Thinking in economics
Thinking in economics
Yang Li
EDUT&L 108.01
Ivan Stefano
December 5, 2011
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Thinking in economics
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I am already a student of university, and even the end of the first quarter is around
the corner! It means one twelfth university life has gone! How amazing it is! Time
flies. I think I am still not ready. What about you? Do you know what major you want
to study for? Do you know which career path you desire to go along with? Or make
the question easier and smaller do you know what class you want to take next quarter?
So many people have no answer. But we have to think. So thinking is the important
issue we need to face everyday.
Also suppose a situation, you are going to have a presentation. You prepared a lot
for it. Everything seems well but suddenly you find your computer is out of order. It
cannot work! All your materials are in your computer. Without the computer you
cannot do anything. But it is your turn. You do not have any more time to fix it. Of
course it is a terrible situation, but suppose you are really facing this, what will you do?
Maybe someone will have no idea and just stands dumbstruck while others will
choose to cancel this presentation and say sorry. Also there is a group of people who
decide to continue, even their computers do not work. Obviously, different people
have different responds to this same situation. But why does this happen? Again, it is
the result of thinking. Now I am very excited and curious about this word “thinking”.
What magic does it have? It can determine so many things and even lead to different
directions.
So will people always have different answers to the question? That is not true.
For example, Kevin loves eating chocolate very much and the price of one bag of
chocolate is usually 10 dollars. One day, for some reasons, the price of the chocolate
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is suddenly cut off to 1 dollar each. Everyone will suggest Kevin go and buy more. In
this case, people respond similarly to the same issue. But why does this happen? The
reason is market rule--- Law of Demand.
In sum, people think, then respond to the situation. Because of environment and
culture, people usually have different and various answer. But in economics, people
will always follow some rules, like market rules and game theory, to make a similar
decision.
Market Rules
People enjoy shopping everyday. Sometimes, they may not go to the malls but do
some shopping online. So when they shop, how can they decide which to buy and
why to buy? Person who loves chocolates and milk buys chocolates and milk and
person who needs desks and beds buys desks and beds. When the price is too high to
afford, people will always give it up. It is common sense in most people’s mind, but in
fact, it is also a rule in market, the most basic rule--- Law of Demand.
McConnell, Brue and Flynn (2009) defined that the law of demand is an opposite
relationship between price and quantity demanded. It means when other requirement is
same, if price goes down, the quantity demanded goes up, and if price goes up, the
quantity demanded goes down. It is so similar as what people usually think. But why
does this opposite relationship between price and quantity demanded exist? The first
reason is easy to understand. People always want to buy more products at the same
price. On the other hand, McConnell, Brue and Flynn (2009) explained that in any
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certain time period, every buyer of a commodity will gain less satisfaction from every
successive unit of the commodity spend. For example, when a man is very thirsty, if he
gets a glass of water at that time, he will benefit a lot and appreciate it. When we put this
in market, even though the price is very high at this time, he will still choose to buy it
because he desires it. But after he drinks this glass of water, though the price of water
becomes very low, he may not buy it since he cannot
derive much utility from buying another glass of water.
McConnell,
Brue
and
Flynn
(2009)
concluded,
“Consumption is subject to diminishing marginal utility.”
(p.47) To make the relationship more intuitionistic, we
From
Microeconomics written
by
McConnell, C. R., Brue, S. L., & Flynn,
draw a graph called The Demand Curve, as shown on the
S. M. (2009)
right.
Everything mentioned above are all about price and quantity demanded. What
about the relationship between price and quantity supplied? As we all know, there
exists buyer (customer) in market, there definitely also exists seller (producer) in
market. Assume, there exists a producer in market, how many products should the
producer supply at a certain price? It comes out another relationship. McConnell, Brue
and Flynn (2009) also defined this relationship as Law of
Supply. When price goes up, the quantity supplied goes up;
when price goes down, the quantity supplied goes down
too. Obviously, it is a direct relationship. We can also
From
draw The Supply Curve, as shown on the right.
Microeconomics
written
by
McConnell, C. R., Brue, S. L., & Flynn, S.
M. (2009)
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Then a problem comes out. Customers always want to buy the same things at a
lower price while producers always want to sell same things at a higher price. Then how
can the price be set? We are looking for a price, called equilibrium price in economics.
It should be a price where buyers are willing to buy and producers are willing to
produce and sell. Graphically, this equilibrium price should be the intersection of The
Demand
From Microeconomics written by McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009)
Curve
and The Supply Curve, as below. Now everything looks perfect.
Dilemma
Certainly, life will not be so easy. Consumers always find it hard to achieve the
entire requirement. According to McClure (2011), Simon represented a tactic used by
people when facing more intricate situation. He called it “satisficing.” This is a “good
enough” tactic. Following this rule, people buy the product that can satisfy most
desires and sacrifice some.
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Then the case continues to be more complex, if there is not only one producer in
the market, what will happen? To obtain more consumers, one producer may set lower
price. But lower price usually decrease the profit per unit. So every producer face a
dilemma.
In economics, some producers competing for bigger revenue in a market is called
Oligopoly Behavior. McConnell, Brue and Flynn (2009) described that the
characteristics of oligopoly pricing behavior is similar to some rules of games. Polak
(n.d.) added that game theory is a way dealing with strategic situations. As for
strategic situations, they are situations except perfect competition and monopolists.
Because firms in perfect competition are price takers, they do not have to worry about
the actions of their rivals. Same to monopolists, they do not have any competitors to
worry about. We can obviously see the most remarkable character of game theory is
the existence of rival. So the optimal method to play is making a decision depending on
what a rival does. In other words, after one opponent changes price of the product or
has other actions, another opponent responds to it. The most famous example in game
theory is prisoner’s dilemma indicated by Merrill Flood and Melvin Dresher. They
created a situation that two prisoners A and B are detained as main suspects, but police
don’t have sufficient proof to convict them, so police separate them into two rooms
with the best hope that one of them confesses to the crime. At this time each prisoner
faces the same dilemma. If A confesses and B stays silent then A will go free but B need
to be in the prison for one year. If they both stay silent, each just serves 1 month. Or
they both confess, they both receive 3 months’ punishment, just as the chart suggests.
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Obviously, both staying silent (cooperates) is the best result for the group, but for
individual, they always prefer to defect for they can gain chance to be free. In
conclusion, people tend to make decision better for themselves not the whole group.
From wikipedia
Now turn back to the market.
Two producers are trying
to gain more profit, if they cooperate, for example, both hold high price, they will
definitely achieve most, because under this situation, customers have no choice. They
can only buy product through a high price, so producers can gain more with higher
profit and unchangeable quantity. However usually, either producer wants to beat each
other, so they decrease their price to gain more customers. Just like the prisoners
confesses to gain chance of freedom. This is the life, though seems ridiculous, it is the
result.
Conclusion
Thinking usually leads people in different direction, but in economics, there are so
many rules. People, no matter customers or producers, usually follow these rules to
make decisions. For customers, basically, they buy products according to Law of
Demand. Similar for producers, they sell products according to Law of Supply.
When customers face dilemma with producers, usually market sets up a price
called equilibrium price to satisfy both. When dilemma happens between several
Thinking in economics
producers, though situation is more complex, it will still have a suboptimal result
because of game theory. All producers decrease their price to gain more customers.
None of them can derive best profits, but they will also never be the only loser in the
market.
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References
McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009). Microeconomics: principles,
problems, and policies. New York: McGraw-Hill Irwin.
McClure, S. M. (2011). Our Brains Know Why We Do What We Do. In M. Brockman
(Ed.), Future science: essays from the cutting edge. New York: Vintage Books.
Young, L. (2011). How We Read People's Moral Minds. In M. Brockman (Ed.), Future
science: essays from the cutting edge. New York: Vintage Books.
Polak, B. (n.d.). Introduction: five first lessons. Lecture presented at Open Yale course
in Yale University, New Haven. Retrieved December 2, 2011, from
http://www.youtube.com/watch?v=nM3rTU927io