Demand and Supply, Consumer Goods, Prices and Exchange

0:00Well, what micro means in economics is dealing with the individual, with the individual level, individual action, the market, prices, dealing with demand, supply, production, the oil price thing which is happening somewhere. These things are part of micro. Macro deals with the larger pictures like inflation, unemployment, business cycles, that's where everybody forecasts, economists forecast every year and always get it wrong, forecast always way off the beam, that's macro. Micro is in pretty good shape, I think it's basically sort of a consensus about micro. Macro is pretty screwed up for good reason, but at any rate, we're dealing now with sort So the basic economics, even good macro is essentially based on micro, so it's best to take micro first.

0:49We deal in economics with, we don't deal only with numbers and graphs. As usually happens in economics, the graphs came in and the numbers came in, in order to simplify, to present a simple basis of theory. Everybody got enchanted with a graph, the graphs became an end of themselves, and economists What we're dealing with, economics really deals with the individual and starts with a very simple fact, simple basic fact, namely everybody has goals which they're trying to achieve, he or she is trying to achieve. The goal can be a very simple one, like eating a sandwich in one hour, a simple short-run goal, it can be a much longer goal, graduating from poly, getting a job in electrical engineering, or whatever. The goals which they're trying to achieve, he or she is trying to achieve. The goal can be a very simple one, like eating a sandwich in one hour. A simple, short-run goal can be a much longer goal. Graduating from poly, or getting a job in electrical engineering, or whatever.

1:38There's a whole structure of goals. And in order to achieve these goals, you have to employ resources of some sort. You have to do something. In other words, by having goals of a sort, you're assuming that people can achieve them. These can take measures to take steps to buy a ham sandwich or to find a newspaper or to buy a hi-fi set or whatever, or to graduate from poly. These things are at least presumably accomplishable. In other words, everybody has a different objective in mind and has an idea of how to arrive at it, how to go about it. This is basically the source of economic theory. Economic theory is a deductive system built on this and this basic fact, on economical action. In other words, the fact that people act in the world to accomplish something. And I say the accomplishment can be very short-run, it can be very simple, it can be eating a sandwich, or it can be very complex, a whole series of things.

2:29It doesn't matter. From the point of view of economics, it doesn't matter what the goals are. That's up to some other discipline to worry about. What we deal with is the fact that people employ resources of different sorts to arrive at goals. Okay, this is what action is. You have goals, and you've got resources to try to achieve them. This is also called a means-ends relationship. You have an end or an objective, and you employ a means, different means to try to achieve it. Okay, what are some of the resources? Well, in first place, we kind of like to deal with what's known as Crusoeconomics. Robinson Crusoe, you're familiar with this little tale, also been in the movies, where the guy shipwrecked and he winds up on an island somewhere in the South Pacific, and he's got no resources except himself.

3:15He has different goals as the chief, one he's got to keep alive, these would be the basic for him to accomplish anything else. So in the case of Crusoe, the reason why we like to use this is it's a stark situation where we can isolate one person, you can take one person vis-a-vis nature and bring in other people later on. That's how you sort of deal in economics. You should take one simple situation and you add on a more complex situation after you analyze it. So if you have Crusoe, okay, he's got different goals or objectives. Food, he looks around fast to find out what the sources of food are. Shelter and clothing or whatever. So that's some of his priorities and he lists them in a certain rank. What are his means? What are his resources that he has? Like, he looks around and first of all he's got himself. He's got his own personal energy, and he's got his own technological knowledge.

4:02Presumably he doesn't have amnesia. He knows how to fish or chop down trees or build a bow and arrow or something like that. Technology is low tech. High tech doesn't make it on Desert Island or Crusoe Island. Unfortunately, the knowledge about how to construct a computer or something, how to use it, is not going to do him much good. But low tech, even if it's low tech, it's an important tech for him, namely how to fish and how to hunt and that sort of stuff. I construct a log cabin. All right, so he's got technological ideas. And he's also got different natural resources. He looks around and he's got, let's say, there's trees or there's fish. He looks around and finds out what the natural resources are, and that's what he starts off with. He starts off with technological ideas, his own personal energy and natural resources. This is basically what we have in the world in general. The world starts off, you look at the caveman. The caveman will start off with just a person, some kind

4:51The Theory of Money and Credit

5:21and the proletariat type, since Marxism came and we think of a laborer as somebody who's working a steel mill or something like that. This concept of labor means anybody who works in production. We haven't defined production. It means doing something in the world to transform it for consumer goods. We'll get to that later. So everybody is a laborer in that sense. Anybody who works in production is a laborer in this sense. The president of General Motors is a laborer just as the guy who works on the assembly line. Who isn't a laborer? Well, People who are clipping coupons, doesn't mean they're not important, just they're not laborers. People who are stockholders, per se, or bondholders, are not engaging in personal labor in the plant, which really means here personal energy. Natural resources, since it was 18th century agricultural Britain, is called land, the famous land and labor.

6:08So we're stuck with the word land, we're stuck with the word labor, but again it doesn't quite mean what we think of in common sense terms now. Land and economics means ground land. It means natural resources. It doesn't mean, in other words, this building here. We think of land, we think of the building, we think of it as the building here. But land is considered in economics only the ground underneath. In other words, nature made and not man made. So land also includes fish, includes natural resources on the water, includes water. See, when they were making up economics in the 18th century, water was not considered a scarce resource. We consider super-abundant and have plenty of wet agriculture. Nowadays we know better, water is scarce, so water is a scarce resource, fish are a scarce resource, also other things like TV channels, frequencies, things like that, are also land in that sense, in other words, natural resources.

6:59Space is land, ocean is land, lots of resources in the ocean which haven't been tapped yet. There's mineral in the bottom of the sea and things like that, this is all land, quote unquote, in other words, natural resource. The land means natural resources, labor means personal energy. Okay, what else is there? What else? Everything else. In other words, people, man, take natural resources and transform them in order to get to what? The consumer goods so they can use it. In other words, Crusoe's got to eat, he's got to take the resources, he's got to shoot the deer or catch the fish and eat it. So he's got to do various things to get to consumer goods. The objective of working hard to do this is to wind up with consumer goods. Food, shelter, clothing, high-fives, that sort of stuff. These things are consumer goods, used as an end of themselves.

7:46This is what the objective of action is all about. Consumer goods are coming off the assembly line, so to speak. Everything else, which is not labor or natural resources, is called capital goods. Capital consists of everything used in production, which is not land or labor. The end process of millions of people engaged in production, By the way, what is production? Production is a transformation, the use of labor, working on natural resources to transform into capital, different types of capital, finally you wind up with consumer goods.

8:44So production is this whole process of starting with land and labor and winding up with consumer goods, with different degrees of capital. So for example, let's take a ham sandwich that goes in there. It's a whole production tree of structure production, starting with a farmer and miner and so forth, going for about 30 years at least, so you get the ham sandwich. Ham Sandwich

9:32You don't have to be combined to get to the one ham sandwich, you have to be produced for many years. The ham is sold by a wholesaler, and they get it from a jobber, which is like Eastern Seaboard, they get it from Chicago, they get the meat packer, the meat packer, they package the meat in slaughterhouses, the slaughterhouse gets it from the farmer, raises the pigs, they have to have stockyards, they have to have trucks in every step of the way, and gasoline for the trucks and tires, and on and on and on, this is only for the ham. The pigs have to eat, they usually eat corn, the corn has to be grown and on and on and on,

10:31at every step of the way, and one of the amazing things about the market, the free market economy, is it all works. For me to get a ham sandwich right today, you don't have to have some world planning board, eight guys on a planning board sitting around 30 years ago, and say, let's see, on January 28th, 1986, we have to get Rothbard a ham sandwich, therefore you gotta go raise the pigs, you over there go raise the corn and so forth, gotta get Rothbard a ham sandwich. Nobody does that. There's no world planning board trying to figure this out. If there were, we'd all be in big trouble. And yet it all works at every step of the way, all these things happen at every step of the way with no shortages and no surpluses. Everything fits together like a latticework structure. The market economy is like a latticework, like a lace thing. It all fits in. How come it all fits in? There's no planning board that fits it all, and the market itself does it.

11:17And really what microeconomics is, is to study how the thing works and what happens when the government intervenes in the process and screws everything up. The big factor here, which is true both in Crusoe and for us, the big factor is this. We contrast the world with what I call the Garden of Eden model. Some people believe mankind used to be in the Garden of Eden and was then kicked out for various transgressions. Whether it's true or not, it's an interesting model to look at. The Garden of Eden, everybody satisfies his or her wants in unlimited fashion, but no work, no nothing. Snap your fingers and Pepsi is trickling down your throat. Nobody has to work at it, nobody has to produce it. Why is that? Because there's no scarcity. If there's no scarcity, you don't need private property, you don't need labor, you don't have to work. Unfortunately, we were kicked out of the Garden of Eden if it ever existed. And so in the world as it exists, in human history, there's tremendous scarcity. You don't have unlimited abundance of all factors of production of all goods.

12:07The Garden of Eden models unlimited abundance of all desire for good. If somebody wants to hear a symphony, they snap their fingers and get it right there. We haven't got that. We have to have somebody working to produce it. And so what we have is the ever-present fact of scarcity. Scarcity meaning scarcity of resources relative to the goals that we have and we've got to try to accomplish. Scarcity of resources, scarcity, we'll see in a minute what the resources are. Obviously, it's scarcity of land, labor, and capital. Scarcity in the sense that we'd like to have more of it. If we had more of it, we could produce more, consume more, get a higher standard of living. If we had no scarcity, if everything was super abundant, we wouldn't have to work, we wouldn't have to worry about anything, we'd just have to eat trickling down our throat, just like that, or whatever equivalent. What happens is the caveman has everything that's extremely scarce. They're in bad shape. Crusoe is in bad shape. Everything is very scared. He's going to die tomorrow. He doesn't get food immediately.

12:53The progress of the human race, the progress of civilization, is essentially the alleviating of scarcity. Scarcity is still there. There's a lot less of it. A lot further from the brink than Crusoe is, or the caveman was. A higher living standard. So the progress of human race is essentially the progressive diminution or alleviation of scarcity. Scarcity is still there, but there's just a lot less of it. In the intellectual world, there are sort of fashions. One of the few good things about being in my advanced age is I've seen them all. All the fashions come and go. Every five years, some new nut comes on with a new theory, and everybody adopts it for about five years and forgets it five years later. One nutty theory that came in about 1970 was there's no more scarcity. Economics, microeconomics might have been correct. In the old days, there was scarcity. Now, there's no scarcity. It's cool. We live in a post-scarcity world.

13:45What does that mean? I don't know what it means. What it really would mean is we're back in the garden of Eden. Nobody has to work, nobody has to produce. No, not. Obviously, we're not in that situation. I remember I had a debate with some turkey. I think it was at the American University in Washington, which is an odd place anyway. I was on the question about, do we live in a post-scarcity world? He was maintaining we live in a post-scarcity world, therefore we don't have to work, and therefore, I don't know what this therefore was, we're all very murky. His conclusion was that you should therefore have socialism. I'm not sure why that was the conclusion. Presumably, if there's no scarcity, you can have anything you want. Deuces are wild. So I said, well, if it's true that Professor So-and-so is right that we live in a post-scarcity world, why does he tear up his paycheck? Why does he at least tear up his raises that he gets every year?

14:30Anyway, his answer was an interesting answer. That's because I, too, have been sucked into the capitalist ethos. So it's interesting in reply. In other words, he's also saying, he's admitting there is scarce, and he's trying to alleviate it as much as anybody else. That has been forgotten. I haven't heard that for a long time now about post-scarce. As a matter of fact, the next fashion that came in shortly after that, I think by 1975, my God, everything is scarce. We're going to run out of resources. That was a big gimmick for about five years. From 1975 to 1980, the same jerks were claiming we live in a post-scarcity world, and therefore we should have socialism. I don't know how the therefor comes in. I can never figure that out. Dens said from 75 to 80, oil resources are running out. Oil is going to run out. Energy is going to run out. Forests are going to run out.

15:15Therefore, we should have socialism. The conclusion is always the same. There's never any connection. Then you have to run around refuting that. And it turned out by 1980, they shut up after that because there's plenty of resources. There is scarcity like there always has been, but there's plenty of resources. Nothing ran out. We got into the oil caper, by the way, fairly shortly. We got into the whole energy crisis, the alleged energy crisis, and all the rest of it. It's an interesting example of this stuff in action. So we have an ever-present scarcity of resources, and people therefore have to allocate their resources to the highest values, to their highest values, and try to make sure that they don't waste them, in the sense that they make sure they don't spend their time or their energy or whatever, and stuff they'll regret, figure that they really should have spent on something else. These resources, by the way, also include time. Time is a resource, scarce, as you all know.

16:05What are you going to do tonight? What are you going to do for a block of hours from, say, 8 to 11 or something? You have all sorts of choices. Every person has a concrete choice. You can go to a whole bunch of movies, not all at once. See people. You can do homework. Each of you could probably get a list right now of seven or eight things you could do tonight. How do you decide what you should do? Well, you decide on basically your own personal values, which you think is most important. Which you think is more fun. Whatever it is, you decide, one way or the other. It doesn't have to be an excruciating decision. You don't have to spend 10 hours on it. You can make a snap judgment. Economists, again, don't care about how long it takes to make a decision. That's not our bag. That's the psychologist or whatever. What we're interested in is the fact everybody's got scarce resources, everybody's got goals they're trying to achieve,

16:46nd the people are trying to achieve scarce time, scarce money, scarce labor, scarce capital, whatever, and they're trying to allocate as best as they can the best possible advantage. If you pick a movie, a certain movie, movie X, and you go to that, it turns out it was a bummer, you find out, I wasted time and money, wasted money going to it, and you went to waste the time, you could've gone to something else, you could have done something else, so. And looking back you figure, you took a loss, a psychic loss on it. The other half of the good movie you figure it was a psychic gain, you benefited from this. If somebody looks at it prospectively, tries to do the best he can, or she can, and looking back, he'd say, well gee, I was good, or I was a bad action, or a good action, or I was too costly, or I was a loser, you figure out the next time you won't go to a movie with this director in it, or a movie with this particular actor in it, because often, the same actor usually appears in the same kind of movies. So you learn from experience, hopefully, you do better next time, presumably. Talking about Crusoe, and also about life in general, and shifting back and forth between them,

18:16Natural Resources, transform them, move them over vast spaces, and finally get to the consumers and sell them consumer goods. That's how the whole economy is oriented. Another thing about human action in general, about CUSO and about life in general, is that it takes time. Everything takes time. Some things take less time, others take more time. And everybody prefers having stuff now than waiting for it. So anybody has a choice of, aside from price changes, human prices remain the same, somebody So I'll either give you a million dollars now or 10 years from now. What are you going to pick? Obviously you'll pick now. This is called time preference. People prefer getting stuff, achieving their goals earlier than later. And this conflicts to the sense that it has to be balanced against the fact that people prefer getting stuff now than later.

19:01But the more they save and invest, the higher their standard of living will be in the future. So they have to choose, consuming now or saving up now, consuming more later. That's the basics. We'll get to that more later on. These things take time, and also there's time preference, and also action is risky. There's uncertainty of the world, and the function of the entrepreneur is to meet that uncertainty, to bear the risk of uncertainty. Crusoe is an entrepreneur, in a sense he hopes he can catch fish, or he hopes he can build a cabin, things like that. Well, everybody's an entrepreneur. To become a mechanical engineer you hope or expect that you'll be able to get a good job at it. More entrepreneurial are the capitalists who invest a lot of money in certain processes and hope they'll make This is called entrepreneurship. There's no good English word for it. It's a French word. It's now been incorporated in English language.

19:49Adam Smith used the word undertaker. That didn't fly for obvious reasons. So, entrepreneur is it. Which essentially means a risk-taking capitalist. Or the person who invests capital in some enterprise and hopes to make profits and not suffer losses. We'll get to them later on too. Right now, we're sort of surveying the basic situation. The situation is that everybody, Crusoe and us, have goals which we want to meet and which we prioritize. We put in terms of priorities and we list them in ranked order. And you pick what's your best choice, most valuable choice, what you think is going to be best. Everybody's got a rank of choices. You pick what's your highest value and you hope you improve to be correct. This is called, I call it a value scale, but it's been given the name in economics of utility. And it's a little unfortunate, again, because utility often means useful, and that's objectively useful, but in economics it means purely subjective valuation. It could be useful or not. If people

20:45think that it is, that's all we care about in economics. In other words, a lot of left-wing intellectuals hate cosmetics. They think it's an evil thing for a lot of women to use cosmetics. Well, most women don't agree with this. They like cosmetics, and their value scale cosmetics is ranked pretty high. So this is purely subjective. The thing about utility scales is that they're ordinal. They're ranking. Unfortunately, this is my first big disagreement with every textbook I know of. Textbooks will give lip service to this. They'll say, yes, it's ordinal. All of a sudden they start talking about utils. This is three utils. That's two utils. Util being a unit of utility. And they add it up and they multiply it. There's no utils. There's Let's just think of the eugle. Who's ever seen a eugle? It's absurd. If you want to choose between going from movie A and movie B, you don't say to yourself, let's see, I value this at eight eugles, right? So, forget it. Forget eugles. It's my first injunction.

21:40It's a purely ordinal ranking order. It's a mathematics often called lexicographic. We could say we rank at one, two, three, four, but it should be ranked as lexicographically, in other words, A, B, C, D. The use of the number sucks economists into thinking that you can do something. We can add, subtract. If you use A and B and C, nobody would say C is twice B. It's one of the sociological phenomenon here which we're dealing with. So there's no such thing as U. It's strictly ordinal, it's strictly ranking, and rank order. So all the laws of economics, they're qualitative and not quantitative. See, one of the problems with economists is they take a qualitative science, which is really what this is, I'm not a convertor to being quantitative because I can predict precisely what's going to happen. I can't do that. The predictions are always wrong. When they make quantitative predictions, they always flop.

22:26What they do is they keep flopping and they keep saying, well, we have to change the model. We missed out on XYZ. They change it and they still flop. This has been going on for 20 years. Some economists begin to realize that it's also customers of economists, people who buy forecasts, corporations, begin to realize this thing is a scam. One of the reasons why the customers of economic forecasters haven't turned on them before this is because of the tax write-off. It's considered a legitimate expense to hire economists. Everybody hires economists to tell you what the unemployment rate is going to be next year. And if it's a lousy unemployment rate, so what? You've hired a top economist, everybody else missed the forecast, and your expenses can be written off as a legitimate tax write-off, one sort or another. So we have a qualitative discipline. There are laws about tendency and direction, not about quantitative.

23:13Let's get back to Crusoe. He's going to make a couple of simplifying assumptions here. He's got a bunch of logs. He's chopped down a bunch of logs. We're going to assume that one log or one set of logs can be used for each of three or four different uses. So you can take these logs and say, okay, what's my first priority? He's got an ordinal value scale, ordinal utility scale. His top priority is food for tonight. He makes the logs for a fire to cook tonight's meat. to Cook Tonight's Meat, and I think in the case of Crusoe, we can come to much more agreement than we would about which movie to go to, down to basics here, down to survival. Second priority might be fire for tomorrow night and keep it for tomorrow. Okay, third priority, let's say, is building a cabin, fourth priority might be setting a perimeter of logs around the little camps that wolves won't come in or whatever, perimeter, The fifth priority is building a boardwalk down to the beach, obviously a real luxury item because it probably won't be full of sand.

24:13Now he has these logs. The point is, if he has a supply, a supply by the way is defined as an amount of N units of a homogeneous good. Meaning that each unit is the same as any other unit. So what you're dealing with is the same log or the same horse or whatever, for more or less practical purposes they're interchangeable. You're not dealing with two totally different types of wood or something like that. There's five N units of a homogeneous good. If he's got one log after all he's got, or one unit, he will satisfy the top priority and let the others go by the board. He will not satisfy priority three and forget about one. In other words, he will pick his highest priority. If he has two logs, he'll pick his first two priorities, and so forth. Looking at it another way, supposing he's got three logs and he loses one, a wave comes and washes it away, or something like that, he will give up his lowest priority, priority three.

25:05Don't forget about food tonight. It will rearrange the logs so as to knock out three and leave one and two. If, on the other hand, he's got five logs and he loses one, he'll give up the boardwalk. He's not going to give up the really tough stuff. Now, what do we deduce from this? We deduce that the greater the supply of the good, the greater the number of units that a person has, the lower the value of the ranking of each unit. So the value now is how much he's willing to give up. the ranking of how much he loses if he loses one unit he's got a supply of three units and loses one the value of each unit is number three or third or C or whatever you want to call it the greater the supply the lower the value of each unit technically the lower the marginal utility because utility means value marginal means each unit if you're highfalutin jargon again but it's basically that's what it means so

25:54marginal means the next unit with one log one pound of butter whatever the The greater the supply, the lower the value of each unit and the lower the marginal utility, vice versa. In almost every law in economics, you can just switch it around. Simply logic. The lower the supply of a good, the greater the value of each unit. This is called, there's a name for this, the law of diminishing marginal utility. It's really saying the same thing, the greater the supply, the lower the value of each unit. And we can put this in a little diagram, and the diagram is supposed to be used for in economics to make it clearer, unfortunately in most cases they're used to make it more complicated. Anyway, if you put marginal utility or value of each unit on the y-axis, and only economic diagrams in microeconomics, the y-axis has either marginal utility or price or something like that, the x-axis has quantity of whatever.

26:46Okay, in this case we have quantity of a good. This is zero for both. So what they're saying is, as you increase the quantity of units one, two, three, four, whatever, the marginal utility keeps dropping. And we don't know what the height is because it's ordinal. Probably you shouldn't connect the dots. But anyway, we know it's falling. Obviously, the greater the number of units, the lower the value of each unit. The lesser the number of units, the greater the value. So this is supposed to be a way of showing this. Pay no attention to the actual distances and things like that. This is the basis of what's known as the Law of Demand or the analysis of consumer demand on the market. How much will people pay for a product? Obviously, if you have one chest set, you're not going to pay as much for a second one, presumably, given the kind of chest set. The Law of Demand, based on Law of Demand and machine margin utility, is trying

27:36to figure out how much people spend on different, how much people buy different goods, given Let's take Wonderbread, one of my favorite consumer purchases. I like Wonderbread, I buy lots of Wonderbread. However, if the price of Wonderbread suddenly magically, let's say the Wonder Company, whatever the name of the company is, Mr. Wonder sells out or whatever, some other guy comes, the other guy's a nut, and the other guy says, I think Wonderbread is so great, a consumer should have to pay a lot of money for it, it's really worth ten bucks a loaf. He issues an order to all the Wonderbread people, they only sell a thing for 10 bucks a loaf. So what happens? Well, what happens is this. Now you have the basic diagram. You have price on the Y axis. Price of the good. What does price mean? Price actually means how much you're willing to pay or what the different terms of the exchange are. In other words, with Crusoe and Friday, let's say Crusoe fishes and Friday hunts. And so

28:28Crusoe has a lot of fish and he decides on one barrel of fish per two pounds of meat or whatever it is. Pure bargaining situation. When they do that, the price is, in terms of exchange, the quantity of one exchange, one good in exchange, is paired to the other good. In other words, two pounds of meat for one barrel of fish. In this case, the price is one fish in terms of meat. When we have money, and we have things that are very simplified, and everything is in terms of money price. So the exchange is between the money and the Specific Good So here you have a situation, let's say, with Wonder Bread. If we insist on $10 a loaf, very few people will buy it. Let's say this is $1 a loaf. In this axis, you have quantity, again, quantity purchased. So I don't know how many loaves of Wonder Bread are sold in the United States or New York at any given time. Let's say 100,000 loaves. 100,000 loaves,

29:23say, in New York in a week. So the quantity is 100,000. The price is $1 a loaf. So if Mr. Wonder suddenly says, in ten dollars alone, very few people want to buy it. The only people who will buy it are very wealthy Wonderbread freaks. If David Rockefeller loves Wonderbread, which is probably dubious, he might shell out a lot of money. Very few of the rest of us will join him. The quantity suddenly plummets. This much will be purchased. He will go bankrupt pretty early. On the other hand, supposing he succeeded by another nut, an opposite kind of nut, who says, well, I think that Wonderbread is so great that every person in the world has been able to afford Wonderbread. I'm going to sell it for a nickel a loaf. Of course, you lose a lot of money per loaf, but he's also crazy. And a nickel a loaf, lots of people buy it. They hear about a nickel a loaf, hey, wonder about a nickel a loaf, you stop buying Pepperidge Farms or Tasty or whatever, you're rushed to buy one, what the hell, you might not like it too.

30:10Oh, but a nickel a loaf is worth it. You get a huge two million loaves or so. It says that much snooze. You get something like this. This is the great law of demand. The law of demand, which is related to two things. There are two things. One is the diminishing margin of utility to keep increasing the supply. And two is the fact that some people are poorer than others and can't afford to spend a lot of money on one specific item. You wind up with a law of demand, which is very simple, but very important, probably the most important single law in microeconomics. Namely, the lower the price, the more will be purchased. We don't know how much more. That's what we don't know. We know it will be more. That's an absolute law. How much depends on the specific item, depends on the specific people, it's sort of like wide punches. But we do know, absolutely, the lower the price, the more will be purchased.

30:58This is called a falling demand curve. We also know, again, conversely, again, there's always the other side of the coin, the higher the price, the less will be purchased, again, saying the same thing. We don't know the shape. As a matter of fact, usually before, I guess the demand curve came in about 1920 or something like that. The key problem in microeconomics, the key difference between quantity demanded and the demand curve. The demand curve is the whole curve. The demand curve is a locus of, given the price, how much will be purchased? Given a high price, given a medium price, a low price, and you map out, it depends on the subject of design, I don't know exactly what it is because it's in the heads of every person, but you do know that the lower the price, the more will be demanded.

31:45So this gives you a demand curve. That means if you go down the curve, the price is lower, there'll be a higher quantity demanded, but the curve as a whole is falling. And the demand curve as a whole is the structure, depends on what people think of Wonder Bread, basically, how much income they've got, and competing products. Pepperidge farm bread, or tasty bread, rolls, or whatever. All these things are competing with Wonder Bread. This determines the demand curve in accordance with the subject of value scales, utility scales of the people. Once given this, this gives you the whole demand curve. And the point is, you must never confuse the quantity demanded at each point. In other words, at 50 cents a loaf, 200,000 loaves will be demanded, okay? That's the quantity demanded at each point.

32:31You never confuse that with the entire demand curve, which is the locus of all quantities demanded at every price. In other words, a falling price will not increase the demand curve, ever. It can't, because the demand curve is defined as a response to prices, price changes, all right? The one thing which cannot increase the demand curve is the falling price. The one thing which can't lower the demand curve is the rising price, because the whole shape of the demand curve has already been incorporated into the demand curve. The one thing which cannot increase the demand curve is the falling price. The one thing which can't lower the demand curve is the rising price, because the whole shape of the demand curve has already been incorporated in the definition of the demand curve. From 1920 or so when the demand curve starts, until about 1940-45, it was always the same shape in the textbooks.

33:17The shape was known in mathematics as a rectangular hyperbola. In other words, the area under the curve was the same at every point. Let's say the curve is based on a schedule, on tables, price, quantity, purchase. If the price is $10 a loaf, let's say they sell a thousand loaves, the total revenue is taken in by the retail stores, price times quantity. If you charge $10 a loaf and you sell it for $1,000, you're making it $10,000, so that's total revenue goes price times quantity, key point. If the price goes down to $5, let's say they sell 20,000 loaves, and the total revenue goes up to $100,000, and so forth. But the way the textbooks used to draw the curves is that the area always remained the same. The total was always $10,000 or whatever. It was adjusted in such a way that the area was always the same.

34:07Finally, by 1943, George Stiegler later won a Nobel Prize as a young professor, wrote a textbook called The Theory of Price. He said, there's no evidence for this. Why do they draw the curve that way? What is this nonsense? So he started drawing it as a straight line. The least doesn't commit you to thinking that the areas are the same. There's no evidence for a straight line either. And so sometimes, I think McCloskey's latest book on applied price theory is sort of a maverick type. He draws the lines as wavy. Well, it could be wavy. I still prefer the straight line, provided that you hold it in your head at all times and it's really convenient. It doesn't mean a damn thing. Unfortunately, most economists don't hold that in their head. By the time they get to Chapter 8 or something, they're thinking this is deeply significant, and they start talking about tangencies, as you'll see when you go along. There are all sorts of crazy conclusions based on tangencies that don't exist because there ain't no straight lines.

34:56Straight lines are easy to cope with and at least doesn't assume you have the area of maintenance. No reason for the area to remain the same. No reason why consumers always spend the same amount of money, regardless of price. At any rate, we now have the mankers with straight lines. And the next thing is dealing with supply. All right, we now have the manker which we know is fooling, although we don't know exactly how much. And we have supply. What's supply? Supply, despite the textbooks, supply is vertical. Supply for everything is how much is around right now. How many loads of wonder better are around at the stores today? Let's say 100,000. So you have at any given time, the supply as a fixed amount changes over time. over time. But the point is, at any given time, and the demand curve after all is a freeze frame situation, how much could be purchased at any given price by consumers? Similarly, the supply curve should be a fixed freeze frame. At any given day, how much is out there?

35:41So the supply curve is vertical. You right now know more economics than most of the people in the country. You know more than the jerks who run the subway system, for example. The way most people who run utilities, particularly, subways, railroads, whatever, they assume that the demand curve is vertical. The implicit is that they don't think about the man curve, but they implicitly assume the man curve is vertical, which means that people essentially kick in to buy the same amount of stuff regardless of what the price is. There's no fooling the man curve. So, for example, every year or so, they keep raising a subway fare because they've got a deficit. Of course they have a deficit. The government always has a deficit. So, almost by definition, the government's always screwed up. They've got a deficit. How do we cure a deficit? We raise the fare. Why not? If you're suffering from a certain deficit, you figure out you can balance the budget. If you raise the price by 20% and you keep the same number of fares, then you'll balance the budget.

36:30So they raise the price by 20%, and by God in that, next year they find out it was a falling off of rides, of fares. So the deficit never gets cured. They always startle of this. Why does the number of fares go down? Why aren't people riding in the subway as much as they used to? Gee, I don't know, maybe it's because it's crummy, but it's always crummy. That's not the answer, it's just a fare went up. So some fine day in the future, it's not going to be too long from now, they're going to raise the fare up again, to five bucks, whatever it is, right? and they're going to find out not only the number of rides are going but the total revenue is going down. That's what they're going to find out. They're going to get up here somewhere and find out that taking in less money than they did before. What are they going to do then? Who knows? They haven't even got the mindset of lowering the fare to get a lot of people.

37:10They might even privatize it. That would help. This is to say the general mindset of authority and fare-setting business. As you can see, it makes a big difference to businessmen. What happens to total revenue? What happens to total revenue becomes the key thing. The businessmen are extremely interested in total revenue, which I say we're now concentrating on. We'll get later in the term of the course question. It becomes very important to them, what happens if the price changes? If you raise the price from here to here, what happens to total revenue? We now come to the most important property of the demand curve, which is the reaction on the demand curve. As you change the price, what happens to total revenue? In other words, how does quantity react compared to price? price. Okay, law of the ministry of marginal utility is a key thing that this is accomplished in the history of economic thought. Adam Smith, the alleged founder of economics, actually he really wasn't, but one of the founders of economics as a separate discipline, said

38:05in the Laws of Nations, which was the famous first economic classic, said there's a value paradox, let's call it value paradox, and he said he couldn't solve it. Now, it's very peculiar in the history of thought, but if he had solved it 20 years earlier in his lectures published much later, about 1900 or so, so it's one of the peculiar situations in history of thought. In fact, it had been solved by scholastic philosophers since the late 16th century. All of a sudden he creates this problem called the value paradox, and it goes as follows, namely, why is it that things like bread and water, let's take bread, it's usually called the diamond water paradox, but water is an extra complication. Anyway, bread, which is the staff of life, it's very important philosophically to man, demand because you need it for life and water, of course, even more. And yet here, bread is very important. It has a high use value. And yet, on the market, it's very cheap. Cheap

38:58on the market, therefore, it has a low exchange value. One puzzling situation. Here's something which has a high use value and a low exchange value. You can probably think of other things. Nails are pretty important for construction. You know, nails are cheap. On the other hand, you have luxuries. They're fripries. And here, and this is one of the reasons why Smith's

39:46Value. It's a very strange thing. I can't solve it. And Ricardo has the cycle say the same thing, or more than, can't solve it. This is a value paradox. Therefore, we can't say anything about consumers, the value of two consumers, the whole utility analysis. I can't say anything about it because they're stuck in this thing. They have to deal with the entrepreneurs and business and labor and all that sort of stuff. And consumer analysis drops out of the picture, except in France, where they never approach this. I mean, Britain We didn't have a dominant economic doctrine in the 19th century, so we were, unfortunately, it took a hundred years to get out of this, to solve the value paradox. From this idea, you see, comes the left-wing position, like Veblen and these other characters in late 19th century America and later, saying, wow, capitalism, market economy, addresses production for profit and not for use.

40:34They 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. This dichotomy between production for profit and production for use is a very important history of left-wing thought. By this time you have the tools in your possession to realize the fallacy in this whole nonsense. Basic fallacy is this, people do not choose on philosophic values. We don't sit around deciding on one big vote. Let's go back to the model of the grand old science fiction movies of the 50s. Some space character interfered, blocked into old television sets. All of a sudden we're asked what channel you want, some guy is speaking to you from the planet Oongbu or something, and he hands earthlings, he says earthlings listen, conclude peace now or die in six days. Some planetary character now comes to earth and presents us with a choice.

41:22From now on you have a world parliamentary decision. You have a choice of losing forevermore, from now on until the end of eternity, either all the bread or all the diamonds in the world. And that's the choice where the human race is faceless. Well, given that choice, I'm sure we'd choose bread rather than diamonds, and the space people would, wherever they are, would go off with the diamonds. 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. We're faced with unit choices, marginal choice, the whole point of the unit. When somebody goes to buy something, they're not faced with the situation of, he's all the bread in the world versus all the diamonds. No, you're faced with the thing, should I buy this loaf of bread, or should I buy this diamond with 12 carats or something? In that situation, the marginal unit becomes extremely important, and the lower the initial marginal utility becomes decisive.

42:07If you only had one loaf of bread in the world, people would be willing to spend hundreds of thousands of dollars with one loaf of bread. Fortunately, we have lots of bread. But each unit, as we deal in units in the real world, each unit, each pound of bread is very cheap, because it's a low marginal value. It's like Crusoe with 20 logs instead of one. Depends on what the supply is. We have a huge supply, fortunately, a huge supply of bread, therefore it's cheap. Units are cheap. On the other hand, with diamonds, supplies are very, very rare, limited, scarce. That's true, we have a government cartel monopoly, which makes it scarcer. I'll get to that when we get to monopoly. So scarce. So we have then, even though diamonds, the first unit is much lower, say the least then, the first unit of bread, there are not that many units around, the supply is limited.

42:57So we have a higher price for diamonds on the market. In other words, a higher valuation by consumers for each unit, for each carat. This is the unit, the unit of weight of diamonds equal to a carat. The value placed by people on each carat is much higher than the value of a piece of each loaf of bread. There's nothing wrong with that. There's nothing paradoxical. There's nothing unphilosophic. There's nothing unnatural about it. It's perfectly legitimate. Once you see what the whole picture is, once you see the interpenetration between supply and Valuation. Once you realize about the margin, this whole thing clears up. That solves the value of paradox. It took until the Austrians and other economists in 1871, the margin utility theorists around 1871, to solve this paradox before margin utility dueled. 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 and let themselves wide open for leftists to say, wow, gee, it's a terrible thing.

43:54And there's no conflict between production for profit and production for use. Profit is what's most useful to the consumer, most valuable, and the demand is highest. Anyway, that solved the value paradox. Any exchange that takes place in the market, people only exchange because it's more valuable for them. They prefer what they're getting to what they give up. They prefer the marginal units. In other words, you work, you change your labor service of 40 hours a week or whatever of Money or exchange money for loaves of bread or cereals or whatever. You're doing that because you prefer the value you're getting for the value you're giving up in exchange. So each step of the way, each kind of exchange is made on the market. Millions of exchanges benefit both parties of the exchange. What we have is a lattice work of two-person exchanges. As always, for every unit exchange, there are two people or two groups and two commodities including two goods and services. Each unit exchange has two people and two commodities.

44:50In the money economy, money is always one part of the equation here. Money is exchanged for other things. So if you graduate and work for IBM, you're exchanging your labor service for salary, for money. So that's again a situation with you and IBM. IBM is not a person, it acts as a unit in this situation. So each step of the way, and this lattice work of of Exchange is both parties' benefit. Otherwise, they wouldn't make the exchange and do something else. They go home, they make some other exchange, they keep their money, they do whatever. Okay, we now get to the most important property of the demand curve. The only property which really is important as a matter of fact. Remember that the demand curve is falling. It's all we really know about it. So you have on the y-axis, you have price, and the x-axis you The Man Curve tells you, it's really the man's schedule, geometric representation of the man's schedule.

45:43It tells you, at this price, how much will be bought, the price of one or better 10 bucks a loaf, this much will be bought, the price of five dollars a loaf, this much. Cheaper, the price, the more will be purchased. So you have a man curve which is sloping, so-called falling man curve, a man curve which slopes downward and to the right. You don't know if it's linear, you don't know if it's steep or shallow or flat, you only The important property of the demand curve is, how much, if this is like a freeze-frame situation, telling you what's on the mind of consumers, of course you don't know that the demand curve, who knows, you don't really know, all you know is that it's falling. The important property of the demand curve is, if you change the price, let's say if you cut the price from here to here, how much will the quantity increase? Or at least in what direction? We know it will increase, we don't know about how much. If it increases just a little bit, you have a steep curve here.

46:33It can either do that, or it can increase a lot. We have a much flatter curve, given the same point. This property of the man curve is called elasticity. Once again, it's borrowing the prestige of physics, where the question, for example, is if you put a certain different weights on a spring, how much will the spring give? give. There are two different kinds of definitions for you all. One kind, which is a textbook definition, there's nothing wrong with it, it's just kind of irrelevant. The more elastic is how much more give there is, in other words, how much the quantity will increase when the price falls. The reason why it's irrelevant is nobody knows anyway. And it's also the really important thing, it's quality, the really important thing for the businessman or for the industry is, will total revenue go up or down? That's what they really care about. If I cut the price, what's going to happen to my total revenue? That's what I

47:23The total revenue, business income, net income, is total revenue minus total cost. This is a very simple 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? If you take in $100,000 a year, you pay out $80,000 total cost, and your net profit is $20,000. If, on the other hand, your total revenue is $60,000 and you pay out $80,000, you're in pretty poor shape, suffer net losses of $20,000. So, therefore, total revenue of any firm, or any person, doesn't matter, equals the price of anything times the quantity sold. Let's take our Wonder Bread example. The curve is based on a schedule. Let's say the price is $10 a loaf. You have very few loaves sold. Let's say $1,000.

48:43So, when you get your total revenue, what we're interested in here is, what happens to total revenue? In other words, the key thing, and I'm thinking on here, is the direction. What happens to total revenue for the change in price? If when you cut the price, if quantity increases by a greater proportion, you have an increase in total revenue, that's an elastic demand curve. You raise the price, then you have a fall in total revenue. It's not easy to forecast in advance what the demand curve will be, because it'll change across the zone, and it can be different from different things, so that's an elastic demand curve. The other hand, if you have that curve, which is relatively steep, then you'd have the new total revenue be smaller, in other words, the increase in quantity is not enough to offset the drop in price, so the result is lower in total revenue.

49:28So in this situation, where a fall in price leads to a fall 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. This is something that businessmen are very interested in. They don't care that much about the percentage or the amount or the formula. They care about what happens to the damn total revenue in this. Because in the real world, businessmen don't know that the man curves are not listed up in the book for them. 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 business man to try to figure out what's going on. This situation is called an inelastic demand curve. Inelastic. In other words, we're setting up here a new definition of elastic and inelastic. Instead of concentrating on percentages, we're concentrating on the direction of total revenue. If the total revenue increases to the full or the full on price of an elastic demand curve,

50:16if it drops to the full on price of an inelastic demand curve, and vice versa. So what can we say about when things will be elastic or inelastic? Well, one thing we can say that other things being equal, A larger range of choice will lead to greater elasticity. In other words, let's say this is a, back to our Wonder Bread example, here's the price of Wonder Bread, let's say a buck, this is a buck a loaf. Let's say Mr. Wonder, you know, huge increase in price, sales are gonna fall off tremendously because all the other breads will remain the same price. Rolled bread, everything is a buck a loaf or so, he's raising his price to $5, $10 a loaf, it means a tremendous falling off, The demand curve is very elastic for Wonderbread. So that's one of the reasons he's not going to do it, if he's sane.

51:03On the other hand, if all the breads go up together, that's a different story. Then there'll still be a falling off, but people won't be able to shift out of Wonderbread as a pepperage formula, because they'll all be going up. So in that situation, to be much steeper, it could still be elastic, but be less elastic for each given firm, or each given brand. Same way on the way down. One thing we can conclude from this is the demand curve in all cases, regardless of how elastic the demand curve is, the demand curve for the firm, any given firm, is more elastic than the demand curve for the industry as a whole. Unless, of course, there's only one firm in the industry, in which case it's the same thing. When you have a big gap, say the demand curve for each firm is quite elastic, and the demand curve of the industry as a whole is inelastic, it sets up a temptation for a cartel agreement among the firms because

51:52The only time a cartel will last for any length of time is when the government steps in and forces it, prevents new competition from coming in, prevents anybody from breaking the agreement. And this is what's happening in Europe a lot. So elasticity is a major property of the man curve, either elastic or inelastic, which means you only have a situation where total revenue either falls or increases and changes in price. And it's obviously extremely important for businessmen to try to figure out what's going to happen. In the real life, there are no given demand curves, businessmen are trying to find out what will happen if they raise the price or lower the price.

52:43That's a trial-error kind of procedure, much of a hunch and based on their intuitive insight in the market, which is of course based on knowledge, but based on a 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, different resources and stuff going on, dynamics, it's the only people involved that I can figure out.