Price Dynamics
Objectives
- Explain the law of demand.
- Distinguish between changes in demand and changes in quantity demanded.
- Explain the law of supply.
- Distinguish between changes in supply and changes in quantity supplied.
- Provide explanations and illustrations of the interaction of the demand for and supply of a commodity and the determination the market price of the commodity and the equilibrium quantity of the commodity that is produced and consumed
Assignment
Write a 3-4 page paper that directly addresses the following questions:
- In economic terms, what are the market consequences of a price floor? Discuss the economic implications of implementing a legal minimum wage.
- What do the laws of supply and demand predict would be the result of an immediate removal of minimum wage in terms of the price of labor and the quantity available?
- Do you believe that the minimum wage should be raised in order to provide workers with a better standard of living? Why or Why not?
- Is the minimum wage law an effective poverty-fighting measure? Discuss at least one alternative policy.
Paper
Minimum wage should not be raised to provide workers with a better standard of living. This paper will explain why minimum wage laws are an ineffective measure for fighting poverty as well as explore market consequences of setting a price floor. Additionally, this assignment will identify the predicted results of an immediate removal of minimum wage and suggest an alternative. Finally, this case will study the laws of supply and demand while also distinguishing between a shift in demand/supply and changes in quantity demanded/supplied.
To best understand the effects minimum wage laws pose against the economy, one must grasp the laws of supply and demand. Demand represents the behavior of buyers and can be defined as, “the maximum prices buyers are willing to pay for each unit of output, ceteris paribus” (Reynolds, YEAR). In other words, demand shows the exclusive relationship between price and units sold. In general, price and units sold have an inverse relationship, as seen in Graph 1. Therefore, the higher a product is priced, the fewer products will be sold.
A change in the price of a product will change the quantity that is demanded of the product, as seen in Graph 2. However, price modifications will not shift the overall demand of a product. A shift in demand is caused by external factors such as income changes or prices of related goods. A shift in demand will impact the price of the product regardless of the quantity sold, as seen in Graph 3.
Supply has a nature similar to demand. However, supply measures the activity of the producer, and can be defined as, “a schedule of quantities that will be produced and offered for sale at a schedule of prices in a given time period, ceteris paribus” (Reynolds, YEAR). In other words, supply shows the exclusive relationship between price and units produced. Price and units produced generally have a positive relationship, as seen in Graph 4. Thus, the higher a product can be priced, the more units will be produced.
As is the case with demand, a change in the quantity supplied is the result of a price change only, as seen in Graph 5. Price modifications will not shift the overall supply of a product. A shift in supply is caused by internal factors such as technology and source material. A shift in supply will impact the price of the product regardless of the quantity produced as seen in Graph 6.
Economists are often tasked with identifying the price at which supply and demand intersect and create equal balance between producers and consumers.
In Neoclassical microeconomics, ‘equilibrium’ is perceived as the condition where the quantity demanded is equal to the quantity supplied; the behavior of all potential buyers is coordinated with the behavior of all potential sellers (Reynolds, YEAR).
In other words, equilibrium implies both producer and consumer are satisfied with the current price, as seen in Graph 7. Locating the point of equilibrium is not an easy task but is critical to maintaining a balanced market.
Minimum wage laws cause market disruption by instantiating a price floor above equilibrium. Dr. Lisa Mohanty (2009), economics professor at TUI University, explains that a price floor is a “government imposed legal minimum a seller may charge.” This occurs as a trickle down effect from increasing the variable costs of producers. Essentially, minimum wage laws increase variable labor costs, which increase total production costs, which lead to a new required price (price floor) in order to continue production.
The price floor is inevitably set above equilibrium thereby creating a surplus of products, as seen in Graph 8. Fundamentally, the surplus exists due to the price increase thus resulting in lower demand and excess production. In other words, the market experiences a negative impact on purchasing power.
Typically, producers have to accept losses and sell the surplus below cost while seeking compensation from alternative means. More often than not, companies will resort to layoffs to balance such losses. From a fiscal perspective, eliminating variable expenses achieves greater security than eliminating predictable, fixed expenses.
Herein lies the chief flaw of attacking poverty using minimum wage laws. “Raising minimum wages forces employers to dismiss low productivity workers” (MacKenzie, 2006). In other words, minimum wage laws actually harm those they are created to help. D. W. MacKenzie (2006) of the Ludwig von Mises Institute, explains, “…it is quite arguable that minimum wage laws keep the national unemployment rate 3 percentage points higher than would otherwise be the case.” Furthermore, “Economist Arthur Okun estimated that for every 1% increase in unemployment GDP falls by 2.5-3%” (MacKenzie, 2006).
Conversely, removing minimum wage laws present a more propitious fight against poverty. MacKenzie (2006) again points out, “Eliminating minimum wage laws would reduce unemployment and improve the efficiency of markets for low productivity labor.” That said, today’s political climate has transformed minimum wage laws from poverty prevention to income redistribution. Therefore, a bipartisan alternative needs to be identified and embraced in lieu of minimum wage.
One such alternative includes tax credits for low-income workers coupled with public support for work and training. Market commentator, Glenn Hubbard (2006) stated, “Compared with the minimum wage, the earned-income credit can increase the incomes of low-skilled workers without reducing employment.” Providing tax credit as well as training and work incentives, reduces unemployment and poverty while increasing national GDP.
In conclusion, this paper explained the concepts behind supply and demand as well as changes in quantity demanded/supplied and shifts in demand/supply. Additionally, the effects of minimum wage were discussed while identifying the impact of setting a price floor within the market. Finally, the effects of removing minimum wage were examined and an alternative was identified.
References
Baker, S. L. (2003). Supply and demand. Economics Interactive Lecture, University of South Carolina, Columbia, SC. Retrieved August, 2007 from: http://hadm.sph.sc.edu/COURSES/ECON/SD/SD.html
Hubbard, Glenn (2006). Alternatives to Raising Minimum Wage. Marketplace, American Public Media. Retrieved June 16, 2009 from: http://marketplace.publicradio.org/display/web/2006/08/02/alternatives_to_raising_minimum_wage/
MacKenzie, D. W. (2006). Mythology of the Minimum Wage. Mises Daily, Ludwig von Mises Institute. Retrieved June 16, 2009 from: http://www.mises.org/story/2130
Mohanty, Lisa Dr. (2009). Market Behavior. TUI University BUS 305, Mod 2.
Reynolds, R. L. (2005) Chapter 8: Demand and Supply in a Market System. Alternative Microeconomics, Boise State University. Retrieved February 24, 2009 from: http://www.boisestate.edu/econ/lreynol/web/PDF/short_8_Dem_supp.pdf
Graphs
Market Behavior
Objectives
- Explain key economic terms such as scarcity, supply and demand, marginality, in the way that economists use them
- Apply the “big ideas” of economics and their addition to common discourse
- Identify ways in which economic facts, action, and changes create ripples that eventually affect you.
Assignment
Adam Smith’s book the Wealth of Nations is one of the classics of economics. This book is still widely read and assigned to students at universities all over the world. He considered himself a philosopher, but he is now considered to be one of the first economists.
Read the article below and do some of your own research in the Cyberlibrary or Internet search engines on Adam Smith. Answer the following questions in a 2-3 page report:
- Adam Smith is considered the father of modern economic theory. Explain his ideas about division of labor, self-interest and the invisible hand. Do you think these ideas are relevant today? How do they relate to do “Big Ideas” from the PowerPoint presentation from this module?
- Define the terms supply and demand, and then indicate how they reflect Smith?s ideas of self-interest and the invisible hand.
- Provide a real-world example from today’s economy of the “invisible hand” or another idea from the article. Explain how your example fits with Adam Smith’s idea.
Paper
As an economist and philosopher, Adam Smith believed self-interest, division of labor, and an invisible hand were the driving factors behind world economies. This assignment will examine the relevance of Smith’s ideas in today’s economy and provide a real-world example of the invisible hand phenomenon. Additionally, this paper will show the relationship between Smith’s concepts and the “Big Ideas” of economy as well as supply and demand. Finally, we will identify ways in which economic facts, actions, and changes create ripples that eventually affect every individual.
Commonly referred to as the father of economics, Adam Smith identified three phenomenon as the driving forces behind the global economy. First, Smith believed every individual was motivated by the pursuit of his own wealth. In An Inquiry into the Nature and Causes of the Wealth of Nations, Smith (1776) wrote, “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” In other words, Smith believed the economy is more efficient when individuals follow their own ambitions instead of focusing on the welfare of society. Modern economists classify this principle as self-interest.
Secondly, Smith considered labor to be most beneficial to the economy as workers became more specialized. In a basic sense, breaking down large jobs into smaller, more skillful jobs accomplished this concept. “Under this regime each worker becomes an expert in one isolated area of production, thus increasing his efficiency. The fact that laborers do not have to switch tasks during the day further saves time and money” (Dhamee, 1996). In today’s economy, this concept is dubbed division of labor.
Lastly, Smith believed the market was divinely orchestrated by an omnipotent being through an instrument he labeled the invisible hand. “Smith was profoundly religious, and saw the ‘invisible hand’ as the mechanism by which a benevolent God administered a universe in which human happiness was maximized” (Joyce, 2001). Smith credits this deity as the originating source of the aforementioned self-interest and specialized skills within each individual. Moreover, Smith believed this supernatural being controlled the overall market by interacting with human nature via the invisible hand and leading people to act in a specified manner.
The invisible hand theory is still relevant today and is most clearly seen throughout large markets. The real estate boom from late 2003 to early 2006 and its subsequent bust reminds many of the self-correcting nature of macroeconomics and interest rates. This single example may suggest that the invisible hand is more apparent today than any time in history. Igor Greenwald (2006) of the Wall Street Journal noted, “The invisible hand isn’t so invisible these days. It’s manifest in the daily gyrations of stock markets all over the world and in the mind-boggling proliferation of exotic derivatives.”
Smith’s philosophies are highly esteemed by present day economists and are the founding principles behind the five “Big Ideas” of economics. Therefore, each of the “Big Ideas” are corroborated by Smith’s doctrines as shown in Table 1. Furthermore, the notion of supply and demand gives evidence supporting Smith’s models of self-interest and the invisible hand.
Supply succinctly defines the process of allocating limited resources toward limitless needs. Natural resources, especially commodities, are essentially immeasurable and unpredictable in terms of volume and availability. Thus, supply lends itself to the invisible hand theory. Demand, in basic context, describes the process of provisioning these resources based on public response. In other words, demand is relative to the desires instantiated from individual self-interests.
Based on Smith’s economic philosophies, the “Big Ideas” of economics, and the concept of supply and demand, one can clearly see how economic facts, actions, and changes affect every individual. For example, the loss of a group of oilrigs in the Gulf of Mexico could inflate oil prices (invisible hand). The price increase would pass to consumers who now need more income to support their driving habits (self-interest). Fringe spending would likely decrease leaving some companies with an overabundance of products (supply and demand). The market could self-correct (invisible hand) or require some government action.
In conclusion, this paper examined Adam Smith’s economic philosophies and their relevance in today’s economy. In addition, real-world examples of the invisible hand were provided and the relationship between Smith’s concepts as well as the “Big Ideas” of economics were illustrated. Finally, the concept of supply and demand were explained within the context of Smith’s teaching and a hypothetical scenario was provided to identify ways in which economic facts, actions, and changes affect every individual.
References
Dhamee, Yousuf (1996). Adam Smith and the Division of Labor. The Victorian Web. Retrieved from http://www.victorianweb.org/economics/division.html
Greenwald, Igor (2006). Adam Smith’s Invisible Hand is Very Much at Work Today. Smart Money. Retrieved from http://www.smartmoney.com/investing/economy/adam-smiths-invisible-hand-is-very-much-at-work-today-20489/
Joyce, Helen (2001). Adam Smith and the Invisible Hand. University of Cambridge. Retrieved from http://plus.maths.org/issue14/features/smith/
Mohanty, Lisa Dr. (2009). Market Behavior. TUI University BUS 305, Mod 1.
Smith, Adam (1776). An inquiry into the nature and causes of the wealth of nations Volume 1. 400.
Tables
Table 1: “Big Ideas” of Economics Supported by Smith’s Concepts.
|
“Big Ideas” |
Adam Smith |
| Choices involve tradeoffs. | Self-interestInvisible hand |
| Choices are made in small steps and involve incentives. | Self-interest |
| Voluntary exchange most beneficial for sellers and buyers. Markets facilitate these exchanges. | Self-interestInvisible hand |
| Government action maybe needed when the market doesn’t work efficiently. | Division of labor |
| Expenditure = income = value of production for the economy as a whole. | Invisible hand |
