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“When we talk about economics, there’s something known as a demand curve with elasticity”

March 25, 2020

“We might as reasonably dispute,” Alfred Marshall wrote in his famous economics textbook first published in 1890, “whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production.”

Prices are determined in the marketplace, through the communication between buyers and sellers, jointly through a negotiation reflecting their willingness to pay, and their costs of offering. Marshall offered us these tools, the demand curve and the supply curve, to understand price determination in perfectly competitive markets. And he also characterized them, and used them to illustrate price determination in a wide variety of examples.

As a part of this he introduced the notion of “elasticity,” a concept that Congresswoman Alexandria Ocasio-Cortez learned well in her economics courses, and used to drive home what she felt were some important lessons in understanding health care. Listen to her.

And so this week’s class in our course, Economics for Everyone, is about elasticity. If she can understand it, so can you. If she can use it, so can you. And that is what we do in the lecture: define the concept, and show how it is used to understand market outcomes for some policy relevant examples.

Download the presentation for Lecture 6, “Understanding and Using Demand and Supply Curves” as a pdf, and if you like listen to narrated version.

17 Comments
  1. Morning professor!

    (Tiny inconsequential fact check: AOC = congresswoman, not senator.) Rousing statement from her…

    First reaction to lecture: A big THANK YOU for the explanatory footnote on page 15 about the “peculiar way” the X and Y axes are depicted…that was bothering the hell out of me until now 😁

    More to come as I read…I can’t imagine a more opportune time to cover this material…

    V.

    • Thanks for this, I’ve corrected the error in AOC’s title. Do let me know about any further questions or concerns you have about the lecture, but also feel free to share insights that you found helpful so that other students can reflect upon and benefit from them.

  2. Thank you for the lecture! I think I erred in both mathematical calculations 😦 — but I understand the story behind the math, and that’s what’s important, right?!

    In answering the questions you had distributed, I went on a little side ramble about needed to purchase a car in the coming months, and whether prices for a slightly used car would be a) lower because the economy has tanked or b) higher/same because tanked economy is prompting people who need cars to shift from new to used. In this lecture, I see there’s an economic term for the second scenario: cross-price elasticity of demand. A change in demand for new cars could increase demand for used cars – substitutes.

    Also, the ban on broker fees is on hold, for now (I had to look this up!): https://commercialobserver.com/2020/03/nyc-brokers-fees-to-remain-until-june/

    • Thanks for this, and for bringing us up to date on the Broker Fee discussion, which I used to motivate our understanding of the difference between the legal and the economic incidence of a tax. I hope that the use of the example wasn’t distracting, the point being that there is a difference between who is required to legally remit the tax revenue to the government, and who actually ends up paying it. Elasticities are important to be able to make this distinction, and to actually develop a reasonable sense of who ultimately pays the burden of the tax.

      Glad to see you have picked up on a very good example of the use of cross-price elasticities, and don’t worry about any mathematical mistakes in your first try at the assignment, the point is to start the conversation, reflect on it, and get better next time … as I assure you there will be a next time!

  3. Robert permalink

    Hello Professor & fellow Students. I have a couple of initial comments, although I may have more later!

    The first is a reflection on our Demand & Supply Curves Assignment: Listening to your lecture, I realize an error I had made in our Supply & Demand Curve Assignment – I was cognizant of the ‘law of demand’ but was confused about if there were a corollary ‘law of supply.’ In looking through my notes, while listening to the lecture, I came across a note from your class lecture of March 10th: ‘the higher the price, the higher the quantity supplied’ – this being because: ‘the marginal cost from each additional unit produced rises.’ My misunderstanding lead to my making mistakes in addressing aspects of questions 3 & 4 in the assignment. Your lecture today was helpful in helping me realize that mistake.

    My second comment is more of a Question – Or, perhaps, a pair of questions simultaneously interacting… (!): In your discussion of Alfred Marshall, you note that the Neoclassical Theory of Value suggests that value is generated simultaneously by demand and supply. You express it, in part, as ‘relative prices’ are determined by the interaction of supply and demand in the market. My question has to do with the relationship between ‘value’ and ‘relative price.’ Are these the same thing? Is relative price a sort of representation of value?
    In classical economics, value seems to be a substantive ‘thing.’ Whereas, in neoclassical economics, value is not so much substantive, as it is relational…? So, perhaps, in classical economics value and price are not the same thing, whereas in neoclassical economics, they are? I realize also, that there is a distinction to be made between absolute and relative prices. You mentioned in your class lecture on March 3, that micro-economics is interested in relative prices and in ratios. Perhaps, value has a different conceptual or practical relationship to relative price than it does to absolute price? These are an amalgam of thoughts and inquiries prompted by your lecture…

    Thank You. I hope Everyone is Well.

    Best,
    Robert

    • Thanks for this Robert, and I’m glad the lecture gave you the opportunity to reflect on your assignment. It is natural that not everything is going to be perfect in our first attempt at these types of questions, a bit riding a bike isn’t perfect the first time we try … a little practice and it all gets easier. So I think you are using the learning materials in exactly the right way, attempting them on your own, allowing them to raise questions in your mind, and then revisiting them and refining your answers as more information comes along. There will be other opportunities to do the questions as the course progresses.

      I think your summary of value is roughly correct. Yes, there are a lot of words floating around, and sometimes similar words are used in different contexts and mean something slightly different. But that’s the case for all languages.

      When we use the word value or theory of value, just think of price. And that price, what we observe in the market, is the rate at which the good in question trades-off with all other goods, the stand in for them being money. We have a subjective valuation, one that exists in our minds, and that is monetized and compared to the valuations in the market. When our subjective rate of exchange, speaking now as a neo-classical economist, is the same as the market valuation we stop buying the good, and have reached an equilibrium of sorts. The text book calls this subjective rate of exchange the “willingness to pay”, but more theoretically, it is a monetized value of our marginal utility.

      But bottom line, what we are trying to offer is a theory of prices.

  4. Donna R. permalink

    Hi there, Miles,

    I greatly appreciate your online lecture. One benefit to this format is that I am able to go back and listen to you explain concepts that are confusing to me.

    Given the situation with the ongoing COVID-19 pandemic, my observations around consumption have been popping into my head while listening to your lecture. Around 24:00, you talk about diminishing marginal utility, and how consumers will eventually reach a satiation point. I’m curious to understand more about how future expectations influence consumption.

    For example, right now consumers are clearing the shelves at grocery stores everywhere. People are panic shopping and “hoarding” goods like toilet paper and food. This has been going on for weeks and grocery stores cannot keep up with the demand. If people continue to be uncertain about the future (like, not knowing if the grocery stores will close next and for how long) could consumers still reach a satiation point?

    Thanks, and take care,
    Donna

    • Your last paragraph raises a very good issue. I think I will start the next lecture by addressing this question, restating the underlying determinants of demand, and in particular future expectations, as well as drawing a distinction between stocks and flows. So stay tuned!

      But I didn’t mean to confuse you when I talked about “satiation” in the lecture, and I don’t think it is necessary to bring that into the conversation to understand the behavior you are describing in the last paragraph in your comment.

      I was using the term just to offer some intuition about diminishing marginal utility. Take my favorite example, my consumption of cappuccini. If you gave me one cappuccino in a day it would increase my utility quite a bit, a second would also increase my utility, but not by as much as the first. And frankly, I can’t possibly drink more than two cups of coffee in a day, those are my preferences. So the third cup you offer me adds nothing to my utility, I’ve had enough, I’m “satiated”. In this way, the declining marginal contributions to my satisfaction are marking out my path to this personal limit. How many I actually end up consuming is a whole other thing of course. That is where we need to know the prices I face, as well as my income, to determine my optimal purchase and consumption.

  5. Antoinette Gregg permalink

    Hey folks! I hope everyone is adjusting relatively well to our social distancing world. I find that many times when I am reading the material I understand it theoretically but then I get lost in the graphical iterations. Marshall did not make it any better by inverting the way in which I learned to interpret variables in a graph. I understand the generally what is meant by demand and supply elasticities but I am hung up on a couple things:

    1. What is the definition of efficiency in regards to a perfectly competitive market?
    2. Is a scarce commodity inherently more elastic? Is that what the Brazilian bean example was getting at?
    3. Would the recent bailing out of the stock market be an example of lump sum redistribution of initial property rights?

    I felt a bit overwhelmed by a lot the dive into what elasticity is and feel like I understand the demand side of it more than the supply side. Also, the elasticity equation keeps tripping me up. I thought I understood it but when you explained it I got more confused about it. I have found, though, that if I substitute buyer and seller for quantity and price I can logic my way through explaining elasticity as is pertains to demand.

    • Yes, you are certainly right about the placement of the variables on the vertical and horizontal axes. That tripped me up a good deal when I first started learning this material. It is just a legacy we have to deal with, though as I believe I mentioned, continental European economics didn’t start off this way.

      To address your questions as best as I can.

      1. Efficiency has a somewhat broader meaning when we are talking about the workings of a perfectly competitive market. First, there is certainly the dimension of efficiency in the sense that we usually use that word: producing as much from a resource as is technically possible. In economics we speak of this as efficiency in production, and we represent it analytically by saying that the economy is “on” the production function. Production would be “inefficient” if we were operating below the production function, producing less from our resources than is technologically possible. If we were more efficient, in the sense of being better managers and engineers, then we could produce more from what we have. We assume that the economy is on its production function.

      But how much of which kinds of goods is the economy producing? We may be efficient in the production of goods, but are we producing the goods people want, and are they going to the people who want them most? This is about sending appropriate signals from consumer preferences to encourage the right production, and it is about sending appropriate signals to individuals to allow them to make exchanges according to their preferences and opportunity costs. So there is also efficiency in exchange that is important.

      Our use of efficiency encapsulates these other dimensions, and when we have attained it there is no way to make anyone better off without making some one else worse off. We call this Pareto efficiency, after the Italian economist Vilfredo Pareto. This is what characterizes the first fundamental theorem of welfare economics that we talked about in class.

      2. I’m a bit uncertain of exactly which Brazilian bean example you are referring to in this question, as I think it came up twice, as an assignment question and as an illustration of the degree of commodity classification and its implication for the elasticity of demand. I think you are referring to the later. If not, just correct me. All commodities are “scarce” in the sense that the demands we place on them exceed the available supply, that is why they have a price in the market place, one that under ideal circumstances represents their opportunity costs. So I’m a bit confused by the use of this term in this context. But commodities are different in nature, given our needs and preferences. Commodities that are necessities tend to have a much lower price elasticity, those that are luxuries (at the consumer’s income level) will tend to be more responsive to price, in other words more price elastic. Does this help?

      3. I’m not certain I would characterize lump sum taxes this way. I think we need to study macroeconomics a bit more to be able to approach questions about the stock market. It is debatable whether a true lump sum tax exists in reality, even if we speak about it in theory. So when we talk about it we are talking about an ideal case. That said, a “poll” tax is considered a lump sum tax. Everyone pays it, pays the same amount, and no one can escape it. A lump sum tax refers to a tax that will not alter market behavior, it changes the distribution of resources without creating an incentives that change behavior and alter the production or allocation of resources.

      Maybe the best way to address your other concerns in the last paragraph is to meet virtually, through a small group or one-on-one to talk through parts of the equation and other things. I’ll be in touch by email, but feel free to reply to this note if you think your input can help your further, and also support other students.

  6. Robert permalink

    As threatened, here comes another comment from me. And, again, I have two.

    The first is by way of being autobiographical, just to touch base on where I am at in my process of grappling with the material: I have been working, slowly, through the lecture. Part of the reason it has been slow going for me is that I am taking rather detailed notes as I go. I find it helpful to write things out. In class, I have to just keep up with the lecture as best I can; but with the recorded lecture, I find myself listening to the same sections over several times to help me grasp the logic and process being presented. I am focusing on strengthening my foundation, hoping it will stand me in good stead moving forward.

    The second is a comment on the content of the lecture. I wanted to say that I find the approach very helpful. When I was completing the Demand & Supply Curves assignment, I honestly felt rather out to sea and over my head. However, having had to work through it on my own, I now find the process of working through these same problems in the lecture to be very helpful and productive. That is, the material in the lecture is making more sense to me than if I hadn’t struggled through the assignment on my own in the first place.

    I intend to continue plugging away tomorrow.

    Best,
    Robert

    • Thanks for this feedback Robert, we all have an approach that works best for us, and I’m glad you’ve been able to find yours and that the resources are supporting you. Keep it up!!

  7. Hello Miles, classmates and netizens in general,

    I appreciate the talk posted here– very useful to return to certain points in the video.

    As I work through the concepts discussed here, I find myself wondering about the new contexts in which these economics terms are being placed. It’s clear that AOC’s use of “elasticity” helps her form an argument against the private provision of healthcare by claiming that our demand for it is perfectly inelastic. Naturally, a mother’s demand for her daughter’s life-saving healthcare might indeed be almost perfectly inelastic: to document the tragic extent that a mother might go to meet that supply curve is the work of those campaigning for healthcare reform. However, for me this seems to prove the point that an economic assessment of health provision is the exact practice which traps political reformers into a discourse of evaluating lives according to the metrics of actuaries. Should the weapon of the oppressor be used in such a scenario?

    As I understand it, universal healthcare was not implemented in other countries because it met the criteria of neoclasscial economic analysis, but because it was a moral principle, emerging from human rights discourse of end of the Second World War, that medical provision should not be available for conspicuous consumption or subject to the income effect. Healthcare of course needs to be paid for; my question is whether an economic analysis via elasticity serves plays into the hands of insurance companies because we are distracted by the embarrassing truth that, yes, people are in fact forced to draw a line under what they can do for those they love on a regular basis, rather than saying that the original scandal was that such a quantitative estimation was made in the first place.

    I’ve also noticed other phrases such as “opportunity cost” have worked their way into public discourse, with the implication that these terms not only derive from and form the lexicon of the field of economics, but that they can shed light on vernacular or mainstream understandings of how daily life is experienced. This seems to form much of the subtext of Tim Harford’s writing– you can view the world as an economist and uncover the hidden systems by which the world is run. But is this a form of uncovering or the new application of an old narrative? The injunction is to examine how and supply and demand constitute economies at all levels, but is this not also an invitation to adopt the perspective of those who are trying to extract the greatest surplus possible from those who haven’t yet gotten wise to the game? Of course, we have to remain good positivists and set aside our judgement of the inventor of the $6 latte, but I remain undecided about the claim that normative economists are the only moralizers in the room.

  8. Hello everyone,

    Sorry for being late to the discussion.

    First of all, I really enjoyed this format and I’m looking forward to interactive lectures as well. A huge advantage for the recorded class is that I can always return to a certain point in the lecture to aid me if I struggle with something in the text. It’s much more effective than lecture notes.

    I wanted to touch on an economic term in the textbook that I found interesting from a sociological perspective. The term is ‘reservation price’ and I really like how it can be linked to the action theory in sociology (because of both Economics and American Sociological tradition basing themselves in British utilitarianism). In particular, the action theory has this notion of subjective orientations (social values, emotional connections, cognition of the object, evaluation of the situation, etc.) that influence an action of an individual. When the textbook describes the motivation of a poor student which is different from the motivation of an affluent student, it hypothetically results in a different reservation price (and WTA). I think that the subjective orientation and reservation price complement each other just like milk and coffee and in theory, the logic of subjective orientation can be a strong tool to explain reservation price. I find these connections between behavioral economics and social theories really helpful in terms of engaging with the economic ideas presented in this course.

    Another parallel that I wanted to draw is the diminishing marginal productivity and diminishing marginal utility, the satiation point as you called it in the lecture. I understand that the former is related to supply exclusively and another to supply-demand dynamics and elasticity, however, is it correct to assume that both have the same underlying growth tendency. Or are they different?

  9. Talk about late to the party 🙈 The selfish benefit of course is I have all these wonderfully insightful observations, questions, and anecdotes to learn from, not to mention professor’s responses.

    To that end, regarding this “new normal” format of learning: At the expense of unoriginality, I echo Donna’s, Robert’s, and George’s appreciation for the recorded lecture, which allows me to spend as much time as I need rewatching a section to understand it better, returning to portions at will. While there might be something lost from the absence of simultaneous class discussion and instant clearing of doubts, I am happy to appreciate the compensating gains from having the entire lecture available at will, along with written Q&A. Not having to take notes frees the mind to absorb better, I find.

    2 observations, 1 rumination, 1 example, and 1 question:

    The notion of price being a proxy, of sorts, for the value of one good in terms of another – that I find eye-opening. My understanding of opportunity cost is slightly sharper in focus after reading this. It is becoming progressively difficult for me to buy anything without the shadow of a question at the back of the mind asking “what else could you be doing with this money?”.

    K. Graddy’s Fulton St fish market example helped me clear some cobwebs of the nature and existence of perfectly competitive markets. In particular, two quotes made a mark: “It’s the absence of perfect competition that makes economics so interesting.”; and “If every firm were to compete perfectly competitive, there would be very little to study.” I found it instructive to relate her historical narrative to the concepts of (1) conflicting interests between buyers & sellers, and (2) the market aim of maximizing self-interest.

    To the latter point: In a manner perhaps similar to Sam, I, too, sometimes question the application of these so-called Homo Economicus traits to the operation of *all* markets. Are there cirumstances where, for instance, cooperation and a recognition of the greater good on the part of all participants might be, in the long run, beneficial to all parties? But, that is surely a topic for a different forum and once we learn more economics 😊

    Touching on elasticity: If I had to proffer my own (simplistic) example to illustrate my understanding of the concept, I would use a topical one – the price of toilet paper these days! Demand for TP seems relatively inelastic – we all need it, come rain or shine, sickness or health, poverty or wealth. After a week’s absence from the shelves, our local grocer “found some stock from other places” (so they explained). Unmarked brand, never seen it before in that store. Price: $2 per roll, compared with $1.50 usually. Same quality – in fact, lower (as we were…dismayed to find). But, we did not have much say in the matter: I was not about to hunt for another shop – both because 50¢ per roll was less than my subjective valuation of my time, and because of the exigent health stipulations. In the short term, I imagine this practice – presuming it is indeed widespread – will continue. But, as you once mentioned in class, we’re interested in long-run equilibria, which should lead to prices either returning to what they were (for that particular local grocer at least), or customers realizing they’ve been conned and shopping elsewhere.

    The simple elegance of the elasticity equation…I find this reassuring. If you feel it appropriate at this stage, I wonder if you might direct us to resources that show “typical baskets of goods” that exist at different points along that continuum. That is, if we imagine the elasticity number line going left-to-right from zero (perfectly inelastic) to close to 1 (relatively inelastic) to 1 (unit elasticity) to more than 1 (relatively elastic) to infinity (perfectly elastic)… is there an empirically-created list of typical goods & services we might place at different points? If so, such a list would be useful to compare against our intuition of where these goods might fall.

    Looking forward to completing question 5, which, as others have said, is clearer after the lecture.

    Best – Vikram.

  10. Addendum:

    There is one calculation doubt wracking my brain, for the coffee market price elasticity problem:

    Should the numerator in the calculation not be (3.6 – 3) / 3.6 = 0.17 rather than what you have as (3 – 3.6) / 3 = 0.20? That is, in terms of the logic of the arithmetic itself, should it not be: (Initial – Final) / Initial, where in this problem initial coffee consumption was 3.6?

    As a reference (and sanity) check, I compared to the previous question’s solution ($20 to $19 / $200,000 to $228,000), where Initial and Final were:

    initial quantity is 10,000
    final quantity is 12,000, calculated as

    = (10, 000 − 12, 000)/10, 000 (20 − 19)/20

    ie, Initial minus Final.

    Thank you.

  11. Dear professor Corak,

    Thank you for your lecture.
    With visual and audio explanation, my understanding on demand and supply was deepened.

    Below are my questions.
    Why elasticity becomes high when price is high?
    From my intuition, I felt that the longer term it is, elasticity of demand is higher. I did not understand well about why the elasticity of demand becomes lower when term is longer.

    Also, below is my question came from the reading.
    How one can differentiate willingness to pay (WTP) from elasticity of demand?

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