Nobody understands that nobody understands supply and demand

Paul Krugman often makes claims like something to the effect that nobody understands liquidity traps—expressing frustration with the views of his fellow economists.  But liquidity traps are a fairly esoteric issue.  Why is there so little outrage that nobody understands supply and demand?

Marcus Nunes has a new post pointing to the latest atrocity, in the WSJ:

Oil’s Plunge Could Help Send Its Price Back Up

If something is cheaper, people will likely buy more of it. That core principle of economics is proving to be especially true with oil after its recent plunge.

The first two sentences of the article are breathtakingly wrong.  It would be easy to mock the particular reporter who wrote this piece, but let’s face it:

1.  The WSJ hires people from top universities, who probably got As in economics.

2.  Just a few days ago I did a post on Nobel Prize winner Robert Shiller doing the exact same thing.

Non-economists don’t know this, but economics instructors in the lunchroom will often sort of roll their eyes at the fact that students are unable to distinguish between shifts in demand and shifts in quantity demanded.  Thus student essays will sometimes say “price fell, so demand rose, so price went up, so demand fell, so price went down . . . ” in an endless circle.

Yes, it’s easy to mock those who know less that we do.  But when even high-level academics, pundits and reporters are making what is essentially the exact same error we accuse the students of making, then something is clearly wrong.

I’ve always thought that we teach economics the wrong way.  In the intro chapter to supply and demand we have all these stupid examples of a frost hitting the orange crop in Florida, reducing supply and driving up prices.  Or heavy demand for Super Bowl tickets driving up prices.  Actually, this is the sort of stuff students already know before taking economics. And it’s exactly what they know after taking economics.  I firmly believe that the value added of the supply and demand chapter in most textbooks is zero.  Students know no more S&D a year after taking the course then they knew going in. Maybe that’s inevitable, maybe supply and demand, like quantum mechanics, is simply too hard for most people.

But I’m not convinced.  QM is too hard for me, but I do understand supply and demand.  Maybe textbooks should reorient their coverage of the supply and demand chapter, putting less emphasis on the stuff that students already know going in and focusing far more heavily on the identification problem.  A good start would be to include 5 examples of experts reasoning from a price change, so you could tell the students, “if you learn this stuff you be smarter than Nobel Prize winners in economics.”  Young people love the idea that they are smarter that old people.  They love challenges.


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60 Responses to “Nobody understands that nobody understands supply and demand”

  1. Gravatar of Market Fiscalist Market Fiscalist
    23. February 2015 at 06:45

    At the high risk of walking into a fallacy…

    What if demand responds only slowly to a price change ?

    New oil fields are discovered and the price of oil halves. Over time people switch from gas to electric cars. The price gradually drifts up again but never to its previous high.

  2. Gravatar of CrisisStudent CrisisStudent
    23. February 2015 at 06:50

    2 comments:

    first, from my experience this is indeed quite hard to grasp for first year student in econ; i reguraly give them example like this and they do not spot it, even though I say sentence “do not confuse change in demand and change in quantity demanded” at least 100 times.

    Second, in later years, when this would become easy for students as they become more comfortable with economics reasoning, we are off to play with equations with typically no relation to real world. and hence student leave universities with very little understanding of economics..

  3. Gravatar of steve steve
    23. February 2015 at 06:53

    OK, I’m lost, what is wrong with that statement? Don’t lower prices usually translate into an increase in the amount sold of a given product/service?

  4. Gravatar of CrisisStudent CrisisStudent
    23. February 2015 at 06:53

    one more thing – please, keep supplying this examples, they are invaluable for teaching

  5. Gravatar of WadeWillson WadeWillson
    23. February 2015 at 07:04

    There is a typo in the quote in the last paragraph.

  6. Gravatar of Dylan Dylan
    23. February 2015 at 07:11

    Steve,

    You have causation reversed and over simplified. Price is going down because people (in the aggregate) don’t demand as much as at the old price and/or supplies (in the aggregate) are willing to sell more than they previously were at the old price.

    But even that’s oversimplified – supply and demand could be going in countervailing directions, but one (weaker demand or stronger supply) is pulling stronger in the direction of a lower clearing price.

  7. Gravatar of Becky Hargrove Becky Hargrove
    23. February 2015 at 07:14

    The easiest real world example I know for this is that – after the Great Recession – some highways in more isolated places, never quite regained the traffic flows they once had.

  8. Gravatar of Nick Rowe Nick Rowe
    23. February 2015 at 07:50

    steve: “OK, I’m lost, what is wrong with that statement? Don’t lower prices usually translate into an increase in the amount sold of a given product/service?”

    Demand curves slope down, yes. (A fall in price causes and a movement along the demand curve and an increase in quantity demanded.)

    But supply curves slope up. (A fall in price causes a movement down along the supply curve and a fall in quantity supplied.)

    If we start in equilibrium, where quantity demanded Qd (the quantity buyers want to buy) = quantity supplied Qs (the quantity sellers want to sell) = the actual quantity bought-and-sold Q, and we observe price fall, Q will rise if the supply curve shifted right to cause P to fall, but Q will fall if the demand curve shifted left to cause P to fall. So it depends on what caused P to fall.

  9. Gravatar of foosion foosion
    23. February 2015 at 08:01

    >>So it depends on what caused P to fall.>>

    This is why it’s a mistake to reason from a price change.

  10. Gravatar of Peter Peter
    23. February 2015 at 08:04

    I think there would have been less confusion if they had named demand ‘demand curve’ and supply ‘supply curve’ instead.

  11. Gravatar of steve steve
    23. February 2015 at 08:09

    I understand the shifting of the demand and supply lines (I got A’s in the much-maligned undergrad econ classes).

    But back to the original statement “If something is cheaper, people will likely buy more of it”…

    Yes, it lacks nuance (prices don’t drop in a vacuum), but isn’t it basically true?

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    23. February 2015 at 08:23

    Steve, there is a lot of cheap real estate available in little ghost towns on the great plains. Are you more likely to buy it now that it is cheaper? Or is it cheaper because you (and everyone else) are less likely to buy it?

  13. Gravatar of steve steve
    23. February 2015 at 08:37

    Kevin: yes, I’m more likely to buy at a lower price. Maybe not enough to consummate the purchase, but more likely, yes. Whatever the number of people wanting to buy a ghost town at P=1, there ought to be more people interested at P<1.

    How about if I rephrase the line: If something is cheaper, people will likely buy more of it… than they would at the previous, higher price.

  14. Gravatar of Steven Kopits Steven Kopits
    23. February 2015 at 08:48

    Ordinarily, oil prices move in cycles. Excluding recessionary periods, when oil’s cheaper, people tend to buy more.

    In reality, we believe the oil demand curve essentially unchanged (although Jim Hamilton might disagree with this), but we see a shift in the supply curve, with greater supply at any given price.

    Thus, we would expect to see i) greater supply at a given price (which we do); 2) a demand response due to lower price (which we do); and 3) a lower price, for a while (which we also do). However, due to lags, the actual supply and demand responses may be greater than anticipated, leading to a surge in oil prices anywhere from Q3 15 to Q1 16.

    The link below covers the major supply and demand forecasts, including mine, which right now is making all the running.

    http://www.prienga.com/blog/2015/1/20/supply-minus-demand-explained

    I’ve written a great deal on this topic, some of which has been written up on Bloomberg, the FT, and last Friday, on NPR’s Marketplace.

    You might pop over to my blog and read a bit.

    http://www.prienga.com/blog/

  15. Gravatar of Steven Kopits Steven Kopits
    23. February 2015 at 08:57

    If you want to review something new and different, why don’t you review my proposal on Greece, and tell me why we shouldn’t create demand for good governance. Why don’t we apply some of your supply and demand analysis to that thorny issue? Tell me why my proposal is not in the interest of the Troika.

    I would argue that it is in fact the most radical libertarian / free market stance on governance you will find anywhere. You’re a free market guy. Let’s see what you make of it.

    http://www.prienga.com/blog/2015/2/19/a-program-for-greece

  16. Gravatar of W. Peden W. Peden
    23. February 2015 at 09:00

    steve,

    “But back to the original statement “If something is cheaper, people will likely buy more of it”…

    Yes, it lacks nuance (prices don’t drop in a vacuum), but isn’t it basically true?”

    I’m afraid you’re still missing the point. WHY is the good/service cheaper?

  17. Gravatar of Becky Hargrove Becky Hargrove
    23. February 2015 at 09:03

    Steve,
    The likelihood that you would purchase cheap real estate in the “middle of nowhere” is a relative equilibrium state. Like you, others might find the price appealing, but not in enough quantity to return property value to the “apparent” utility it seems to hold based on price. Accessibility to work determines the pricing equilibrium that individuals generally select.

  18. Gravatar of ssumner ssumner
    23. February 2015 at 09:12

    Market Fiscalist, Yes, that would have been fine, if he’d said that.

    Crisisstudent, Very good example.

    Steve, See Nick’s comment below.

    Wade, Where is the typo?

    Becky, Yes, a shift in demand for oil.

    Peter, Good point.

    Thanks Nick.

    Steve, You asked:

    “Yes, it lacks nuance (prices don’t drop in a vacuum), but isn’t it basically true?”

    If it is true, it’s not because of anything in supply and demand theory in EC101. If it’s true it’s because supply curves shift more frequently than demand curves. reread the quote above, he was making it seem like a prediction of S&D theory.

    Steven, Those observations about the oil industry may be true, but it’s not clear how they relate to this post.

  19. Gravatar of jb jb
    23. February 2015 at 09:35

    I think the key is the word “oil” – everyone has a social, emotional and structural attachment to oil, because it is so important to our economy, and we all have to buy it on a regular basis. So it skews understanding.

    So, what if we changed the object:

    The price for a bucket of warm spit has plummeted in recent months.

    And then we saw the reporter write:

    If something is cheaper, people will likely buy more of it. That core principle of economics is proving to be especially true with spit after its recent plunge.

    Divorced from the context of “something I buy every week”, perhaps the underlying logic will rise to the surface?

  20. Gravatar of Charlie Jamieson Charlie Jamieson
    23. February 2015 at 09:39

    Is it fair that say falling price affects demand, but only in the context of other factors and usually only in a limited degree.
    Re: Great Plains realest estate — price matters but can’t overcome other factors, like supply, utility, liquidity, securitization prospects.

  21. Gravatar of Doug M Doug M
    23. February 2015 at 09:40

    While I understand your primary point… if prices fall due to a supply shock, people will buy more of that good. This is a shift in the equilibrium point, it is not a shift in the demand curve. This increase in quantity demanded will not push the price back up toward the original price…

    However, suppose I was considering the purchase of a new car. In the June of 2014, I had a view of the likely range of gas prices and I was leaning toward the electric car, but today gas prices are lower, and I am thinking that the gasoline powered car makes more sense.

    If enough people think like me, it seems possible that a significant shift in the short-run price could cause a long-run shift in the demand curve.

  22. Gravatar of William William
    23. February 2015 at 09:45

    steve,

    Let me try my hand at an explanation.

    The demand curve embodies the notion that the quantity demanded of a good is a function of the price of that good. So we’re talking about theoretical but still imaginable situations in which suddenly all potential demanders are offered the opportunity to buy at a series of prices P, then we record how much they would buy at those various prices.

    But the important thing to realize is that a real-world change in the price of something is an entirely different thing from that theoretical survey we did of potential demanders. Recall that the big payoff of drawing those supply and demand curves is that we find the equilibrium price and quantity at their intersection. But if the real-world, observed equilibrium price of oil changes, it cannot possibly be the result of either a downward-sloping demand curve or an upward-sloping supply curve. If the equilibrium price has changed, then one or the other of those curves has to have shifted.

    If two lines intersect at a lower point than they did before, it can’t be caused by the fact that one of those lines is downward-sloping.

  23. Gravatar of Steven Kopits Steven Kopits
    23. February 2015 at 09:48

    Scott:

    You write or quote

    “Oil’s Plunge Could Help Send Its Price Back Up

    ‘If something is cheaper, people will likely buy more of it. That core principle of economics is proving to be especially true with oil after its recent plunge.’

    The first two sentences of the article are breathtakingly wrong.”

    I think most readers of the WSJ appreciate that there has been in recent months an oil supply surge, not a global recession. While there has been some question of whether demand is weak or not (to wit, Hamilton and PIRA), in reality oil consumption did not much change during the course of 2014, and of course, US gasoline demand is up 8% year on year; and Europe is up; China is up; and the rest of the non-OECD is also up.

    I think your analysis implies that everyone out there is living in some sort of vacuum and has no feel for the broader economic context. I think that’s untrue.

    Therefore, when the WSJ writes that people buy more of something when it’s cheap, the typical WSJ reader is thinking of a well-documented supply surge, rather than that the US or global economy is falling apart. Put another way, when falling prices are due to excess supply, we can expand demand to increase and supply to decrease over time.

    But even if you were right, if prices are below marginal cost–and no one disputes that oil prices are today below system-wide marginal cost–supply and demand will equilibrate over time with the effect of raising prices.

    We can nitpick that the WSJ didn’t quite get the wording right to correctly answer an essay question on an economics exam. But the writer is not taking an economics exam, but rather writing for an audience with whom he shares knowledge and certain assumptions about the state of the world.

  24. Gravatar of TravisV TravisV
    23. February 2015 at 10:19

    Krugman has a new column getting a lot of attention but I think there are problems with it…..

    http://www.nytimes.com/2015/02/23/opinion/paul-krugman-knowledge-isnt-power.html

    Soaring inequality isn’t about education; it’s about power

  25. Gravatar of Major.Freedom Major.Freedom
    23. February 2015 at 10:53

    It is OK to be absolutely certain that there is a difference between shifts in demand and shifts in quantity demanded.

    Just make sure you pay lip service to skepticism when asked.

  26. Gravatar of honeyoak honeyoak
    23. February 2015 at 10:55

    I think much of the confusion stems from sloppy empiricism by economists. It is a very difficult task (even for experts) to bridge the Gap between models and reality. I think that most people use theoretical language to describe what is going on (demand goes up) rather then formulate a coherent understanding of what events happen. My dear father for example disagreed with me that empirical evidence on commodity prices disproves mean reversion unlike stocks. It wasn’t until I questioned him that I discovered mean reversion to him is “prices that fall can sometimes go up”.

  27. Gravatar of TravisV TravisV
    23. February 2015 at 10:57

    Ezra Klein on Krugman’s new column:

    http://www.vox.com/2015/2/23/8091137/krugman-soaring-inequality-isn-t-about-education-it-s-about-power

  28. Gravatar of Charlie Jamieson Charlie Jamieson
    23. February 2015 at 11:09

    The Krugman column is true enough — it’s conventional wisdom.
    You need more and more education these days just to stay in the same place.
    Because there are fewer jobs available, companies can demand educational requirements that used to be unnecessary.
    Agree that power is the root of inequality. After the financial crisis, owners of financial assets were bailed out but labor was liquidated.

  29. Gravatar of Major.Freedom Major.Freedom
    23. February 2015 at 11:11

    Steve wrote:

    “OK, I’m lost, what is wrong with that statement? Don’t lower prices usually translate into an increase in the amount sold of a given product/service?”

    Nick Rowe replied:

    “Demand curves slope down, yes. (A fall in price causes and a movement along the demand curve and an increase in quantity demanded.)”

    “But supply curves slope up. (A fall in price causes a movement down along the supply curve and a fall in quantity supplied.)”

    I hope Nick is speaking counter-factually, because each successive moment in time is very much capable of having a new supply and demand “cross”. The cross is hypothetical at every point except the intersection. One must not assume that for a given cross, that a change in supply or demand will result in a “movement along” one of the hypothetical trend lines.

    Falling prices do not cause a counter-factual reduction in supply. Falling relative profitability does that. A rise in quantity demanded that is brought about by a rise in productivity and lower costs does not reduce profitability, ceteris paribus.

  30. Gravatar of Jason Smith Jason Smith
    23. February 2015 at 11:23

    One can imagine an analogy to the forces of supply and demand using an entropic force like osmosis. Osmotic pressure (price) goes up, but that doesn’t tell you whether you’ve added salt to one side of the semi-permeable membrane (supply change) or water to the other (demand change) …

    http://informationtransfereconomics.blogspot.com/2015/02/why-focus-on-supply-and-demand.html

  31. Gravatar of Vivian Darkbloom Vivian Darkbloom
    23. February 2015 at 11:23

    “Rising inequality isn’t about who has the knowledge; it’s about who has the power.”

    Did you notice how Krugman moves seamlessly from “college” to “education” to “knowledge” as if they are necessary and inevitable progressions?

    I’m pretty sure that the correlation between a college degree and “education”, much less “knowledge”, has gotten more tenuous over the past several decades. Bill Gates may not have a college degree, but that certainly doesn’t mean he lacks knowledge.

  32. Gravatar of Vivian Darkbloom Vivian Darkbloom
    23. February 2015 at 11:25

    Postscript: Perhaps Paul Krugman should pay more attention to what (or what is not) happening in college these days.

  33. Gravatar of Charlie Jamieson Charlie Jamieson
    23. February 2015 at 11:37

    He’s talking about college, because that’s what the debate is centered around.
    It might be better to talk about skills and what their economic value.
    An education in art history would be less economically valuable than an education in dentistry, for example.
    Bill Gates is an interesting example is why we have inequality — a system in which gains flow to concentrated groups of people. It’s why we need trust busting and similar actions to stop these concentrations of wealth and power.

  34. Gravatar of bill woolsey bill woolsey
    23. February 2015 at 11:42

    An increase in quantity demanded and an increase in demand both mean that people want to buy more.

    However, economists use the different phrases depending on what caused people to buy more. If it is a decrease in the good’s own price, it is described as an increase in quantity demanded. If it is anything else that causes people to buy more, it is described as an increase in demand.

    Now, if you think economics is a branch of geometry, then I suppose you can refer to movements along a curve or shifts of a curve. But I would suggest that this talk of curves, while true enough, leads to a question–why do we draw the curves in that fashion? Why is the goods price always on the vertical axis and not one of the many other things that influence what people will buy or sell?

    The reason for the odd terminology is that economists have long believed that prices adjust to coordinate purchases and sales. All sorts of things to break up coordination, but then prices adjust to bring them back together.

    The use of the special terminology does help avoid the “endless circle” nonsense Higher demand, higher price, lower demand, lower price, higher demand, higher price and on and on.

    It is higher demand, shortage, higher price lower quantity demanded (and higher quantity supplied,) no more shortage, higher price and quantity done. I didn’t include in my story “lower demand” though I did say lower quantity demanded.

    Maybe it helps.

    As a long time teacher, I think students don’t get much beyond the equilibrium price and that if the price is too high or low, there is a surplus or shortage. The whole, shifts in the curve business looses many of them.

  35. Gravatar of Zack Zack
    23. February 2015 at 13:42

    Does Krugman really think what the “skills gap” people are complaining about is that there aren’t enough people who have pieces of paper saying they graduated from college? I thought it was pretty obvious that the argument has been that people, including college grads, are not entering the workforce with necessary skill sets and knowledge. That’s a completely separate debate.

  36. Gravatar of Donald Pretari Donald Pretari
    23. February 2015 at 14:50

    “If something is cheaper, people will likely buy more of it.”

    I might not understand either, since my first thought was that such a law would make saving almost impossible. I read it as meaning the same people already buying it immediately begin buying more of it.

  37. Gravatar of Gordon Gordon
    23. February 2015 at 14:51

    I see these kinds of mistakes being similar to situations in which reasonably intelligent people who know basic probability will get the probability of a coin flip wrong. Or remember when Marilyn Vos Savant published in her newspaper column the Monty Hall brain teaser involving three doors behind which were two goats and a car? Many mathematicians got the wrong answer. Furthermore, even when shown the correct answer many insisted that the wrong answer was the proper one.

  38. Gravatar of Toby Toby
    24. February 2015 at 00:54

    Scott,

    I don’t feel like splitting hairs, but just to be sure you do mean the two sentences in combination right? I don’t feel particularly qualified to lecture you a Chicago PhD and a professor of economics on economics, but the statement,

    “If something is cheaper, people will likely buy more of it.”

    is essentially correct.

    It’s what follows that is incorrect: whether something is cheap or dear has nothing to do with its price. What matters is what has to be given up in comparison and this is all that cheap or dear can refer to. What other meaning could it possibly have?

    I suppose though that we’re on the same page regarding this?

  39. Gravatar of Ray Lopez Ray Lopez
    24. February 2015 at 02:36

    Exercise for the student that understands supply and demand: explain how money, even fiat money, is a commodity like any other. Given this neutrality of money, demonstrate that increasing the money supply, absent a constant Zimbabwe style acceleration of the money supply, will not affect anything, certainly not Q or real GDP. Ergo, it follows ‘targeting NGDP’, within limits (i.e. no Zimbabwe style printing) is an exercise in futility.

  40. Gravatar of dtoh dtoh
    24. February 2015 at 04:36

    Scott, you said,
    “QM is too hard for me, but I do understand supply and demand.”

    If you did not suspend your otherwise sound understanding of supply and demand when it comes to financial assets, QM would not be hard for you. Hint….Changed expectations of future NGDP causes a shift in the supply curve.

  41. Gravatar of Nobody understands that nobody understands supply and demand « Economics Info Nobody understands that nobody understands supply and demand « Economics Info
    24. February 2015 at 05:01

    […] Source […]

  42. Gravatar of ssumner ssumner
    24. February 2015 at 05:56

    Charlie, You asked:

    “Is it fair that say falling price affects demand, but only in the context of other factors and usually only in a limited degree.”

    No. Price has no effect on demand.

    Doug, Here you want to think in terms of less elastic short run demand and more elastic long run demand.

    Steven, Sorry, but your defense fails on two levels. The second sentence is still wrong, and the press has been full of stories of slowing growth in China, Europe, etc, impacting oil demand. But the basic point is that EC101 does not predict that lower prices will cause people to consume more. That’s just false. Period, end of story. Furthermore, people frequently make these reasoning from a price change arguments even when the needed shift in S&D did not occur, as in the Shiller example I did a couple weeks ago.

    Travis, I don’t like that Krugman post, I’ll do a reply.

    Jason, Good analogy.

    Vivian, Good point. That was my reading as well.

    Bill, Yes, most students struggle with this.

    Gordon, Very good comparison. I’d add that you can compare to the famous multiple choice question of opportunity cost, which 75% of economists got wrong at an econ convention.

    Toby, You asked:

    “If something is cheaper, people will likely buy more of it.”

    is essentially correct.

    No, it’s false. You cannot predict quantity from changes in price. You need to know whether the price change was cause by a shift in supply or demand. If demand falls then price will be lower and people will buy less.

  43. Gravatar of dtoh dtoh
    24. February 2015 at 06:19

    Scott – By QM I thought you meant quantity of money. Now I suspect you were referring to Quantum Mechanics.

  44. Gravatar of Jeff Jeff
    24. February 2015 at 08:26

    Sometimes I wonder if our ordinary intuitions are closer to the truth than experts think. Sometimes.

    It makes perfect sense to argue that if price fell, either demand shifted in or supply shifted out. But why is it wrong to think, or project that in response to the lower price, consumers will demand more? In the traditional PxQ diagram, preferences are held constant (right?), but if consumer preferences favor the cheaper good, then it would seem that knowledge of the cheaper good can shift the demand back out.

    I’m curious to know why this argument fails.

  45. Gravatar of TravisV TravisV
    24. February 2015 at 08:52

    Prof. Sumner,

    You might also find this discussion interesting:

    http://www.nextnewdeal.net/rortybomb/one-where-larry-summers-demolished-robots-and-skills-arguments

    Particularly this from Larry Summers:

    “I think that the broad empowerment of labor in a world where an increasing part of the economy is generating income that has a kind of rent aspect to it, the question of who’s going to share in it becomes very large. One of the puzzles of our economy today is that on the one hand, we have record low real interest rates, that are expected to be record low for 30 years if you look at the index bond market. And on the other hand, we have record high profits. And you tend to think record high profits would mean record high returns to capital, would also mean really high interest rates. And what we actually have is really low real interest rates. The way to think about that is there’s a lot of rents in what we’re calling profits that don’t really represent a return to investment, but represent a rent.”

  46. Gravatar of TravisV TravisV
    24. February 2015 at 09:02

    Pethokoukis: “Krugman vs. Piketty on what to do about inequality”

    http://www.aei.org/publication/krugman-vs-piketty-inequality

  47. Gravatar of TravisV TravisV
    24. February 2015 at 09:25

    Prof. Sumner,

    Are you as dismayed as I am that Joe Leider wrong the following:

    http://joeleider.com/economics/the-division-between-capital-labor-part-ii

    “Any owner of assets whose value is determined by interest rates will have benefited tremendously from Fed policy. House prices have reflated because mortgages cost less. Stocks are up because bonds return practically nothing.”

  48. Gravatar of Charlie Jamieson Charlie Jamieson
    24. February 2015 at 09:29

    Price has no affect on demand?

    We must be defining ‘demand’ in some way that I don’t understand.
    Because if you lower prices (all things being equal) you will sell more goods or services and bring more people into the marketplace.
    You must be saying that if prices fall then it’s because the supply expanded … and that there was demand all along at the higher price but the consumer wouldn’t act because of price.
    In that case you could just say that if prices fall, sales will rise.
    Example: Demand for laptops is always high, but when technological advances make them cheaper to make and prices fall then more laptops are sold.

  49. Gravatar of Toby Toby
    24. February 2015 at 10:28

    Scott,

    I don’t disagree with your statement regarding price. What I don’t understand then is what it means for you to say that something is cheap or cheaper.

    To me it means that less has to be given up for the same thing or to supply the same thing.

    Does it mean to you that prices drop or something else?

  50. Gravatar of TravisV TravisV
    24. February 2015 at 13:00

    Noah Smith: “Back to corporatism?”

    http://noahpinionblog.blogspot.com/2015/02/back-to-corporatism.html

  51. Gravatar of Joe Leider Joe Leider
    24. February 2015 at 14:22

    TravisV, I do think that interest rates will affect the demand for stocks. But certainly it’s not the only link in the chain of causality. For example, if interest rates are low because markets expect a collapse in demand, that would be terrible for stocks. But rates are low now because our expectations of inflation are muted, but we expect the Fed to at least keep the economy alive. That’s very good for stocks because wages remain muted and rates will stay low, but the economic news will stay positive. Now I’m not 100% certain that I’m not engaging in circular logic (sorry for the double negative). I’ll let Scott be the judge of that.

  52. Gravatar of Gordon Gordon
    24. February 2015 at 14:44

    “I’d add that you can compare to the famous multiple choice question of opportunity cost, which 75% of economists got wrong at an econ convention.”

    As a non-economist, I had to Google this story and the results are surprising. 78.4% of the economists gave the wrong answer. Amongst college students, only 7.4% of those who had taken an economics course gave the correct answer while 17.2% who had never taken an economics course answered correctly. And I didn’t see anything in the question that was designed to mislead people.

  53. Gravatar of Derivs Derivs
    24. February 2015 at 15:55

    “It would be easy to mock the particular reporter who wrote this piece”

    Start counting the times someone says the market went up because there were more buyers than sellers. Pretty much the same thing.

    It always intrigued me how people can be so aggressive to buy something at a high price, and moments later, when a market starts dropping you can’t find ANY buyers at much lower prices.

  54. Gravatar of Don Geddis Don Geddis
    24. February 2015 at 19:19

    @Charlie Jamieson: “Because if you lower prices … you will sell more goods

    Who is the “you” here, that is lowering prices? The supplier, right? This means, in the standard Econ 101 Supply and Demand model, that the supplier is willing to provide the same quantity, at lower prices. This means that the supply curve has shifted right. At each hypothetical price, the suppliers are willing to provide greater quantity.

    Yes, a shift in the supply curve to the right, indeed results in both lower prices and higher quantity.

    But there’s a second, completely opposite, way for prices to fall. Instead of the supply curve shifting right, you could have the demand curve shifting left. (Notice that all of your examples were only supply changes, and you offered no examples of demand changes.) If demand shifts left (but supply stays the same), then both prices and quantities fall.

  55. Gravatar of Rajat Rajat
    25. February 2015 at 03:28

    Check this out – now the RBA Governor is reasoning from a price change: http://www.abc.net.au/news/2014-08-21/reserve-bank-stevens-says-real-wage-declines-a-positive-for-eco/5685874

    No wonder things have been going pear-shaped the last few years!

  56. Gravatar of mico mico
    25. February 2015 at 04:34

    Perhaps I also belong in the stupid box…

    but surely even if it is true that price has fallen because demand has fallen due to some exogenous factor, the lower price means that demand is likely to be higher than it would have been with that same exogenous factor but in the absence of the price fall?

  57. Gravatar of ssumner ssumner
    25. February 2015 at 06:22

    dtoh, Yup, quantum mechanics.

    Jeff, You asked:

    “But why is it wrong to think, or project that in response to the lower price, consumers will demand more?”

    If you mean that other things equal quantity demanded will rise, that’s fine. But it has no bearing on this post. I was criticizing claims about QUANTITY bought and sold in equilibrium, not a change in quantity demanded holding other things constant. I was discussing market equilibrium. Would it also be correct to argue that lower prices lead to less quantity supplied? And hence less sold?

    Travis, Thanks for the links, and yes, you should be dismayed by almost everything you read.

    Charlie, You said:

    “We must be defining ‘demand’ in some way that I don’t understand.”

    I’m using the official definition from any EC101 textbook. Price has no effect on demand. I’d strongly suggest you read one, as almost everything you said in this comment is completely wrong. I can’t teach EC101 to commenters, I don’t have the time. No offense, but a certain minimum level of economic knowledge is assumed if you are going to follow this blog. S&D is one of those things I expect people to know.

    Toby, When I say cheaper I mean the price drops.

    Joe, I think the point of your comment is that you need to look at multiple factors.

    Gordon, I had the same reaction—the question seemed simple to me. But some economists claimed it was deceptive.

    Rajat, Thanks for the link.

    Mico, Quantity demanded, not demand—the distinction is crucial. Consider a price ceiling. That’s a good example of the price changing, other things equal. In that case the quantity demanded rises but the quantity purchased falls

  58. Gravatar of Peter Drake Peter Drake
    8. March 2015 at 00:32

    You’re using demand in a way I dodn’t understand either. FYI, I took EC101 (almost 30 years ago) and read business and financial press everyday. If prior knowledge of your definition of demand is a prereq for understanding the blog then you’re basically asking me to leave.

  59. Gravatar of Major.Freedom Major.Freedom
    8. March 2015 at 01:34

    Charlie, and Peter Drake:

    The textbook definition of “demand” that Sumner is referring to, can best be understood as a list of prices and quantities demanded for the same good.

    Consider apples as the good. As examples: At a price of $0.10, the quantity demanded is 10 apples. At a price of $0.20, the quantity demanded is 8 apples. At a price of $0.30, the quantity demanded is 7 apples.

    Graph these points out. Connect them.

    That trend line you draw, THAT is the “demand” for apples.

    So according to this definition of “demand”, it is true to say that a price change has no effect on “demand”, because going from $0.10 to $0.20 to $0.30 price for an apple, each corresponding to a particular quantity of apples demanded, we are just referring to “the demand” for apples.

    Personally, on the other hand, I find the classical definition of “demand” to be most useful and most clear. The classical definition of demand is the total dollars spent on a group of the same good. For example, ‘the “demand” for apples is $100’ means that $100 is being spent on all apples, from either one person or two or more persons.

    Working with ceteris paribus conditions with this definition yields the following statements that I am sure you will find intuitive:

    If the supply of apples rises, then holding demand constant, the price of apples will fall.

    If the demand for apples rises, then holding supply constant, the price of apples will rise.

    If the supply of apples rises, and the demand for apples rises by the same rate, then the price of apples will remain unchanged.

    If the demand for apples rises more than the supply of apples, then the price of apples will rise.

    If the demand for apples falls, but the supply of apples falls further, then the price of apples will rise.

    Etc

    I believe a main reason of confusion over the mainstream definition of demand, can be overcome by using the classical definition of demand and then translating it.

  60. Gravatar of Don Geddis Don Geddis
    8. March 2015 at 09:42

    @Peter Drake: “Demand” is not really so hard. But you do understand that there needs to be a difference between “movement along a demand curve” and “a movement of the demand curve”, right?

    You know the standard supply and demand graph, right? There’s a supply curve, and a demand curve, and, in a free market, the intersection is where the price settles (which causes quantity demanded to equal quantity supplied, at that market-clearing price). Now, what happens if the demand curve doesn’t change, but the supply curve moves? Both price and quantity observed in the market will be different, at a new equilibrium. But the demand curve “hasn’t changed”. What words do you want to use to describe that situation?

    The mainstream press sometimes writes “demand has changed”, while confusing whether it was a movement along the demand curve, or a movement of the curve. But on an econ blog, it’s critical that you distinguish them.

    Here, the term “demand” refers to the demand curve — which already, by itself, refers to many different quantities (potentially) demanded, at a whole range of different (possible) prices. A supply change that causes a movement to a different price/quantity equilibrium on the same demand curve, is not a “change in demand”.

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