WEBVTT NOTE Value 1 00:00:00.000 --> 00:00:14.000 Okay, so last time we dealt with the law of diminishing marginal utility, the fact that as the supply of a good increases, the value of each unit of a good goes down. 2 00:00:14.000 --> 00:00:17.000 In other words, the marginal utility of a good goes down. 3 00:00:17.000 --> 00:00:27.000 And also talk about the two basic band curve, meaning how much the consumers will buy at any given price. 4 00:00:27.000 --> 00:00:51.000 Okay, on the law of diminishing marginal utility, there's a key thing that this is accomplished 5 00:00:51.000 --> 00:00:58.000 and History of Economics Thought 6 00:00:58.480 --> 00:01:02.480 Adam Smith, the alleged founder of economics, actually he really wasn't, but 7 00:01:02.480 --> 00:01:07.280 he was, I guess, one of the founders of economics as a separate discipline 8 00:01:07.280 --> 00:01:08.780 uh... 9 00:01:08.780 --> 00:01:12.400 Senator Walter Nations, which was a famous 10 00:01:12.400 --> 00:01:13.280 first 11 00:01:13.280 --> 00:01:14.920 classic 12 00:01:14.920 --> 00:01:17.800 economic classic, said there's a value paradox 13 00:01:17.800 --> 00:01:19.540 that's called value paradox 14 00:01:19.540 --> 00:01:26.300 and he said he couldn't solve it, and that's very peculiar in the history of thought, but if he had solved it twenty years earlier in his lectures 15 00:01:26.300 --> 00:01:29.900 which were published much later, about nineteen hundred or so 16 00:01:29.900 --> 00:01:34.260 so it's a very peculiar situation in the history of thought 17 00:01:34.260 --> 00:01:39.020 in fact it had been solved by scholastic philosophers since the late sixteenth century 18 00:01:39.020 --> 00:01:41.000 and all of a sudden he creates this problem 19 00:01:41.000 --> 00:01:43.660 called the value paradox 20 00:01:43.660 --> 00:01:45.800 and it goes as follows, namely 21 00:01:45.800 --> 00:01:47.000 how is it 22 00:01:47.000 --> 00:01:49.180 why is it that 23 00:01:49.180 --> 00:01:51.180 uh... 24 00:01:51.180 --> 00:01:54.060 things like bread and water, which are 25 00:01:54.060 --> 00:01:57.720 let's take bread, it's usually called the diamond water paradox 26 00:01:57.720 --> 00:02:01.180 but water has those extra complications 27 00:02:01.180 --> 00:02:05.660 anyway, bread, which is the staff of life, it's very important philosophically to man 28 00:02:05.660 --> 00:02:09.560 because you need it for life, and water of course needs more 29 00:02:09.560 --> 00:02:16.560 and yet here, bread is very important, it has a high use value 30 00:02:19.180 --> 00:02:20.140 and yet 31 00:02:20.140 --> 00:02:25.280 on the market it's very cheap. Bread in those days was much cheaper than a bucket of loaf. 32 00:02:25.280 --> 00:02:27.780 Water in those days was free, quote unquote. 33 00:02:27.780 --> 00:02:29.640 But anyway, it's very cheap. 34 00:02:29.640 --> 00:02:35.180 It's cheap on the market, therefore it has a low exchange value. 35 00:02:35.180 --> 00:02:37.780 So, that's one 36 00:02:37.780 --> 00:02:45.200 puzzling situation. Here's something which has a high use value and a low exchange value. 37 00:02:45.200 --> 00:02:51.960 On the other hand, this is bread and water. 38 00:02:51.960 --> 00:02:55.040 You can probably think of other things. Nails are pretty important 39 00:02:55.040 --> 00:02:57.840 for construction. Nails are cheap. 40 00:02:57.840 --> 00:03:02.740 On the other hand, you have other things, which are luxuries. They're fripries. 41 00:03:02.740 --> 00:03:07.240 And Smith, I think, is one of the reasons why Smith fell under. Smith was a Scottish Calvinist. 42 00:03:07.240 --> 00:03:12.720 He wasn't a hard-core Calvinist, but he was a soft-core Calvinist. So he hated luxury anyway. 43 00:03:12.720 --> 00:03:15.120 He didn't like luxurious consumption. 44 00:03:15.120 --> 00:03:19.420 Diamonds are a mere flippery. As he put it, they have no value. 45 00:03:19.420 --> 00:03:21.720 No use value. 46 00:03:21.720 --> 00:03:23.500 A little extreme. 47 00:03:23.500 --> 00:03:27.260 Most of us will say, well, they have, you know, philosophically, they do not have a very high value. 48 00:03:27.260 --> 00:03:29.560 They have low use value. 49 00:03:29.560 --> 00:03:31.220 Diamonds. 50 00:03:31.220 --> 00:03:36.360 Crusoe, and Robinson Crusoe, and his dozen island, will not go for diamonds as the first 51 00:03:36.360 --> 00:03:39.260 highest priority, obviously. 52 00:03:39.260 --> 00:03:43.120 And yet, look at diamonds. Diamonds are extremely expensive on the market. They have a high 53 00:03:43.120 --> 00:03:46.120 and my exchange value, okay? 54 00:03:46.120 --> 00:03:53.120 And, well, it's a very strange thing. 55 00:03:53.120 --> 00:03:55.120 I can't solve it. 56 00:03:55.120 --> 00:03:58.120 And Ricardo, his disciple, said the same thing. 57 00:03:58.120 --> 00:03:59.120 I can't solve it. 58 00:03:59.120 --> 00:04:01.120 This is a value paradox. 59 00:04:01.120 --> 00:04:06.120 Therefore, we can't say anything about consumers, the value to consumers, the whole utility analysis. 60 00:04:06.120 --> 00:04:09.120 I can't say anything about it because they're stuck in this thing. 61 00:04:09.120 --> 00:04:12.120 They have to deal with the entrepreneurs and business and labor and all that sort of stuff. 62 00:04:12.120 --> 00:04:17.120 and consumer analysis drops out of the picture except in France where they never went close to this 63 00:04:17.120 --> 00:04:23.120 but Britain has a dominant economic doctrine in the 19th century 64 00:04:23.120 --> 00:04:28.120 so we were, unfortunately, took a hundred years to get out of this 65 00:04:28.120 --> 00:04:31.120 to solve the value paradox 66 00:04:31.120 --> 00:04:39.120 and from this idea you see comes the left-wing position like Veblen and these other characters in late 19th century America and later 67 00:04:39.120 --> 00:05:09.120 saying, wow, capitalism, market economy, stresses production for profit and not for use, they produce things like diamonds which are for profit of a high value, they don't produce bread and water or something which are of a low value, use value, alright, so this dichotomy between production for profit and production for use has a very important history of left-wing thought, by this time we have the tool, you have the tool in your possession to realize the fallacy 68 00:05:09.120 --> 00:05:15.120 The basic fallacy is that people do not choose on philosophic value. 69 00:05:15.120 --> 00:05:20.120 We don't sit around deciding on one big vote, like a world vote. 70 00:05:20.120 --> 00:05:26.120 Supposing, let's put it this way, I like to use models, in macro I use a model which I call the Angel-Gabriel model. 71 00:05:26.120 --> 00:05:33.120 Let's go back to the model of the grand old, I can say the grand old science fiction movies of the 50s, 72 00:05:33.120 --> 00:05:52.120 In the 1850s and 60s, some space character interfered blocks into old television sets, all of a sudden we're asked what channel you want, some guy is speaking to you from a planet Ongo or something and he hands Earthlings, he says Earthlings listen, have peace, conclude peace now or die in six days, something like that. 73 00:05:52.120 --> 00:06:01.120 Well, this, the planet, some outer planetary character now comes to earth and presents us with a choice, okay, you got your choice, folks. 74 00:06:01.120 --> 00:06:07.120 From now on, you have a world parliamentary decision, you all vote, you know, on your TV set or something. 75 00:06:07.120 --> 00:06:17.120 You have a choice of losing from forevermore, from now on until the end of eternity, either all the bread in the world or all the water outside, whichever, or all the diamonds in the world. 76 00:06:17.120 --> 00:06:23.120 And that's the choice that human race is faced with. Well, given that choice, I'm sure we'd choose bread or water rather than diamonds. 77 00:06:23.120 --> 00:06:28.120 And the space people would, whatever they are, will go off of the diamonds. 78 00:06:28.120 --> 00:06:33.120 So the point is, in real life, we're not faced with this kind of a choice. We're not faced with all-encompassing class choice. 79 00:06:33.120 --> 00:06:40.120 We're faced with unit choices, marginal choices. That's the whole point of a unit. 80 00:06:40.120 --> 00:06:44.120 When somebody goes to buy something, they're not faced with a situation of, 81 00:06:44.120 --> 00:06:48.120 oh gee, here's all the bread in the world versus all the diamonds. 82 00:06:48.120 --> 00:06:51.120 No, you're faced with thinking, should I buy this loaf of bread? 83 00:06:51.120 --> 00:06:54.120 Or should I buy this diamond with 12 carats or something? 84 00:06:54.120 --> 00:06:57.120 In that situation, the marginal unit becomes extremely important, 85 00:06:57.120 --> 00:07:00.120 and the law of diminishing marginal utility becomes decisive. 86 00:07:00.120 --> 00:07:08.120 Namely, it so happens that bread and water are super-abundant. 87 00:07:08.120 --> 00:07:13.120 the money is abundant, they're everywhere. Water, of course, is not plentiful in some states. 88 00:07:13.120 --> 00:07:17.120 Basically, bread and water are supermarkets. There's a huge supply of it. 89 00:07:17.120 --> 00:07:24.120 Even if you start, there's one loaf of bread on the world, one gallon of water, you have a very, very high marginal utility. 90 00:07:24.120 --> 00:07:27.120 This is quantity. 91 00:07:27.120 --> 00:07:35.120 If you only had one loaf of bread on the world for some reason, or one gallon of water, you have extremely high. 92 00:07:35.120 --> 00:07:40.120 We spend hundreds of thousands of dollars for this one little loaf or one little gallon. 93 00:07:40.120 --> 00:07:44.120 Fortunately, we have lots of bread and lots of water all over the place. 94 00:07:44.120 --> 00:07:49.120 This is a marginal utility curve. We're out here somewhere. 95 00:07:49.120 --> 00:07:53.120 Each unit, because we deal in units in the real world, 96 00:07:53.120 --> 00:08:03.120 each unit, each gallon of water, each quart of water, or each pound of bread is very cheap 97 00:08:03.120 --> 00:08:10.120 It's cheap, because it's a low marginal value. When we choose units, as I say we don't choose, it's like Crusoe with 20 logs instead of one. 98 00:08:10.120 --> 00:08:17.120 It depends on what the supply is. We have a huge supply, fortunately, a huge supply of both water and bread. 99 00:08:17.120 --> 00:08:24.120 Therefore, it's cheap. Units are cheap. On the other hand, with diamonds, supply is very rare, limited, scarce. 100 00:08:24.120 --> 00:08:30.120 It's true we have a government cartel monopoly, which makes it scarcer. I'll get to that when we get to monopoly. 101 00:08:30.120 --> 00:08:35.120 It's run by the South African government, a collaboration of the Beers & Company. 102 00:08:35.120 --> 00:08:38.120 But anyway, it's still extremely scarce. 103 00:08:38.120 --> 00:08:44.120 South Africa virtually has the only diamond mines. 104 00:08:44.120 --> 00:08:53.120 So even though the first unit is much lower, say the least, than the first unit of bread or water, 105 00:08:53.120 --> 00:08:56.120 there are not that many units around, as the supply is limited. 106 00:08:56.120 --> 00:09:01.800 So we have a higher price for diamonds on the market. In other words, a higher valuation 107 00:09:01.800 --> 00:09:09.800 by consumers for each unit, for each carat. I guess it's the unit, the unit of weight of diamonds for a carat, C-A-R-A-T. 108 00:09:09.800 --> 00:09:13.800 The value placed by people on each carat is much higher than the value placed on each loaf of bread. 109 00:09:13.800 --> 00:09:17.800 There's nothing wrong with that. There's nothing paradoxical. There's nothing unphilosophic. 110 00:09:17.800 --> 00:09:23.400 There's nothing unnatural about it. It's perfectly legitimate. Once you see what the whole picture is, 111 00:09:23.400 --> 00:09:35.400 Once you see the interpenetration between supply and valuation, it's marginal. Once you realize about the margin, this whole thing clears up. 112 00:09:35.400 --> 00:09:57.400 So, anyway, that solves the value of power. It took until the Austrians and other economists in 1871, the marginal utility theorists, around 1871, to solve this paradox for marginal utility school. 113 00:09:57.400 --> 00:10:08.400 For a hundred years, economics had been misled by Adam Smith into this cul-de-sac where they couldn't analyze consumers' behavior, they couldn't analyze consumer actions because they couldn't understand the value paradox. 114 00:10:08.400 --> 00:10:13.400 And they left themselves wide open for leftists to say, wow, gee, it's a terrible thing. 115 00:10:13.400 --> 00:10:17.400 And there's no conflict between production for profit and production for use. 116 00:10:17.400 --> 00:10:21.400 Profit is, what's profitable is what's most useful to the consumer, most valuable. 117 00:10:21.400 --> 00:10:24.400 And the demand is highest. We'll get into the demand as we go along. 118 00:10:24.400 --> 00:10:35.600 Anyway, that solved the value paradox. 119 00:10:35.600 --> 00:10:38.640 The other thing about exchange, I'm not going to mention it before, the other thing about 120 00:10:38.640 --> 00:10:42.520 any exchange that takes place in the market is that people would only exchange because 121 00:10:42.520 --> 00:10:44.080 it's more valuable for them. 122 00:10:44.080 --> 00:10:46.040 They prefer what they're getting to what they give up. 123 00:10:46.040 --> 00:10:47.800 They prefer the marginal units. 124 00:10:47.800 --> 00:10:52.840 In other words, you work, you exchange your labor service of 40 hours a week or whatever 125 00:10:52.840 --> 00:10:59.600 for a certain amount of money or exchange money for loaves of bread or stereos or whatever, 126 00:10:59.600 --> 00:11:05.080 you're doing that because you prefer the value you're getting for the value you're giving 127 00:11:05.080 --> 00:11:06.080 up an exchange. 128 00:11:06.080 --> 00:11:10.400 And so each step of the way, each kind of exchange is made on a mark, literally millions 129 00:11:10.400 --> 00:11:13.800 of exchanges benefit both parties to the exchange. 130 00:11:13.800 --> 00:11:22.260 Those are also very important concepts, as I mentioned last time, I reiterate it. 131 00:11:22.260 --> 00:11:30.760 Both parties, what we have is a latticework of two-person exchanges in the market. 132 00:11:30.760 --> 00:11:44.260 We have, as always for every unit exchange, there are two people or two groups and two commodities, 133 00:11:44.260 --> 00:11:46.260 including two goods and services. 134 00:11:46.260 --> 00:12:16.260 In other words, if I go downstairs and buy a newspaper, so I buy the post, then you have two things, you have me and the news dealer, and I give the news dealer $0.35, and I get the post, alright, so I'm getting, both of us benefit from the exchange, I give up the $0.35, I value getting the post more than getting the $0.35, the other hand, of course, the news dealer values the $0.35 a lot more than the post, 135 00:12:16.260 --> 00:12:23.980 500, 325 posts, pretty obvious in his situation, but at any rate, both of us then benefit. 136 00:12:23.980 --> 00:12:29.900 Each unit exchange has two people and two commodities, or two goods that serve one. 137 00:12:29.900 --> 00:12:35.220 In a money economy, money is always one part of this equation here. 138 00:12:35.220 --> 00:12:36.900 Money is exchanged for other things. 139 00:12:36.900 --> 00:12:41.320 So if you work for IBM, if you graduate and work for IBM, you're exchanging your labor 140 00:12:41.320 --> 00:12:44.020 service for salary, for money. 141 00:12:44.020 --> 00:12:52.020 So that's, again, a situation with you and IBM, since IBM is not a person, it acts as a unit in this situation. 142 00:12:52.020 --> 00:12:58.020 So you have money and then labor service exchange for it. 143 00:12:58.020 --> 00:13:03.020 So each step of the way, and the lattice work of exchanges is both parties' benefit. 144 00:13:03.020 --> 00:13:07.020 Otherwise they wouldn't make the exchange and do something else. 145 00:13:07.020 --> 00:13:13.020 They go home, they make some other exchange, they keep their money, they go to Bahamas or whatever. 146 00:13:13.020 --> 00:13:28.020 Okay, we now get to the most important, we talked about the demand curve last time, we get to the most important property of the demand curve, the only property which really is important as a matter of fact. 147 00:13:28.020 --> 00:13:34.020 Remember the demand curve is falling, it's all we really know about it. 148 00:13:34.020 --> 00:13:43.740 So you have on the y-axis, you have price, on the x-axis you have quantity, and the demand 149 00:13:43.740 --> 00:13:48.140 curve tells you, it's really the demand schedule, it's a geometric representation of the demand 150 00:13:48.140 --> 00:13:49.140 schedule. 151 00:13:49.140 --> 00:13:53.540 It tells you, at this price, how much will be bought, the price of 1 or better, 10 bucks 152 00:13:53.540 --> 00:13:58.740 a loaf, this much will be bought, if the price is 5 dollars a loaf, this much, whatever, and 153 00:13:58.740 --> 00:14:00.060 you get something like that. 154 00:14:00.060 --> 00:14:05.060 In other words, the cheaper the price, the more will be purchased. 155 00:14:05.060 --> 00:14:12.060 So you have a demand curve which is sloping, so-called falling demand curve, a demand curve which slopes downward and to the right. 156 00:14:12.060 --> 00:14:19.060 You don't know how it's sloping, you don't know exactly how, you don't know if it's linear, you don't know if it's steep or shallow or flat. 157 00:14:19.060 --> 00:14:24.060 Only know if it's falling. 158 00:14:24.060 --> 00:14:32.620 Now, the important property of the demand curve is how much, if this is like a freeze-frame 159 00:14:32.620 --> 00:14:36.100 situation telling you what's in the mind of consumers, of course you don't know that 160 00:14:36.100 --> 00:14:38.860 the demand curve, you don't really know it, all you know is that it's falling. 161 00:14:38.860 --> 00:14:42.900 There's no way to have an x-ray machine in the minds of every consumer and figure out 162 00:14:42.900 --> 00:14:49.780 if you freeze today and find out, well, let's see, how much will they buy at different prices? 163 00:14:49.780 --> 00:14:52.500 What you do now, as I say, is that it is falling. 164 00:14:52.500 --> 00:14:58.460 If, so there are two, the property, the important property of the man curve is, if you change 165 00:14:58.460 --> 00:15:03.340 the price, let's say if you cut the price from here to here, how much will the quantity 166 00:15:03.340 --> 00:15:04.340 increase? 167 00:15:04.340 --> 00:15:10.940 Okay, in other words, or at least in what direction? 168 00:15:10.940 --> 00:15:14.580 We know it will increase, we don't know about how much, if it increases just a little bit, 169 00:15:14.580 --> 00:15:28.580 You have a steep curve here, it can either do that or it can increase a lot, we have a much flatter curve, given the same point. 170 00:15:28.580 --> 00:15:34.580 Now there's this property, the man curve is called elasticity. 171 00:15:34.580 --> 00:15:50.580 Once again, it's borrowing the prestige of physics, where the question of example is if you put a certain different weights on a spring, how much will the spring give? 172 00:15:50.580 --> 00:16:00.580 Now there are two different kinds of definitions for you. One kind, which is a textbook definition, there's nothing wrong with it, it's just kind of irrelevant. 173 00:16:00.580 --> 00:16:07.580 That goes through a whole formula. Namely, you take the percentage of the quantity change. 174 00:16:07.580 --> 00:16:17.580 In other words, let's say this is a 10% drop in price. If this is a 40% increase in elasticity, then you have all these ratios. 175 00:16:17.580 --> 00:16:26.580 It's called a very elastic curve. If, on the other hand, you have a 10% drop in price and quantity only goes up by 5%, it's obviously very inelastic. 176 00:16:26.580 --> 00:16:31.580 So, the more elastic is how much more give there is, 177 00:16:31.580 --> 00:16:34.580 in other words, how much the quantity will increase when the price falls. 178 00:16:34.580 --> 00:16:36.580 The reason why it's irrelevant is nobody knows anyway, 179 00:16:36.580 --> 00:16:39.580 and it's also the really important thing, it's quality, 180 00:16:39.580 --> 00:16:42.580 the really important thing for the businessman or for the industry is, 181 00:16:42.580 --> 00:16:45.580 will total revenue go up or down? That's what they really care about. 182 00:16:45.580 --> 00:16:48.580 If I cut the price, what's going to happen to my total revenue? 183 00:16:48.580 --> 00:16:53.580 That's what I want to focus on here. 184 00:16:53.580 --> 00:17:01.580 Now, total revenue, business income, net income, is total revenue minus total cost. 185 00:17:01.580 --> 00:17:11.580 This is a very simplified way of looking at it, but basically it is how much money do you take in a year over the transom or over the cash register or whatever, how much money do you pay out? 186 00:17:11.580 --> 00:17:22.580 If you take in $100,000 a year, you pay out $80,000 total cost, and your net profit is $20,000, you're in fairly good shape. 187 00:17:22.580 --> 00:17:31.580 If, on the other hand, your total revenue is $60,000 and you pay out $80,000 and you're in pretty poor shape, and you suffer net losses of $20,000. 188 00:17:31.580 --> 00:17:40.580 So therefore, total cost we'll get to later on in the course, but right now we're focusing on total revenue, total revenue of part. 189 00:17:40.580 --> 00:17:51.580 Total revenue is of any firm, any person, it doesn't matter, and it equals the price of anything times the quantity sold, P times Q. 190 00:17:51.580 --> 00:18:07.580 Let's take a Wonderbread example. 191 00:18:07.580 --> 00:18:13.580 The curve is based on the schedule. 192 00:18:13.580 --> 00:18:15.580 Let's say the price is ten bucks a loaf. 193 00:18:15.580 --> 00:18:19.580 You have very few loaves, so let's say a thousand. 194 00:18:19.580 --> 00:18:22.540 thousand very wealthy winter bread freaks 195 00:18:22.540 --> 00:18:27.420 if you have a total revenue then of P times Q equals TR 196 00:18:27.420 --> 00:18:28.700 you sell 197 00:18:28.700 --> 00:18:33.700 ten bucks a loaf, you sell a thousand loaves, you get ten thousand dollar total revenue, very simple concept 198 00:18:33.700 --> 00:18:36.000 simple but important 199 00:18:36.000 --> 00:18:39.800 if the price is one dollar, you might be selling a hundred thousand loaves 200 00:18:39.800 --> 00:18:42.780 so then your total revenue is a hundred thousand dollars 201 00:18:42.780 --> 00:18:45.100 if the price is a nickel a loaf 202 00:18:45.100 --> 00:18:49.140 I don't know, you might be selling 203 00:18:49.140 --> 00:19:00.140 Five hundred thousand. What's that? That's five thousand dollars, isn't it? 204 00:19:00.140 --> 00:19:09.140 Anyway, that gives you an idea. You take the price per unit, multiply by the number of units sold, and you get your total revenue. 205 00:19:09.140 --> 00:19:15.140 So, what we're interested in here is, what happens to total revenue? 206 00:19:17.140 --> 00:19:21.140 When, let's see, this is the man curve here. 207 00:19:31.140 --> 00:19:35.140 Here's price on the y-axis, quantity on the x-axis. 208 00:19:35.140 --> 00:20:00.140 If this is one point out of the man curve, it means that the price is, whatever this is, let's say a low for $10 a case or whatever happens to be, times a thousand, that means the total revenue is, the geometry of the total revenue is the total area. 209 00:20:00.140 --> 00:20:06.140 What's the price times the quantity? Then what happens when you lower the price? 210 00:20:06.140 --> 00:20:18.140 If the case of Wonder Belt can be a huge increase in total revenue, other cases it could be of course only even lower total revenue. 211 00:20:18.140 --> 00:20:24.140 If you have a relatively flat curve like that, you wind up, let's say from here to here, 212 00:20:24.140 --> 00:20:30.140 So the new total revenue, which would be a lot bigger. 213 00:20:30.140 --> 00:20:40.140 In other words, in this diagram here, I've postulated, a fall in price leads to an increase in total revenue. 214 00:20:50.140 --> 00:20:52.140 Increase in TR. 215 00:20:52.140 --> 00:20:59.140 And then looking at, this is $9 or something, whatever this is, if you go back, of course the reverse happens. 216 00:20:59.140 --> 00:21:04.140 In other words, you increase, you start with here, you raise the price to here, you get a big drop in total revenue. 217 00:21:04.140 --> 00:21:09.140 So this is the other side of a coin, given the same two points. 218 00:21:09.140 --> 00:21:16.140 So here you have a rise in price, leading to a fall in total revenue. 219 00:21:16.140 --> 00:21:27.140 This situation, when a demand curve is in this situation, it's called an elastic demand curve in that zone, in that region, because it does change all the way up and down the curve. 220 00:21:27.140 --> 00:21:32.140 But what you have here, this is a definition of an elastic demand curve. 221 00:21:32.140 --> 00:21:39.140 In other words, the key thing I'm focusing on here is the direction. What happens to total revenue, or the change in price? 222 00:21:39.140 --> 00:21:53.140 If when you cut the price, if in other words quantity increases by a greater proportion, you have an increase in total revenue, that's an elastic demand curve. Raise the price, then you have a fall in total revenue. 223 00:21:53.140 --> 00:22:04.140 So some demand curves will be elastic. It's not easy to forecast in advance what the demand curve will be, because it will change across the zone, and it can be different from different things. 224 00:22:04.140 --> 00:22:12.140 Usually, we consider that wheat has an elastic demand curve. It's not necessarily true, but anyway. 225 00:22:15.140 --> 00:22:17.140 So that's an elastic demand curve. 226 00:22:17.140 --> 00:22:26.140 The other hand, if you have a demand curve which is relatively steep, and goes like that, a fall in price, 227 00:22:26.140 --> 00:22:33.640 Then you have this total revenue. The new total revenue, the new area will be smaller. 228 00:22:33.640 --> 00:22:38.640 In other words, the increase in quantity is not enough to offset the drop in price. 229 00:22:38.640 --> 00:22:44.640 So the result will be a lower demand, lower total revenue. 230 00:22:44.640 --> 00:23:09.640 So in this situation, a situation where a fall in price leads to a fall, a drop in total revenue, or looking at it again the other way around, if you raise the price from here to here, you've got an increase in total revenue. 231 00:23:09.640 --> 00:23:19.640 Rise in price. This is something that businessmen are very interested in. They don't care that much about the percentage, the amount, the formula. 232 00:23:19.640 --> 00:23:22.640 They care about what happens to the damn total revenue in this. 233 00:23:22.640 --> 00:23:27.640 In the real world, businessmen don't know that the man curves are not listed on the book for them. 234 00:23:27.640 --> 00:23:34.640 They have to try to find out. It's not easy to find out. It's part of the job of the entrepreneur or the businessmen to try to figure out what's going on. 235 00:23:34.640 --> 00:23:39.640 Okay, so rise in price leads to then an increase in total revenue. 236 00:23:39.640 --> 00:23:46.640 This situation is called an inelastic demand curve, inelastic. 237 00:23:46.640 --> 00:23:53.640 So in other words, we're setting up here a new definition of elastic and inelastic. 238 00:23:53.640 --> 00:24:01.640 Instead of concentrating on percentages, what I'm saying is if the, I'm concentrating on the direction of total revenue, 239 00:24:01.640 --> 00:24:08.640 If the total revenue increases or falls at a falling price, you have an elastic demand curve. If it drops to the falling price, you have an inelastic demand curve. 240 00:24:08.640 --> 00:24:20.640 And vice versa. If the total revenue falls off at an increase in price, you have an elastic demand curve. If it goes up at an increase in price, you have an inelastic demand curve. 241 00:24:20.640 --> 00:24:26.640 So what can we say about when things will be elastic or inelastic? 242 00:24:26.640 --> 00:24:37.640 Well, one thing we can say that other things being equal, given the range of choice, I mean a larger range of choice will lead to a greater elasticity. 243 00:24:37.640 --> 00:24:52.640 In other words, let's say this is the, let's say this is the, back to our wonder bread example, here's the price of wonder bread, say a buck, this is a buck a loaf. 244 00:24:52.640 --> 00:25:05.640 And, let's say Mr. Wonder, you know, huge increase in price, it's gonna, sales are gonna fall off tremendously because all the other breads will remain the same price. 245 00:25:05.640 --> 00:25:16.640 Rolls, breads, everything is a buck a loaf or so, he's raising his price to $5, $10 a loaf, it means a tremendous falling off, it means that the man curve is very elastic for Wonder bread. 246 00:25:16.640 --> 00:25:23.660 they have a big falling off in total revenue so that's one of the reasons 247 00:25:23.660 --> 00:25:28.180 not going to do it if he's sane on the other hand if all the breads go up 248 00:25:28.180 --> 00:25:32.100 together for one reason or another but some kind of a situation all bread 249 00:25:32.100 --> 00:25:34.980 prices go up to two bucks that's a different story then they'll still be a 250 00:25:34.980 --> 00:25:39.940 falling off but people won't be able to shift out fast from one to out of Wonder 251 00:25:39.940 --> 00:25:44.260 Bread into Pepperidge form or whatever they'll all be going up so in that situation be much 252 00:25:44.260 --> 00:25:52.260 It's much steeper. It could still be elastic, but be less elastic than for each given firm, or each given brand. 253 00:25:53.260 --> 00:25:56.260 Same way on the way down. If you have a... 254 00:26:00.260 --> 00:26:05.260 If this one cuts its price and all the others remain the same, it'll pick up a lot of sales. 255 00:26:05.260 --> 00:26:08.260 It's going to be very elastic demand. 256 00:26:08.260 --> 00:26:13.260 On the other hand, if all bread prices go down, it'll pick up some, but not as much. 257 00:26:13.260 --> 00:26:19.260 So one thing we can conclude from this is that the demand curve, in all cases, regardless of how elastic the demand curve is, 258 00:26:19.260 --> 00:26:31.260 the demand curve for the firm, any given firm, is more elastic than the demand curve for the industry as a whole. 259 00:26:31.260 --> 00:26:36.260 Unless, of course, there's only one firm in the industry, in which case it's the same thing. 260 00:26:36.260 --> 00:26:42.260 So, more elastic than demand for the industry. 261 00:26:42.260 --> 00:26:51.260 And when you, this sets up a temptation, in the case of where there's a big gap, and we'll see later on, 262 00:26:51.260 --> 00:26:56.260 there's various reasons why demand curve for every firm is going to be elastic, or also what firm it is. 263 00:26:56.260 --> 00:26:58.260 It's going to be elastic. 264 00:26:58.260 --> 00:27:02.260 Where some demand curves for industries are inelastic, some are elastic. 265 00:27:02.260 --> 00:27:32.260 When you have a big gap between the two of them, let's say the man curve of each firm is quite elastic and the man curve of the industry as a whole is inelastic, it sets up a temptation for a cartel agreement among the firms because it means that they can get together, I'll get to that later on when we get to monopolies, they can get together and agree to cut production and raise price, they'll all benefit, all the firms will benefit because they can, let's say they raise price by 20%, their production gets cut by 10%, they pick up more total revenue. But it's only if each firm will keep the 266 00:27:32.260 --> 00:27:42.260 Agreement. As I'll point out later on in the course, there are inexorable conditions in the free market that lead to a breaking up, a very quick breaking up of all cartel agreements. 267 00:27:42.260 --> 00:27:57.260 The only reason why a cartel agreement ever remains in action is because the government enforces it. When the government steps in, what's the matter out there? I'm going to close the door. 268 00:27:57.260 --> 00:28:14.260 I only have a few minutes. Eager class for the next hour, I say. Well, God bless them. 269 00:28:14.260 --> 00:28:44.260 Okay, so the, where was I, what was I talking about, cartel, yeah, so if a cartel, the only time a cartel will last for any length of time is when a government steps in and enforces, it prevents new competition from coming in, it prevents anybody from breaking the agreement, and this is what's happening in Europe a lot and so on, we'll get to that later, this is just a teaser on cartel, so this is, 270 00:28:44.260 --> 00:28:52.260 sets up a big gap between the industry of the man curve and the firm of the man curve, sets up the conditions for at least a temptation for that sort of agreement. 271 00:28:57.260 --> 00:29:08.260 Okay, now there are some, all these man curves, they might look flat or steep, but you can only tell the relative elasticity when they're from the same point. 272 00:29:08.260 --> 00:29:16.260 If you have this kind of situation, and going down from that price, you have a flat curve, this is a steep curve, you know this is more elastic than that. 273 00:29:16.260 --> 00:29:28.260 But if you just look at a curve like that, or look at that, it's not necessarily true that this will be more elastic throughout the entire range. 274 00:29:28.260 --> 00:29:33.260 As a matter of fact, when you get up high enough in this thing, it will be elastic, even if it's steep. 275 00:29:33.260 --> 00:29:44.260 You get to the point finally where people can't afford to buy more, whatever it is, if the price goes up, even if it's something which is inelastic, even if it's weak or something like that. 276 00:29:44.260 --> 00:29:57.260 So you can't gauge by looking at it, you can only gauge by looking at the focal point here and looking at it, what happens when you go up or down from that point and have a common point. 277 00:29:57.260 --> 00:30:08.260 So as I say, the elasticity will range over the, will stiffer over the range of each curve, except for three curves, which are hypothetical, which usually never exist. 278 00:30:08.260 --> 00:30:19.260 The only cases where the elasticity is constant throughout the entire range of the curve, and those of you who are mathematically inclined will see the reason for this. 279 00:30:19.260 --> 00:30:25.260 Three curves. One is the situation where you have an absolutely horizontal demand curve. 280 00:30:25.260 --> 00:30:27.060 We've already seen you can't have it. 281 00:30:27.060 --> 00:30:33.780 It's one of my big gripes with the later chapters on simple, perfect composition. There ain't no such thing because the band curve always has to be full. 282 00:30:33.780 --> 00:30:37.780 If you had an infinite, this is if you ever had this crazy situation where 283 00:30:37.780 --> 00:30:41.780 it means you could produce as much as you want, still have the same, still have the same price, 284 00:30:41.780 --> 00:30:46.660 this would be an infinite elasticity. You know, E, epsilon, fireplace, 285 00:30:46.660 --> 00:30:50.780 epsilon would be infinite size. 286 00:30:50.780 --> 00:30:54.940 Throughout the entire range of the curve. 287 00:30:54.940 --> 00:31:01.660 On the other hand, if you had a vertical demand curve, absolutely vertical, also which can't exist, we were already going through 288 00:31:01.660 --> 00:31:03.800 for quite a while explaining that, 289 00:31:03.800 --> 00:31:05.980 the elasticity would be zero throughout. 290 00:31:05.980 --> 00:31:07.780 It means, regardless of what happens, 291 00:31:07.780 --> 00:31:11.700 you never have a change one way or the other in the quantity, which is again absurd. 292 00:31:11.700 --> 00:31:14.280 This is mathematical extreme cases. 293 00:31:14.280 --> 00:31:16.340 Another point, another 294 00:31:16.340 --> 00:31:19.240 constant elasticity, which is not absurd, it's just 295 00:31:19.240 --> 00:31:23.320 I doubt whatever happens. I mean, it's extremely unrealistic, let's put it that way. 296 00:31:23.320 --> 00:31:38.320 In a situation where the main curve is a rectangular hyperbola, it doesn't look like that, such that the total revenue is always constant, in other words, the area under the curve is always constant. 297 00:31:38.320 --> 00:31:49.320 Like that. Regardless of what the price is, consumers always spend the same amount of money. That could happen. It could even happen for certain individual ranges, but there's no reason to assume it happens. 298 00:31:49.320 --> 00:31:54.320 There's no evidence that it ever happens and whatever, but it's not logical, it's not absurd like the other two cases. 299 00:31:54.320 --> 00:32:00.320 Now, oddly enough, in the history of economics, demand curves first come in about 1920. 300 00:32:00.320 --> 00:32:08.320 For about 25 years or so, the textbook demand curves were always like this, a totally insane situation. 301 00:32:08.320 --> 00:32:10.320 This is the way it was shaped. 302 00:32:10.320 --> 00:32:17.320 And so they were assuming it all the time, but it really assumes away the whole point, which is changes in the elasticity, or changes in total revenue. 303 00:32:17.320 --> 00:32:31.320 It's a very weird kind of assumption. Finally, in about 1943 or so, Professor Stiegler was a young economist then, wrote a price theory textbook, I guess it should now be called Intermediate Micro, and he since then got a Nobel Prize, etc. 304 00:32:31.320 --> 00:32:40.320 Anyway, he starts off and he says, why are these like this? There's no evidence for this, no reason for it, just sort of fashion, and he says, the hell with it, it's ridiculous, let's make it a straight line. 305 00:32:40.320 --> 00:32:47.320 So from then on, all of the man curves in the textbook are in straight lines. At least you don't have the assumption of constant total revenue. 306 00:32:47.320 --> 00:32:54.320 On the other hand, there's no evidence of a straight line either. It's purely for convenience. These would be like that. 307 00:32:54.320 --> 00:32:59.320 No evidence for a straight line. 308 00:32:59.320 --> 00:33:08.320 So, I think Ronald McCluskey is sort of a maverick type, very interesting economist, kind of a nut, very interesting. 309 00:33:08.320 --> 00:33:13.320 He has a textbook now recently on intermediate and micro. He has an anchor like that. 310 00:33:13.320 --> 00:33:17.320 Well, okay, but I still prefer using a straight line. It's more simple to do it. 311 00:33:17.320 --> 00:33:20.320 But always keep in mind that this is only for convenience. 312 00:33:20.320 --> 00:33:24.320 See, what happens later on in the course, they start using tangency. 313 00:33:24.320 --> 00:33:28.320 There was also some very important conclusions from nonsense. There's no reason. 314 00:33:28.320 --> 00:33:31.320 If it ain't straight line, it ain't going to be tangent. 315 00:33:31.320 --> 00:33:35.320 So at any rate, just keep that in mind. What happens in economics, 316 00:33:35.320 --> 00:33:45.320 has happened for many years now that they start using math or diagrams as a convenience as sort of a graphic illustration of economic concepts 317 00:33:45.320 --> 00:33:51.320 and after about some years of doing that they start thinking of the graphs as ends in themselves 318 00:33:51.320 --> 00:33:55.320 and they forget about the economics and they start talking about tangencies and all sorts of other stuff 319 00:33:55.320 --> 00:33:58.320 so we're trying to keep close to earth here 320 00:33:58.320 --> 00:34:14.320 At any rate, this is the, so elasticity is a major property of demand curve, either elastic or inelastic, which means you only have a situation where total revenue either falls or increases and changes in price. 321 00:34:14.320 --> 00:34:17.320 And it's obviously extremely important for businessmen to try to figure out what's going to happen. 322 00:34:17.320 --> 00:34:22.320 In real life, there are no given demand curves, this is a no given cost curve right or wrong. 323 00:34:22.320 --> 00:34:26.320 Businessmen are trying to find out what will happen if they raise the price or lower the price. 324 00:34:26.320 --> 00:34:56.320 and that's a trial-error kind of procedure and it's much of a hunch and based on their intuitive insight into the market, which is first based on knowledge, but based on the sort of knowledge economists don't have, because we're not in the fish market or the computer market or whatever it is, each market is different, has different people in it, all sorts of stuff going on, dynamics, which only people involved in it can figure out what's going on. So, okay, I think that's enough for today. Press on.