.680 --> 00:44:38.080
You talked about the rounding thing, the same thing happened at Richard Howard's marathon that I won in October.

388
00:44:38.080 --> 00:44:48.680
The entry fee was $100 for a race, and I'm like, I haven't fought college students, I'm already driving, but I'm running like hell, and I'm like, let's do that.

389
00:44:48.680 --> 00:44:49.880
I left the fence.

390
00:44:49.880 --> 00:44:50.680
You're going to what?

391
00:44:50.680 --> 00:44:52.480
I left the fence to get in.

392
00:44:52.480 --> 00:44:53.880
Oh, left the fence.

393
00:44:53.880 --> 00:45:05.880
The thing is, about a half an hour before the race started, from like a half an hour on, you see a whole lot of other kids without my age also losing things, but they're making it for the $100.

394
00:45:23.880 --> 00:45:32.880
where you can just stand, you don't try to take a seat because somebody else is obviously, if they have the same ticket as you, you can get thrown out.

395
00:45:32.880 --> 00:45:40.880
But in any case, yeah, I mean, these types of behaviors are encouraged by these prices that cause shortages.

396
00:45:40.880 --> 00:45:45.880
In your case, though, you're talking about a price that's really too high and is shutting out.

397
00:45:45.880 --> 00:45:55.880
Well, you know what, if they could, you know, the policy there, again, it's a nonprofit organization that's sponsoring this race.

398
00:45:55.880 --> 00:46:01.880
They could give discounts to college students because of their greater elasticity of demand.

399
00:46:01.880 --> 00:46:05.880
Okay, and that might actually increase their revenues. Maybe you should talk to them about that.

400
00:46:05.880 --> 00:46:07.880
Yes.

401
00:46:07.880 --> 00:46:11.880
But still, I'm sure it was sponsored for charitable reasons.

402
00:46:11.880 --> 00:46:26.880
Well, then they sell them. You have to show an ID, though. I guess they sell them to people that look like them or something like that.

403
00:46:26.880 --> 00:46:35.880
I know that that's not a problem, that selling them is not a problem, even though formally you have to show your ID to get in. No, it's always packed.

404
00:46:35.880 --> 00:47:03.880
All right, let's go on and talk about one other very, very important characteristic or attribute of the price, of the equilibrium price, and that is that the equilibrium price emerges at the same time, or let's say contemporaneously, with the plain state of rest, okay?

405
00:47:03.880 --> 00:47:13.880
That is, this price of $5 is the only price that guarantees that all the gains from exchange are exhausted.

406
00:47:13.880 --> 00:47:22.880
Meaning that everyone now ranks milk, anyone who has purchased the milk, ranks the milk above the $5.

407
00:47:22.880 --> 00:47:29.880
Any additional gallon they would purchase above what they purchased, they rank below $5.

408
00:47:29.880 --> 00:47:35.680
And anybody who hasn't purchased any of the milk ranks even the first unit below the $5.

409
00:47:35.680 --> 00:47:42.680
So what happens is that at the end of the market day, there is no more room for exchange.

410
00:47:42.680 --> 00:47:51.080
Everybody now ranks $5 above milk because they have their milk and they've left the market.

411
00:47:51.080 --> 00:47:53.880
So you have a plain state of rest that sets in.

412
00:47:53.880 --> 00:48:05.880
Now, that's not to say that the next day, value scales will change, supplies change, as you go from day to day, you have new equilibrium prices emerging and new plain states of rest.

413
00:48:05.880 --> 00:48:17.880
But on that day, okay, everyone purchases right up to the point where the last unit they purchase exceeds the market price and any additional unit will be lower than the market price.

414
00:48:17.880 --> 00:48:24.880
And anybody who doesn't purchase and walks away ranks the market price above the unit of the good.

415
00:48:24.880 --> 00:48:28.880
So what we have then is a plain state of rest.

416
00:48:28.880 --> 00:48:36.880
Now let me also talk a little bit about misconceptions about how prices are determined.

417
00:48:36.880 --> 00:48:41.880
We're often told that consumers really have nothing to do with the setting of prices.

418
00:48:41.880 --> 00:48:48.880
I go to a supermarket, there are prices already on those items that I'm going to purchase.

419
00:48:48.880 --> 00:48:52.880
Or if I go to a new car dealer, there's already a sticker price on there.

420
00:48:52.880 --> 00:48:59.880
Or if I go into a department store, for example, women's clothing or men's clothing, they're all priced.

421
00:48:59.880 --> 00:49:06.880
Well, the point is, while it seems that the seller has sold discretion over price,

422
00:49:06.880 --> 00:49:12.880
And it certainly is his or her property until it's sold. They do not determine the price.

423
00:49:12.880 --> 00:49:18.880
Because if the price is set, they're free to ask any price they want, but that's not the price.

424
00:49:18.880 --> 00:49:25.880
The price refers only to the sum of money that actually exchanges hands.

425
00:49:25.880 --> 00:49:28.880
So you might call it an asking price or something like that.

426
00:49:28.880 --> 00:49:31.880
And in fact, we know what happens.

427
00:49:31.880 --> 00:49:43.880
If a certain model of car has been overpriced, and this has happened with GM products and Ford products in the last few years, what happens at the end of the model year?

428
00:49:43.880 --> 00:49:50.880
There are many of them left on the lot, and you and I know, they're called leftovers, that if we go there, we do not have to pay the sticker price.

429
00:49:50.880 --> 00:49:54.880
and Ford products in the last few years, what happens at the end of the model year?

430
00:49:54.880 --> 00:50:01.880
There are many of them left on the lot and you and I know, they're called leftovers, that if we go there, we do not have to pay the sticker price.

431
00:50:01.880 --> 00:50:05.880
And they'll give us a price much below sticker price.

432
00:50:05.880 --> 00:50:09.880
Or they'll give us free financing.

433
00:50:09.880 --> 00:50:16.880
In fact, the price might be so low that it's actually below their own cost of production.

434
00:50:16.880 --> 00:50:26.880
Take the example of these, the discounts, the clothing stores, like here in Auburn there's a Ross's Dress for Less, you must have heard of TJ Maxx, in the Northeast we have Marshall's.

435
00:50:26.880 --> 00:50:36.880
Especially with women's clothing, the demand for women's clothing at the end of the fashion season tends to fall off very rapidly.

436
00:50:36.880 --> 00:50:40.880
Anything that's not sold is sold at bargain based on prices.

437
00:50:40.880 --> 00:50:51.880
So, for example, my niece a few years ago went to her senior prom and she got a gown that was list priced at $200 at TJ Maxx or Marshalls.

438
00:50:51.880 --> 00:50:54.880
She got it for $12. Very nice, beautiful gown.

439
00:50:54.880 --> 00:51:02.880
But we know with women's fashions that last year's fashion is in the sale bin.

440
00:51:02.880 --> 00:51:08.880
That's also true sometimes of DVDs or CDs.

441
00:51:08.880 --> 00:51:15.880
So it is not the seller that determines the price, even if the seller owns the property prior to it being sold.

442
00:51:15.880 --> 00:51:20.880
It's an interaction between the stock available and consumer value scales.

443
00:51:20.880 --> 00:51:28.880
And if initially they've been selling at a price above the price that's going to result in the sale by the end of a certain period of the entire stock,

444
00:51:28.880 --> 00:51:34.880
at the end of nearing the end of that period, they will cut their prices and they'll cut their prices radically in some cases.

445
00:51:34.880 --> 00:51:42.880
Secondly, some people say, well, it's really cost of production that determines price.

446
00:51:42.880 --> 00:51:48.880
Well, if that were true, why did GM lose $10.6 billion last year?

447
00:51:48.880 --> 00:51:54.880
They lost $10.6 billion, largest loss by an industrial company ever.

448
00:51:54.880 --> 00:52:01.880
That must mean that they were selling their cars, or many of the models of their cars, below what?

449
00:52:01.880 --> 00:52:09.880
below cost. You can't lose money unless you've sold some units below the price of producing those units.

450
00:52:09.880 --> 00:52:17.880
So why did IBM lose 13 billion dollars in two years? 5 billion one year, 8 billion the next in 1990-1991.

451
00:52:17.880 --> 00:52:22.880
Because they were selling their mainframes at that point below the cost of producing the mainframes.

452
00:52:22.880 --> 00:52:30.880
And that happens all the time. In fact, if sellers really had power to, or if somehow cost of production was really

453
00:52:30.880 --> 00:52:42.880
If production was really what the term of price is, then GM would have simply just raised its price, so that it covered all its costs and returned a tidy rate of return on its investment.

454
00:52:43.880 --> 00:52:49.880
But if it did that, it would be left with a tremendous amount of surplus stock, unsold stock.

455
00:52:52.880 --> 00:52:59.880
So neither sellers, even large sellers, determine prices arbitrarily, nor does cost of production determine price.

456
00:53:00.880 --> 00:53:14.320
Price is determined by supply and demand, by people's value scales and the stock available.

457
00:53:14.320 --> 00:53:18.960
Okay, what causes prices to change?

458
00:53:18.960 --> 00:53:30.860
Well, if its prices are determined by supply and demand, well then, a change in demand, change in supply, or change in both, can bring about a change in the equilibrium price.

459
00:53:30.860 --> 00:53:34.860
Let's begin with a change in demand.

460
00:53:34.860 --> 00:53:38.860
A change in demand, as opposed to a change in quantity demanded,

461
00:53:38.860 --> 00:53:46.860
a change in demand refers to a shift of the entire demand curve to the right or to the left.

462
00:53:46.860 --> 00:53:49.860
Let me just give you an example of that.

463
00:54:00.860 --> 00:54:14.220
Okay. When the demand curve shifts to the right, from D1 to D2, notice what that indicates.

464
00:54:14.220 --> 00:54:17.980
That indicates that at any given price, whether it's a high price up here or a low price here,

465
00:54:17.980 --> 00:54:27.500
people are willing to purchase more than they were before. Okay? So, shift to the right indicates an increase in demand.

466
00:54:27.500 --> 00:54:33.500
That is that at any given price people will purchase more units than they were willing to purchase before.

467
00:54:33.500 --> 00:54:37.500
Now, how does that differ from a change in quantity demanded?

468
00:54:37.500 --> 00:54:42.500
A change in quantity demanded refers to a movement along a demand curve.

469
00:54:42.500 --> 00:54:45.500
Take a fixed demand curve such as D1.

470
00:54:45.500 --> 00:54:49.500
At a high price people will buy less than they will at a low price.

471
00:54:49.500 --> 00:54:51.500
Down here they'll buy more.

472
00:54:51.500 --> 00:54:56.500
So a change in quantity demanded can only be caused by a change in price.

473
00:54:56.500 --> 00:55:10.500
A change in demand is caused by anything but a change in price, that is, if people's tastes change for a good, they'll be willing to buy more than before at the price, at any given price, okay?

474
00:55:10.500 --> 00:55:13.500
Or if prices of other goods change, we'll talk about that.

475
00:55:13.500 --> 00:55:19.500
Now, when we have a decrease in demand, that's illustrated by a shift to the left in the demand curve.

476
00:55:19.500 --> 00:55:32.500
So at D2, if you take any price and just draw a line straight across to both demand curve, you'll find that at D2 people are willing to buy a lower quantity than they are at any given price when compared to D1.

477
00:55:32.500 --> 00:55:35.500
So that represents a fall in demand.

478
00:55:35.500 --> 00:55:44.500
Again, to repeat, and this is something that my students always get wrong on exams despite the fact that I repeat it over and over again,

479
00:55:44.500 --> 00:55:54.500
A change in quantity demanded refers to a movement along a fixed demand curve. A change in demand refers to a shift in the entire demand curve.

480
00:55:54.500 --> 00:55:59.500
A change in demand is never caused by a change in price. That's absolutely wrong.

481
00:55:59.500 --> 00:56:08.500
As we'll see, it's caused by a change in people's value scales, how they rank various goods with relation to one another or in relation to money.

482
00:56:08.500 --> 00:56:14.500
Let's now talk a little bit about the causes of a change in demand.

483
00:56:14.500 --> 00:56:19.500
As I said, demand can only change as a result of a change in people's value scales.

484
00:56:19.500 --> 00:56:22.500
What's one thing that can change people's value scales?

485
00:56:22.500 --> 00:56:30.500
Well, what if you won a lottery tomorrow and your payoff was $10 million?

486
00:56:30.500 --> 00:56:37.500
Money would become much more abundant, your cash balance would increase tremendously,

487
00:56:37.500 --> 00:56:43.500
In relation to goods, what would happen to the marginal utility of money to you personally?

488
00:56:43.500 --> 00:56:49.500
It would fall way down, meaning it would fall below many goods that you don't currently have in your possession.

489
00:56:49.500 --> 00:56:55.500
So what would you do? These goods would now have relatively higher marginal utilities than their money prices,

490
00:56:55.500 --> 00:56:58.500
so you'd rush out and do what with a lot of this money? Not all of it.

491
00:56:58.500 --> 00:57:04.500
Spend it, buy yachts, buy a Ferrari, so on and so forth. Spend it.

492
00:57:04.500 --> 00:57:17.500
So, an increase in the supply of money will bring about for the entire economy a shift to the right in the demand curves.

493
00:57:17.500 --> 00:57:24.500
That's how an increase in the money supply causes inflation, causes prices to rise.

494
00:57:24.500 --> 00:57:32.500
By making money more abundant on people's value scale, or more abundant, the marginal utility of money on people's value scale drops,

495
00:57:32.500 --> 00:57:35.300
and they rush out and spend it on goods.

496
00:57:35.300 --> 00:57:38.300
Goods now take a higher rank on their value scale in relation to money.

497
00:57:38.300 --> 00:57:44.800
And that shift to the right in most demand curves as a result of an increase in supply of money is what actually causes inflation.

498
00:57:44.800 --> 00:57:48.900
Now, you don't get that analysis from the simple quantity theory of money,

499
00:57:48.900 --> 00:57:54.600
which says, oh, the quantity of money is greater, there's more money chasing fewer goods, and that pushes prices up.

500
00:57:54.600 --> 00:57:57.100
Well, that leaves out the subjective element.

501
00:57:57.100 --> 00:58:00.100
That leaves out the law of margin and utility.

502
00:58:00.100 --> 00:58:05.380
Anything that changes the demand curve has to change people's value scales.

503
00:58:05.380 --> 00:58:10.500
And having more abundant money causes the margin utility of money to drop on people's value scales

504
00:58:10.500 --> 00:58:18.100
and them to be more willing to pay, rush out and purchase goods that they before would not have purchased.

505
00:58:18.100 --> 00:58:19.060
Okay.

506
00:58:19.060 --> 00:58:23.220
All right. Now, we'll come back to that when we talk about money.

507
00:58:23.220 --> 00:58:27.500
Now let's talk about what happens if the money supply is fixed.

508
00:58:27.500 --> 00:58:31.500
What would cause, or how demand curves would change?

509
00:58:31.500 --> 00:58:41.500
Well in that case, when the money supply is fixed, if the demand curve for one good goes up, that means the demand curve for another good, and we're also assuming the demand for money is fixed.

510
00:58:41.500 --> 00:58:50.500
But if the supply and demand for money are fixed, then if the demand curve for one good goes up, then the demand curve for one or more other goods has to what? Go down.

511
00:58:50.500 --> 00:58:56.500
There has to be a relative shifting of goods on people's value scales.

512
00:58:56.500 --> 00:59:03.460
okay and there's you know many many examples of this you know for example

513
00:59:03.460 --> 00:59:07.300
back you know when people became more health conscious in the 80s and 90s they

514
00:59:07.300 --> 00:59:10.820
began to substitute you know frozen yogurt for ice cream so demand for frozen

515
00:59:10.820 --> 00:59:15.860
yogurt went up demand for ice cream fell for a while there ice cream the old

516
00:59:15.860 --> 00:59:19.620
fashioned ice cream parlors disappeared and you had frozen yogurt shops you're

517
00:59:19.620 --> 00:59:25.340
cropping up all over the place people also began substituting fish and chicken

518
00:59:25.340 --> 00:59:37.140
and Fish for Beef, to the point that even McDonald's gave in to that trend, saw that they better shift their mix of products.

519
00:59:37.140 --> 00:59:42.140
They began to offer more and more chicken sandwiches and salads and so on.

520
00:59:42.140 --> 00:59:53.140
Also back, probably starting in the 80s, there was a shift from the heavier liquors like bourbon and scotch and so on, rye, to lighter liquors like vodka.

521
00:59:53.140 --> 00:59:56.440
So the demand for vodka went way up. I mean, we see all different brands of vodkas now.

522
00:59:56.440 --> 00:59:59.540
That wasn't the way it was back in the 50s and 60s, okay?

523
00:59:59.540 --> 01:00:04.740
Demand for vodka went up at the expense of the demand for, let's say, bourbon and so on, okay?

524
01:00:04.740 --> 01:00:09.940
So that there was a revaluation of people's value scales of those goods.

525
01:00:09.940 --> 01:00:15.140
An interesting phenomenon, also, by the way, people used to drink in the 70s and 80s white wine.

526
01:00:15.140 --> 01:00:19.740
Everyone had white wine and cheese parties. So every faculty party I went to had white wine and cheese.

527
01:00:19.740 --> 01:00:26.740
No red wine. That began to change in the 90s when people began to hear about the health benefits of drinking red wine.

528
01:00:26.740 --> 01:00:37.240
And that the French were much healthier, even though their diets tend to be fattier because they drink red wine.

529
01:00:37.240 --> 01:00:44.740
And then it became even more of a fad that occurred with that sideways movie, which was a pretty good movie, came out last year.

530
01:00:44.740 --> 01:00:48.740
People, for some reason, had drifted towards Merlot.

531
01:00:48.740 --> 01:00:52.740
They were sort of drinking, Merlot was sort of the favorite red wine.

532
01:00:52.740 --> 01:00:55.740
But when that came out, I guess that movie, they bad-mouthed Merlot,

533
01:00:55.740 --> 01:00:58.740
and they really began to talk up Pinot Noir.

534
01:00:58.740 --> 01:01:01.740
Now, everybody wants Pinot Noir, and it's all over the store.

535
01:01:01.740 --> 01:01:02.740
You couldn't find it.

536
01:01:02.740 --> 01:01:06.740
I had heard about Pinot Noir earlier in the 90s from Hans Hoppe,

537
01:01:06.740 --> 01:01:08.740
who was a big connoisseur of wines.

538
01:01:08.740 --> 01:01:12.740
And so now, though, you can easily find Pinot Noir all over the place.

539
01:01:12.740 --> 01:01:17.740
Again, it's just a pure change in value scale.

540
01:01:17.740 --> 01:01:35.740
Let's look now at the results of a change in demand on price.

541
01:01:35.740 --> 01:01:48.740
Okay, let's say this is the market for, you know, Pinot Noir, whatever, you know, let's say a medium-price Pinot Noir, it's $6, there's a certain amount sold, okay, available and sold.

542
01:01:48.740 --> 01:01:56.740
Now, people's value scales change and they suddenly demand the wine more intensively, okay, because they've shifted away from other types of red wine.

543
01:01:56.740 --> 01:02:06.540
The man curve shifts to the right, so at $6, they now want to buy a much greater quantity, quantity A, which is 0A is greater than 0X, obviously.

544
01:02:06.540 --> 01:02:11.740
So now there's a sudden shortage. This is sort of the mechanics of how prices change.

545
01:02:11.740 --> 01:02:17.440
Sellers realize this. Let's assume that for the moment, the stock is fixed. There's a shortage.

546
01:02:17.440 --> 01:02:24.740
So as a result, what happens? To equilibrate supply and demand, prices begin to rise.

547
01:02:24.740 --> 01:02:30.940
People see that the Pinot Noir is running out, and the wine sellers will then begin to raise their price.

548
01:02:30.940 --> 01:02:40.060
And the price will rise up to the point where, at the new price, everyone who wants a bottle of this wine can find the bottle of the wine.

549
01:02:40.060 --> 01:02:42.100
You have a new equilibrium.

550
01:02:42.100 --> 01:02:53.420
On the other hand, for those goods, for the wine like Merlot or other types of red wines, the man falls, because people are shifting, their tastes have shifted to the Pinot Noir.

551
01:02:53.420 --> 01:03:04.620
Demand falls and as a result, you get, let's start up here, the dashed line is the original demand curve.

552
01:03:04.620 --> 01:03:15.320
Initially then, there is a surplus, so people want to buy less than they did before, $9, let's say Y amount down here at some point, and so there's a surplus.

553
01:03:15.320 --> 01:03:18.020
So the wine sellers see that these wines are piling up, what will they do?

554
01:03:18.020 --> 01:03:23.020
They'll have sales, they'll cut the price, and as they cut the price, the law of demand kicks in.

555
01:03:23.020 --> 01:03:38.520
Quantity demanded along the new lower demand curve increases, okay, the quantity demand increases along the new lower demand curve after the fall in demand, okay, and as it does so, we have a movement towards equilibrium and we have a new equilibrium at the lower price.

556
01:03:38.520 --> 01:03:54.880
So, the rule is that when you have an increase in demand, the equilibrium price rises, and a decrease in demand will result in a fall in the equilibrium price, okay?

557
01:03:54.880 --> 01:04:06.320
It's as simple as that, which brings us to the whole issue of price gouging, okay?

558
01:04:06.320 --> 01:04:14.320
What is price gouging? How would you define price gouging? Well, people usually talk about, certainly it's not a scientific phenomenon, okay?

559
01:04:14.320 --> 01:04:24.320
All price gouging is, is a rapid increase in price due to a rapid change in demand for a given product, or sometimes a rapid change in supply.

560
01:04:24.320 --> 01:04:29.320
Generally, price gouging occurs, or people make the charge of price gouging,

561
01:04:29.320 --> 01:04:39.320
come after certain natural disasters that have rapidly increased the marginal utility of certain types of goods on their value scales.

562
01:04:39.320 --> 01:04:47.320
Power generators, flashlights, candles, bottled water, ice, okay?

563
01:04:47.320 --> 01:04:54.320
All that price gauges is a rapid move, or what people refer to as price gauges, I don't want to give it any credence,

564
01:04:54.320 --> 01:05:01.320
A rapid shift to the right of the demand curve, almost from one day to the next.

565
01:05:01.320 --> 01:05:10.320
So to give you some examples of what people might call price gouging, but really is simply a rapid increase in demand for a product.

566
01:05:10.320 --> 01:05:23.320
Let me just mention the blackout that we had in the Northeast back in the summer of 2003, I believe.

567
01:05:23.320 --> 01:05:29.320
Now, in New York City, people couldn't get out because the trains weren't running and so on, subways weren't running.

568
01:05:29.320 --> 01:05:43.320
There's an interesting article in the New York Post, of course, predictably, it's entitled, Paying Through the Nose, Gouging Businesses Way Up.

569
01:05:43.320 --> 01:05:58.320
But at least at the very first paragraph they say the law of supply and demand kicked in across the city, so they realized that there's a change in demand, the fixed supply of the stuff is a change in demand initially.

570
01:05:58.320 --> 01:06:08.320
And so to give examples, one woman wanted to get a ride back to Queens.

571
01:06:08.320 --> 01:06:13.320
It was very difficult to find any taxis, and if you did, you had to pay through the nose, as they say.

572
01:06:13.320 --> 01:06:16.320
And she found a livery driver.

573
01:06:16.320 --> 01:06:21.320
There are people that can drive from outside the city into the city, but really can't pick up in Manhattan.

574
01:06:21.320 --> 01:06:27.320
But anyway, he said, yeah, I'll take you to Queens, which is only a few miles away, but you have to pay me $400.

575
01:06:27.320 --> 01:06:32.320
And when she said no, he drove away. It wasn't like he was going to bargain with her, because there were other people out there willing to pay that much.

576
01:06:32.320 --> 01:06:51.320
Another individual went into a dollar store, and he bought up 30 flashlights and 20 candles at a 99-cent store and stood on the corner peddling these flashlights for $10 and the 99-cent candles for $2.

577
01:06:51.320 --> 01:06:59.320
Okay, and he got his price, he sold out, alright. What else? Some other interesting...

578
01:07:03.320 --> 01:07:18.320
Oh, someone was selling commuters who were waiting in the train station, it was very hot there, Poland spring water at $5 a bottle and then was about to jack its price up to $10 a bottle because of the tremendous demand.

579
01:07:18.320 --> 01:07:23.320
So, in other words, in effect, it's really the buyers that are pushing the price up.

580
01:07:23.320 --> 01:07:27.320
At $5 a bottle, he's running out, okay?

581
01:07:27.320 --> 01:07:34.320
So, he's allocating the bottles of water by raising the price of those people who put the highest value on them.

582
01:07:34.320 --> 01:07:39.320
There's 99-cent stores all over New York, but even they began to raise their prices,

583
01:07:39.320 --> 01:07:47.320
because they saw that the so-called scalpers or whatever were buying up their products and selling them at higher prices right outside the store.

584
01:07:47.320 --> 01:08:13.920
So, on West 23rd Street, there was long lines for batteries, radios and candles, and one 30-year-old financial analyst, he could afford it, stood on line for over a half hour and by the time he reached the store, there were no batteries, no radios and he had to pay $13 for a box of six candles, $13 for that.

585
01:08:13.920 --> 01:08:19.260
There was a woman who found a gypsy cab. Now, gypsy cabs are semi-legal in New York City.

586
01:08:19.260 --> 01:08:27.580
They can pick up and drop off in certain areas. But anyway, she wanted a ride, not very far.

587
01:08:27.580 --> 01:08:32.560
He said, you know, I'll take you for $125. She offered him $20 and he just shook his

588
01:08:32.560 --> 01:08:39.020
head and drove away. Okay. All right. So, in other words, you know, people think this

589
01:08:39.020 --> 01:08:43.680
is somehow exploitation. They're exploiting people's misfortune. Well, the point is,

590
01:08:43.680 --> 01:08:51.120
Yeah, okay, there's a greater situation of scarcity at that point and very rapidly the demand is shifted out to the right.

591
01:08:51.120 --> 01:09:01.000
If, in fact, you didn't allow the price to rise, the first people there would buy up a lot of the good and leave very little for other people.

592
01:09:01.000 --> 01:09:16.000
That happened a while in Miami with the hurricanes. My parents would go right after the hurricanes to public and it would open and there would basically be zero gallons of water because they couldn't raise the price for the price gouging.

593
01:09:16.000 --> 01:09:28.000
Basically everyone who got there first took four gallons of water than they might have needed and therefore didn't leave enough for the rest which would have been fallen by rising the price. So that happens a lot when hurricanes go around.

594
01:09:31.000 --> 01:09:45.000
A number of years ago, I guess it was in South Carolina when Hurricane Hugo hit, the price of a bag of ice went from 89 cents a bag to 10 dollars a bag.

595
01:09:45.000 --> 01:10:00.000
Now let's see what that does. And of course, the Charleston City Council, for example, bemoaned the fact of, berated rather, the sellers for their price gouging and by the end of the day had imposed some sort of price control.

596
01:10:00.000 --> 01:10:30.000
on the city. But in any case, what would happen if you left the price $0.89, the people who walk up early and rushed out would get the ice, they'd put it in their bathtub, because that's what you do, and then they'd take all their perishable foods out of their refrigerator, put them in the ice, but they'd also take their beer out and put it on ice. They'd get enough ice to keep their beer cool and so on. At $10, they'd buy much less ice and just enough ice to keep their meat from spoiling, but that leaves a lot of ice.

597
01:10:30.000 --> 01:10:33.000
There's a lot more ice for other people to keep their meat from spoiling.

598
01:10:33.000 --> 01:10:41.000
Whereas if you leave the price at 89 cents, what happens is that some people keep their meat from spoiling and keep their beer cool.

599
01:10:41.000 --> 01:10:44.000
And other people don't have any ice to keep their meat from spoiling.

600
01:10:44.000 --> 01:10:51.000
So in other words, people reallocate the use of the good at the higher price to their most important wants.

601
01:10:51.000 --> 01:10:56.000
Now the second thing is, and this is a long run effect, no one will drive refrigerated trucks down there.

602
01:10:56.000 --> 01:11:01.000
The problem is, if you put the stocks down there, no one will drive bottles of water down there at a normal price.

603
01:11:01.000 --> 01:11:09.000
They won't rush to stock up their trucks and so on with ice and water and so on, and rush down there at 89 cents.

604
01:11:09.000 --> 01:11:16.000
At $10, they will. So in the long run, this is where law and supply comes in, which I'll talk about, I'll probably get to it today.

605
01:11:16.000 --> 01:11:24.000
In the long run, you tend to get more of the good coming from areas where it's not scarce, drawn in by the higher prices.

606
01:11:24.000 --> 01:11:33.000
So, by putting laws in place against price gouging, you don't increase the supply over time, okay?

607
01:11:33.000 --> 01:11:42.000
But again, the rationing effect itself, which occurs immediately when the price is raised, is certainly economically justified,

608
01:11:42.000 --> 01:11:50.000
meaning that it does cause people to use the good more economically, okay?

609
01:11:50.000 --> 01:11:53.000
Let me just say a few words about changes in supply.

610
01:11:53.000 --> 01:11:58.000
How do we represent a change in supply? What causes a change in supply?

611
01:11:58.000 --> 01:12:03.000
Well, let's first of all look at how it's represented.

612
01:12:03.000 --> 01:12:13.000
It's simply a shift in the vertical line that we were talking about.

613
01:12:13.000 --> 01:12:21.000
So, an increase in supply is represented by a shift to the right of the supply curve.

614
01:12:21.000 --> 01:12:25.000
A decrease in supply is represented by a shift to the left.

615
01:12:25.000 --> 01:12:30.000
And first, what are the causes? Well, let's take one-time natural events.

616
01:12:30.000 --> 01:12:34.000
For example, best example are agricultural examples.

617
01:12:34.000 --> 01:12:41.000
If you have a good or a bad harvest, if you have a bad harvest one year because of a frost, the supply will shift to the left.

618
01:12:41.000 --> 01:12:44.880
If you have a good harvest, the supply will shift to the right, okay?

619
01:12:44.880 --> 01:12:55.320
If you're talking about milk and there's a mad cow disease fear and some cows have to be destroyed, dairy cows, there's a decrease in the supply, okay?

620
01:12:55.320 --> 01:12:58.520
It shifts to the left.

621
01:12:58.520 --> 01:13:06.960
If, for example, there's an earthquake that destroys some factories that produce iPods and so on, there's a shift to the left, okay?

622
01:13:06.960 --> 01:13:21.400
If there's new discoveries of deposits of oil in Alaska or off the coast, the East Coast, where there's the continental shelf supposedly has a lot of oil, but environmental regulations don't allow exploration there.

623
01:13:21.400 --> 01:13:28.000
But when you find new mineral deposits and deposits of oil, you have a shift to the right.

624
01:13:28.000 --> 01:13:34.840
So it's easy. It's just to use these one-time examples to show what the results are of a change in supply.

625
01:13:34.840 --> 01:13:40.040
Obviously, if supply increases, what we're going to get is a fall in price.

626
01:13:40.040 --> 01:13:48.240
When it decreases, the good becomes more scarce, people, the more utility of the good gets more scarce,

627
01:13:48.240 --> 01:13:51.040
rises on people's value scales and therefore prices are higher.

628
01:13:51.040 --> 01:13:53.240
And so let me just give you the example here.

629
01:13:58.740 --> 01:14:04.240
So what happens is that if you have an increase in supply of a good,

630
01:14:04.240 --> 01:14:10.240
Okay, so let's say you have an increase in a, you have a better crop of grapes, you have an increase in let's say Merlot wine, all right?

631
01:14:10.240 --> 01:14:20.240
So, it was, previously it was selling for $12 a barrel, or rather $12 a bottle, excuse me, and there's a certain quantity being sold on the market.

632
01:14:20.240 --> 01:14:31.240
Well, now there's much more, okay? The sellers will realize pretty quickly that they cannot get the same $11 without incurring a surplus of the product.

633
01:14:31.240 --> 01:14:39.240
So, sellers will compete with one another to lower the price and the price of Merlot, in case of a good year for the great, will fall.

634
01:14:39.240 --> 01:14:42.240
Okay, so from $11 to $6.

635
01:14:42.240 --> 01:14:48.240
As the price falls, the quantity demanded will increase. People will be willing to buy more and more bottles of Merlot.

636
01:14:48.240 --> 01:14:53.240
To the point where they're willing to purchase the entire increased stock of the good.

637
01:14:53.240 --> 01:15:15.240
And the reverse occurs if you have a particularly bad year, let's say there's a frost that destroys a lot of the orange crop in Florida, and as a result then the supply of orange juice, let's say, shifts back to the left.

638
01:15:15.240 --> 01:15:24.240
So you start at $7 a gallon for orange juice, then suddenly there's a drop in supply and there's a temporary shortage.

639
01:15:24.240 --> 01:15:32.240
Sellers realize this and see that they're running out of orange juice, raise the price, have been sent to raise the price,

640
01:15:32.240 --> 01:15:38.240
because they know they can still sell the full amount that they have on hand and yet get a higher price, which means the profits increase.

641
01:15:38.240 --> 01:15:42.240
So the price of a gallon of orange juice goes from $7 to $12.

642
01:15:42.240 --> 01:15:54.240
Okay, so that serves to show you the effect of changes in supply.

643
01:15:54.240 --> 01:16:11.240
It's more likely that changes in supply will result from, in the long run, and I'll just mention this and we'll talk more about it next class, that is tomorrow.

644
01:16:11.240 --> 01:16:17.240
It's more likely that changes in supply will result on a regular basis from changes in demand.

645
01:16:17.240 --> 01:16:24.240
In other words, if the demand for a product goes up, we know in the immediate run, when the demand shoots up, we know price will go up.

646
01:16:24.240 --> 01:16:27.240
But suddenly that will mean that there's more profit to be earned.

647
01:16:27.240 --> 01:16:37.240
If people believe that that demand is going to continue at that high level, you'll have new entrepreneurs entering and devoting more and more resources to producing this good.

648
01:16:37.240 --> 01:16:51.240
for example, producing Pinot Noir and as a result eventually in the next few years you'll have more and more of this wine on the market and prices will begin to come down again.

649
01:16:51.240 --> 01:16:58.240
Not to the old price but to a price that does not include any extra profit.

650
01:16:58.240 --> 01:17:03.240
So we're going to talk about how supply responds in the long run.

651
01:17:03.240 --> 01:17:13.240
And then we'll also talk a little bit about what happens to demand for good when prices of substitutes for that good or prices for the complements of that good change.

652
01:17:13.240 --> 01:17:18.240
So what happens to demand for coffee if suddenly the price of tea goes down?

653
01:17:18.240 --> 01:17:23.240
Or what happens to the demand for sugar if suddenly the price of coffee shoots up?

654
01:17:23.240 --> 01:17:28.240
What we have to learn is that all prices in the market economy are interrelated.

655
01:17:28.240 --> 01:17:42.240
It seems like that how the prices are all interrelated to make it more impossible to have a fee to deliver them, so it's more like a price of any kind to deliver them, or...?

656
01:17:58.240 --> 01:18:03.240
It's difficult to see how prices will ever attain equilibrium,

657
01:18:03.240 --> 01:18:07.240
because the change in any one price will cause changes in other prices.

658
01:18:07.240 --> 01:18:14.240
Well, the point is at any given moment, people's value scales are fixed at the moment of choice.

659
01:18:14.240 --> 01:18:17.240
And those value scales will determine prices.

660
01:18:17.240 --> 01:18:24.240
So there will be a plain state of rest, if you will, or a momentary equilibrium that does exist at a moment in time.

661
01:18:24.240 --> 01:18:32.600
Now, people will react to those changes in prices and will change their demands in the next market period, okay?

662
01:18:32.600 --> 01:18:41.520
But at that point in time, as we'll see, we'll talk about the long run, but at a given point in time, people rank the goods and money,

663
01:18:41.520 --> 01:18:51.180
everyone does, and then they come to market and those interactions of their value scales with the stocks available will determine prices, okay?

664
01:18:51.180 --> 01:19:00.780
But their demands will take into account, because all goods are ranked on one value scale, will take into account prices of other goods.

665
01:19:00.780 --> 01:19:05.080
I mean, you regularly do that when you go to a restaurant.

666
01:19:05.080 --> 01:19:17.780
If you thought you wanted, let's say, a steak dinner, and that steak dinner is $10, but then you see that there's a special on steak and shrimp.

667
01:19:17.780 --> 01:19:20.460
one thing that seems that the models don't really cover is the fact that buyers and sellers aren't on the same location.

668
01:19:20.460 --> 01:19:20.940
one thing that seems that the models don't really cover is the fact that buyers and sellers aren't on the same location.

669
01:19:20.940 --> 01:19:26.740
you'd shift to steak and shrimp for 12 dollars because it's a special, $22 more.

670
01:19:26.740 --> 01:19:33.640
so you take into account those differences in prices and how they impact on your demands for other goods.

671
01:19:33.640 --> 01:19:42.460
that's one thing that we haven't covered is the fact that buyers and sellers are not in the same location.

672
01:19:42.460 --> 01:19:48.460
One thing that we haven't covered is the fact that buyers and sellers are not in the same location.

673
01:19:48.460 --> 01:19:53.460
And that's true, okay? And also that there is a speculative component.

674
01:19:53.460 --> 01:19:59.460
When they're not in the same location, since there is imperfect knowledge, what you'll find is that goods that,

675
01:19:59.460 --> 01:20:04.460
if they knew about them, would have the same prices, if everyone had perfect information, will have different prices.

676
01:20:04.460 --> 01:20:10.460
So you may very well have tomatoes in one area selling at a different price than tomatoes in another area,

677
01:20:10.460 --> 01:20:13.460
and even take into account difference in transportation costs.

678
01:20:13.460 --> 01:20:16.460
But that's where the theory of arbitrage comes in, okay?

679
01:20:16.460 --> 01:20:23.460
And there's a profit to be made for those people who are aware of these differences

680
01:20:23.460 --> 01:20:29.460
and who can buy in the low-priced area and sell in the high-priced area.

681
01:20:29.460 --> 01:20:33.460
For example, on the day of the blackout in New York City, people pretty quickly found that

682
01:20:33.460 --> 01:20:39.460
if you buy at uptown 99-cent stores and rush down to Penn Station

683
01:20:39.460 --> 01:20:43.460
where commuters were waiting to get out of New York City, you'd get a much higher price.

684
01:20:43.460 --> 01:20:47.460
Because people in residential neighborhoods already had candles on hand and so on.

685
01:20:47.460 --> 01:20:51.460
But commuters didn't have candles, they didn't have flashlights and so on.

686
01:20:51.460 --> 01:20:59.460
So you would tend to see entrepreneurship being exercised in a spatial way.

687
01:20:59.460 --> 01:21:05.460
So you're right, we have not talked about interspacial differences in prices.

688
01:21:05.460 --> 01:21:09.460
We'll mention that when we talk about entrepreneurship.

689
01:21:09.460 --> 01:21:11.460
Any other questions?

690
01:21:11.460 --> 01:21:13.460
Okay then, thank you.