Download Relative scarcity and relative prices What makes

Relative scarcity and relative prices
What makes something scarce?
In unit 1 we discussed the general condition of scarcity, the fact that our resources
are insufficient to allow us to reach all of our goals. A more limited condition is
the scarcity of individual goods, services, or resources. Even though there may
not be much of a good, service, or resource, it is not necessarily scarce. Scarce is
not to be confused with limited or rare. Rare indicates that not much of the stuff
exists regardless of whether people want it or not. A disease that is very rare is not
likely to be scarce from the economist’s perspective.
Limited means there is only so much of the stuff. Even the sands of the sea and
the stars in the sky are limited. but they may or may not be scarce, depending on
time and place. Using limited in the same breath as scarce muddies the water.
If there is not much of it, but no one wants it, the good is not scarce. Nuclear
waste is not scarce, my brother-in-law’s paintings are not scarce. Resources are
only scarce if they have to be allocated (using them one way means NOT using
them another way) because the amount desired is greater than the amount
available at a price of zero. They are scarce if, by using them one way, an
opportunity to use them another way is given up; or, if one person’s use of them,
denies another’s use. The key is whether a choice has to be made about the use of
the resource.
[Example] Sand at the beach is limited but, in most cases, it is not scarce. Most
people don’t want to haul a lot of sand home with them, so there is plenty of sand
to go around at zero price. The little girl who wants to take a bucket of sand home
can do so and pay no money. The gardener who lives in Fresno, however, doesn’t
have a lot of sand lying around, so he goes to the nursery and pays a price for use
of some sand. Sand is not scarce at the beach, but it is scarce in Fresno.
Scarce indicates that people want it, there is not enough to fulfill all those
wants, it has alternative uses, and using it one way means not using it in
another way.
Relative scarcity and relative price
To avoid confusion, recognize that, at this point, students understand scarcity as a
general concept…you can’t have everything you want. So it’s important to let
them know that you are going beyond the general concept now and asking the
question, “How scarce is this particular product in comparison to income and all
other products?” Help them make the leap between the general concept of scarcity
and the concept of the scarcity of a particular product If you have been successful,
your students understand that a product or resource is scarce if a choice has to be
made about how to use it. Now we want them to understand the scarcity of one
product relative to all others. So, we will try to help them ask and answer the
question, “Well how scarce is this product compared to other products?” “Which
is scarcer, a pencil or a huge diamond?” “How do we know how scarce one
product or resource is compared to all others?”
When the word “price” is used in economics, the inference is that the price under
discussion is the price of a product relative to all other products. In studying
economic history, it is often frustrating when authors state the price of a product
such as cinnamon or silk in ancient currencies and weights. For example, in 1284,
a pound of mace cost 4s 7d. That statement, by itself, is of no help whatsoever. If
a further statement is added, “This sum could also buy three sheep,” we have a
little more information. But the final piece of information that would help make
sense out of the original statement would be the income of a peasant in 1284. The
point is that the first statement provides no information unless the reader knows
the prices of other goods and services and the typical income of the consumer. 4s
7d must be put in perspective.
The scarcity of a product is determined by the relationship of supply and demand
and it is measured by price. But that doesn’t provide much information. Suppose
that I told you that the price of a new full sized fully operational car is $1250. You
are likely to ask, “Where can I buy it?” and I would have to tell you that you can
buy it in 1950 and your salary is $2,900 per year. Take a look at the table below
which shows nominal incomes, and prices of different products in 1950 and 1958.
1950
Average annual salary
Minimum Wage per hour
$2,900
40 cents
Car
House
Gas per gallon
Bread per loaf
Milk per gallon
Postage Stamp
$1,250
$10,000
21 cents
9 cents
62 cents
3 cents
Rel
Scarcity
% of
income
1958
Rel
Scarcity
% of
income
2
1
4
5
3
6
40%
327%
$5,500
$1.00
2
1
4
5
3
6
43%
345%
$2,200
$18,000
30 cents
19 cents
$1.01
4 cents
1
The first thing to notice is that both cars and houses went down relative to income
from 1950 to 1958. In 1950, the price of a car was 43% of average income; in
1958 it was only 40%. In 1950, the price of a house was 3.45 times average
income; in 1958 it was only 3.27 times average income. The next thing to notice
is that the relative scarcity of the items did not change; the scarcest was still the
house, followed by the car, and the least scarce was still the postage stamp. So
now you know something about relative prices in 1950 and 1958. Had you been
told that the price of a house in 1950 was $10,000, you would have thought, “Gee,
1
The History of Television: The First 75 Years http://www.tvhistory.tv/1945%20QF.htm
Unit 9: Buyers and Sellers Determine Prices 2
that is cheap!” But looking at that price as a percent of income from 1950 to 1958,
you know that it was actually pretty expensive.
The same is true of the statement that the price of a CD is $17. In 2013, $17 is
about twice the price of a paperback book and about ½ the price of a sweater and
the average income of a worker is about $40,000 per year. If the price of the CD
falls, and nothing else changes, buyers will buy more CDs. If however, the price
of a CD doubles, at the same time that the price of all other goods and services
and all incomes double, there is no incentive to change the amount of CDs
purchased. Only if the relative price of CDs changes, is there a change in the
incentives of CD buyers and sellers.
Ask your students to discuss supply relative to demand in the following examples.
The air is electric as people file into the crowded room. A newly discovered Van
Gogh is up for auction and art dealers from all over the world have come to bid.
Rumors of the discovery have been circulating for months, but most readers
figure they are false and that the painting is a hoax. But here it is, validated by the
finest art experts in the world, displayed on the podium, closely watched by two
not so disguised security guards. What will it go for? Who will get it? The art
world is abuzz with speculation. The bidding starts at $2 million but quickly rises
to $12 million. The final sale price is $15 million.
A young man goes into a hobby shop and wants to buy a famous baseball player’s
rookie year baseball card. Two years ago he bought one for $20. The price today
is $50.
A student decides it is time to buy a new laptop. She goes to the electronics store
to find that she can buy a laptop with more memory, greater speed, and many
more accessories than she would have dreamed of two years ago. And the price is
lower than when she looked a year ago.
It is not the supply alone or the demand alone that determines relative scarcity; it
is the interaction of sellers (supply) and buyers (demand). As mentioned above, if
a thing is rare (low supply), that does not necessarily make it scarce; a rare
tropical disease is not scarce. A rare tropical fish, on the other hand, might be very
scarce and command a high price if lots of people want it and are willing to pay
for it. Rare describes how much is available, scarce describes how much people
are willing and able to supply it compared to how much people want it and are
willing to pay for it.
Relative scarcity depends upon both sellers (supply) and buyers (demand). Even
though every human being must have water to survive, it is not very scarce
because there is lots of it. In the Sixties, people were buying “pet rocks.” They
were ordinary rocks, cleaned, placed in a box, given a name, and sold. (Yes,
people actually bought them!) Even though there are not many pet rocks around
today, they are not scarce. The reason is not that there aren’t many, the reason
Unit 9: Buyers and Sellers Determine Prices 3
they are not scarce is because there is no demand for them. The fact that they
were relatively scarce at one time dramatizes the role of demand in the equation.
The fact that there is a lot of a product or a little of a product does not, by itself,
determine relative scarcity. The fact that lots of people want a product or only a
few people want a product does not, by itself, determine relative scarcity. The
prices of baseball cards, art, and old stamps and coins illustrate the determination
of relative scarcity by supply and demand.
Relative price is the measure of relative scarcity.
Price is not fair or unfair. As we will see in Unit 10, a price change is caused be a
change in either supply or demand, and those changes have nothing to do with fair
or unfair. When a teenager’s shoe size goes from 9 to 12 in six months, very few
would declaim the fact as being unreasonable, unfair, ridiculous, or a ripoff.
When asked how tall she is, a woman might reply that she is 5”6’ and no one
would rail against the fact, claiming that a plot had been hatched. If a recipe calls
for two cups of flour, very few would claim that the recipe is a plot by the
international flour conspiracy. If a worker lives 30 miles from home, people don’t
usually picket the office, claiming that the distance is part of management’s plan
to exploit the workers. If the temperature rises above 100 degrees, people may
complain, but they are not likely to ask Congress to investigate the air
conditioning industry. All of the questions above can be answered by a unit of
measurement, shoe size, feet and inches, cups, miles, degrees Fahrenheit. And yet
that is often the reaction to price changes or prices that people don’t like. A price
(in our case in dollars and cents) is the unit which measures relative scarcity.
Neither shoe size, nor height, nor weight, nor temperature, nor price are moral
measures.
Price is not a measure of “worth”. A diamond is merely a shiny rock. While it has
some commercial value, it is used mainly to adorn people. Insulin is lifesaving;
without it, many people would die. And yet ounce for ounce, the price of insulin
is far lower than diamonds. That would appear to make little sense. In some sense,
insulin is more “useful” than a diamond. But price is not a measure of the
usefulness of an item alone. Water is extremely useful, in fact, necessary for
survival, but it has a very low price compared to gold. How is this possible? Isn’t
insulin worth more than a diamond? Isn’t water of more use than gold?
The confusion lies in the loose use of the words “worth” and “value” and the
assumption that they are the same as price. Unlike “worth” or “value,” price is not
a measure of the moral or social value of a product; it is the measure of relative
scarcity.
Price provides a good deal of information about products. Ask your students to
rank the following items in terms of relative scarcity.
yacht
candy bar
Unit 9: Buyers and Sellers Determine Prices 4
laptop computer
mini truck
nice dinner for two in San Francisco
Without any information about supply or demand, they would probably rank the
yacht as most scarce, followed by the mini truck the laptop, the dinner and the
candy bar. They were able to rank the items because they had some idea of the
relative prices of the items. Relative scarcity does not give an absolute value of
scarcity; it lets people know how scarce a particular item is in comparison to how
scarce other items are. It is relative!
Remember we said that markets can’t function without information. The price of
a product sends information to both buyers and sellers that this product is scarcer
or less scarce than other products. Prices are extremely helpful to sellers in that
they allow them to make decisions about what to produce and how much to
produce. Prices are helpful to buyers because they allow them to make a
subjective judgment about how much benefit they expect to get from the product,
compare that to the price, and decide whether to buy or not to buy
What may seem to be “unfair” is the fact that, in certain markets, a few sellers
have some control over price. Many people dislike the existence of the
Organization of Petroleum Exporting Countries (OPEC) and the fact that they
attempt to manipulate supply, but that does not change the fact that the price of a
barrel of oil reflects the relative scarcity of the product as determined by supply
and demand. Others may rail against advertising agencies and the ways in which
they attempt to manipulate demand for particular products, but that doesn’t
change the fact that the price of a carton of lemon yogurt reflects the relative
scarcity of lemon yogurt. The fact that those with market power (some control
over supply or demand) may succeed in manipulating supply and demand does
not change the fact that the price of the product reflects the relative scarcity of
that product.
Main Points:
The Law of Demand states that a higher price will cause a decrease in
the quantity demanded and a lower price will cause an increase in the
quantity demanded.
A demand schedule is a relationship between prices and quantities
demanded.
The Law of Supply states that a higher price will cause an increase in the
quantity supplied and a lower price will cause a decrease in the quantity
supplied.
A supply schedule is a relationship between prices and quantities
supplied.
Unit 9: Buyers and Sellers Determine Prices 5
Price elasticity of demand is the strength of the buyers’ response to price
changes.
The determinants of price elasticity of demand are availability of
substitutes, percentage of income, and time.
Price elasticity of supply is the measure of the strength of seller’s
response to a price change
The determinants of price elasticity of supply are time, use of easily
transferable resources, and divisibility of inputs.
Buyers and sellers (demand and supply) determine equilibrium price and
quantity exchanged.
At the equilibrium price, the number of items that sellers are willing and
able to offer for sale equals the number of items that buyers are willing
and able to purchase.
Relative scarcity is the relationship of supply and demand.
Price is the measure of relative scarcity.
Learning Hurdles
Incorrect Statement
Price is unfair, immoral, and ridiculous.
Correct Statement
Price is nothing more than the unit by
which we measure relative scarcity.
A price increase is caused by greed.
Price is determined by supply and demand.
When costs increase, sellers will just pass
the increase on to consumers by raising the
price.
While an increase in cost is likely to cause
a price increase, the amount of the price
increase depends upon price elasticity of
demand. Sellers must always beware of
negative buyer response to price increases.
Sellers are constrained by demand.
Sellers can charge any price they want.
Multiple Choice Questions
1. According to the law of demand, a price increase will cause a(n):
a. increase in supply
b. decrease in supply
c. increase in quantity demanded
d. *decrease in quantity demanded
2. Which of the following illustrates a relationship between a set of prices
and quantities demanded?
a. a supply schedule
b. *a demand schedule
c. a change in quantity demanded
Unit 9: Buyers and Sellers Determine Prices 6
d. a change in quantity supplied
3. According to the Law of Supply, a price decrease will cause a(n):
a. increase in supply
b. decrease in supply
c. increase in quantity supplied
d. *decrease in quantity supplied
4. Which of the following illustrates a relationship between a set of prices
and quantities supplied?
a. *a supply schedule
b. a demand schedule
c. a change in quantity demanded
d. a change in quantity supplied
5. Which of these products is likely to have the greatest price elasticity of
demand?
a. salt
b. pepper
c. a particular medicine that has no substitutes
d. *a particular brand of gasoline
6. Price elasticity of supply for a particular product is likely to be greater if:
a. the time period is short
b. the resources used are specific to the product
c. *the resources used are easily divisible
d. the product lasts a long time
7. Who determines the price of a product?
a. buyers
b. sellers
c. *buyers and sellers
d. neither buyers nor sellers
8. Relative scarcity is:
a. the same as relative rareness.
b. determined by how much of the product exists.
c. a measure of the worth of a product to society.
d. *the relationship between supply and demand.
9. Relative scarcity is measured by:
a. the supply of the product.
b. the moral value of the product.
c. *the relative price of the product.
d. the demand for the product.
Unit 9: Buyers and Sellers Determine Prices 7