The Price of Things

Supply and demand. Everyone has heard of these two curves, the intersection of which on a graph is said to represent an equilibrium of prices paid and quantities supplied. Unfortunately, this is an oversimplification of reality, and like all oversimplifications is a logical fallacy that shrouds and buries truth. We need to look at a couple of things about how markets really work.

First, please grab a sheet of paper and a pencil. (It’s OK. The hand drives the brain, anyway. The fossil record indicates that primates developed opposable thumbs before they did large brain cases.) Establish a “zero point” about two-thirds way down the page and an inch or so from your left-side margin. Extend two lines at a right angle to each other. Label the vertical line (the ‘Y-axis’) “Price in Dollars” and the horizontal line (the ‘X-axis’) “Units Supplied.” So far, so good.

Right? Now, mark ten points on each axis, about an equal distance apart, and label the points ‘1, 2, 3, and so on.

Good. Now draw another vertical line, a parallel to your ‘Y/Price-axis,’ beginning at 3 or 4 units and extending to the top of your graph. Fine. Now, what have you made?

You have constructed a demand curve for a good that is perfectly price inelastic. In other words, no matter what the price of the good, the quantity demanded and supplied remains the same. What sort of good is this, and what is going-on here? Clearly, this is not a normal good and one for which there are few, if any substitutes. Think gasoline.

Think food.

Take gasoline. Say you are a commuter, need to drive your car to the job, and there is no public transportation available, or that you have a psychological aversion to public transportation and to car-pooling. Exxon Mobil knows about you. They know that they can raise prices and raise them some more before your behavior changes. Your obdurate psychology will remain as unchanging as the amount of personal driving you do until the pain at the pump you experience drives you to public transport, to a car-pool, to the purchase of a smaller vehicle, or to a shrink.

But, suppose you live in rural North Dakota; there is no public transportation nor car-pool available because of low population density; you are too poor to buy a different vehicle; and your job is in the city. Now what? Do you really believe that drilling in the Arctic National Wildlife Refuge or that off-shore drilling will give you $2.00 gasoline? Or will this simply mean more money for Exxon Mobil and increasing threats to the environment of our one-and-only planet Earth?

Recollection of price inelasticity of demand may be a surer guide than the platitudes of politicians who promise you an easy fix. Besides, John McCain takes millions of dollars from oil lobbyists, and the ridiculously sycophantic Michele [sp. sic.] Bachmann, 6th District Congresswoman from Minnesota, belongs to a church that is heavily invested in oil.

You could look that up and remember it the next time she holds a news conference on a Louisiana offshore oil platform (after being helicoptered in), while, at the same time, the mouth of the Mississippi is closed to navigation because of an oil spill.

Well, as in oil, so it goes with food. We all have to eat. The demand curve for food is not perfectly inelastic as in the extreme case of the indigent and air-conditioned North Dakota gypsy we have described above. The demand curve for food is shifted outward and to the right, like a backward slash on a keyboard. Try it. You will see that as prices decline, the quantity supplied and demanded increases. Besides, we can always substitute one food for another. It is something like a normal good; substitutions are possible and it may be possible to eat less—up to the point of starvation. However, consider the case of the poor.

The poor have fewer options. They spend a higher proportion of their income on food than do the wealthy. They spend a higher proportion of theie income on fuel for transportation and for heating than do the wealthy. You may have heard of a government statistic called the core rate of inflation. You may have also noted that this statistic excludes the prices for food and for fuel. Why is that? Could it possibly have anything to do with political and government types—smart people, after all—knowing about price inelasticity of demand and wanting us to believe that we are better-off than we really are?

Surely, confidence and psychology have as much to do with markets and elections as does the dismal science, economics.