Everything You Need to Know about Economics

Everything You Need to Know about Economics



Product Details

ISBN-13: 9780671534912
Publisher: Pocket Books
Publication date: 10/01/1999
Series: Pocket Professor Series
Pages: 144
Product dimensions: 5.31(w) x 8.25(h) x 0.48(d)

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Law #1: The Law of Demand

The more of it there is to go around, the less people are willing to pay for it; conversely, the less of it there is to go around, the more people are willing to pay for it.

Let's take the case of air and diamonds.

Air is one of the most plentiful things in the world and diamonds are one of the rarest.

According to the law of demand, that means most people aren't willing to pay much for air (since it's so accessible) but they understand that if they want to buy a diamond, they're going to have to pay a lot (since diamonds are so scarce).

If we used air instead of diamonds to express our love, it would be a gesture so cheap and common it would be insulting. It would almost seem to imply "Honey, I love you as much as this cup of air I just went outside to get, and you know, if I hadn't scooped up this particular cup of air I could have scooped up any cup of air because hey, it's just air. There's nothing special about it."

True love is a priceless, rare, and uncommon thing; therefore, we use the diamond, another rare and uncommon thing, as a symbol for expressing it.

When we give our love a diamond, we want to say, "I chose this diamond because it is unique and there is no other diamond like it in the world -- just as with my love for you, there is no other love like it in the world."

Of course, there's another way to express the same law, and it goes like this: The more you want it, the more you have to pay for it, and the less you want it, the less you have to pay for it.

Imagine, for example, that clean air became inaccessible. Suddenly, you'd want clean air very badly. And we bet you'd be willing to pay for it.

Law #2: The Law of Supply

The more people are willing to pay for something, the more of it other people are going to try to produce; the less people are willing to pay for something, the less of it other people are going to try to produce.

In other words, if people are willing to pay a lot for diamonds, other people will find a way to supply them. Same thing with air.

In fact, since clear air in some cities like Los Angeles, Toronto, and Tokyo can be hard to find, people really are willing to pay for it. And, not surprisingly, other people are willing to supply it via oxygen bars, where you can go if you need to catch a breath of fresh air.

Law #3: The Law of Elasticity

If you're flexible, you pay less, and if you're inflexible, you pay more.

For some people, a sneaker is a sneaker is a sneaker. For others, only a Nike will do.

If you think a sneaker is a sneaker is a sneaker, then you'll go to Kmart or Wal-Mart or some such discount store and buy the cheapest tennis shoe you can find. Your demand for any particular brand or style of sneaker is elastic. You're flexible. You're willing to bend.

On the other hand, if you believe only a Nike will do, you are inelastic. Inflexible. You're not willing to give in at all. If you have to drive 100 miles to get Nikes, you do it. If the Reeboks are on sale and half the price of the Nikes you normally get, you're still going to buy the Nikes.

Another example: for some people, rock 'n' roll is rock 'n' roll. But if you've got a hankering to hear Mick Jagger sing "Satisfaction," then no Yoko Ono or Garth Brooks or Muzak version of "Satisfaction" will satisfy you. You are completely and utterly inflexible. Utterly and completely inelastic -- only the Rolling Stones will do.

This is an important concept in economics. It helps explain why brand-name products (and Rolling Stones concert tickets) are so expensive.

Law #4: The Law of Self-Interest

Given a choice, you will always do what is best for you.

One of your authors is a notorious cheapskate. To him, the only standard by which a banking institution should be judged is by the amount it charges in fees. And any fee over a penny is, in his estimation, too much. In other words, he doesn't want to pay a cent to do his banking.

In fact, your author will do almost anything to avoid paying a banking fee. If that means he cannot ever go inside the bank to do his banking, lest they levy a fee, he will do all his banking online or at an ATM. If it means he has to drive 10 minutes out of his way to one of his own bank's free ATMs to withdraw cash once in a while, he'll do it.

This particular author's wife, on the other hand, has a different standard by which she judges the value of a bank. She likes to go inside the bank, chat with the tellers, have a cup of coffee, read the bank's free literature, and generally bask in the experience. She is a commercial artist by training and therefore will keep her money only in a bank that (1) looks nice from the outside, (2) feels nice on the inside, (3) has pleasant employees who are ready to chat, and (4) provides coffee and something to read. (Oh, and the something to read must be well written and attractively designed -- otherwise, what's the point?) She concedes, however, that she is asking for her bank to provide her with a lot...so she is perfectly happy paying a small monthly fee for this pleasant banking experience.

Needless to say, your author and his wife keep their money in different banking institutions. Your author has found a bank that serves his best interest -- that is, he doesn't have to pay to bank there, but they won't let him walk through the door and talk to a human being without charging him for it, and he has to drive out of his way once in a while to get money from an ATM for free. To him, it's worth it. If he plays by the rules, he gets the free checking he so loves. His wife, on the other hand, has found an attractive bank that looks good on the outside, feels good on the inside, hires only the most pleasant bank tellers, serves free coffee, and puts a lot of care into the writing and design of its brochures. All of these added amenities contribute to the satisfaction of what is important to her -- her self-interest -- and she's perfectly happy to pay for it every month.

The law of self-interest is tricky because it requires you to concede that what is best for you may not be best for someone else. Instead, you get to choose what is best for you, and everyone else gets to choose what is best for themselves.

Law #5: The Law of Economic Reality

No matter what the situation, some combination of laws 1 through 4 will apply.


Hey! C'mon! Let's take those five laws of economics out on the windy, curvy track called "your life" and put them to the test:

Let's say you're the office manager for the local branch of American Widget. The economy's gone bad and the company's closing your office. You're out of work for the first time in your life.

Meanwhile, the economic picture in your town is looking so bleak that the only work you can find at all is as a low-paid bicycle messenger or short-order cook.


So what should you do?

Well, let's apply laws 1 through 5:

Law #1A: The Law of Demand

Suddenly, you remember that when you accepted your last job, the economy had been booming and there were more jobs than people to take them.

Back then, a really good office manager such as you was almost impossible to find. When American Widget offered you the job, you knew you had the company over the barrel: If the company didn't hire you, it'd have to hire some kid who was currently working as a -- gulp! -- bicycle messenger or short-order cook. There was no one else around. So you really played hard to get -- you made American Widget pay you twice your previous salary and you demanded a big office with a view, a parking space with your name on it, and your own secretary, and you even held out for the right to eat in the executive dining room with all the other big cheeses.

Boy, those were the days!

Now, the complete opposite is true. There are lots of good office managers looking for work...and you know what that means: The more of it there is to go around, the less people are willing to pay for it; conversely, the less of it there is to go around, the more people are willing to pay for it.

In this case, the people are prospective employers. And they ain't willin'to pay you much...because they know that they don't have to. So you're going to have to pay instead -- by taking a lowerpaying job.

Law #1B: The Law of Demand (An Alternative Perspective)

Let's look at your situation from a prospective employer's perspective.

From his or her point of view, there are lots of "yous" -- that is, lots of other unemployed office managers out there who are looking for work -- and, unfortunately, there aren't enough jobs for all of them. So guess what? The supply of workers is high and demand for them is low -- so the employer knows that he or she is not going to have to pay as much to hire you as would have been necessary when demand for good employees was high and the supply was low. Back then, people like you could get away with demanding things like window offices and exclusive dining privileges. So where you were once thrilled to be on the receiving end of the law of demand because you knew the more your employer wanted you the more he/she had to pay, now you begrudgingly appreciate the corollary of the law, which states that the less an employer wants you, the less he/she has to pay to get you.

Law #2: The Law of Supply

As you'll recall, the law of supply says that the more people are willing to pay for something, the more of it other people are going to try to produce, and the less people are willing to pay for something, the less of it other people are going to try to produce.

It's funny how you have inadvertently become a walking example of this.

Since employers are currently willing to pay less for a good office manager than they were in the past, you are less willing to serve in the job. The problem is, from your perspective, there aren't any other comparable jobs out there for you, either. You are therefore stuck in a supply-side nightmare.

Law #3: The Law of Elasticity

Here's where things get tricky. You sure don't want to work for less money than you made at your last job, but it looks like you won't have much choice. And if that isn't bad enough, it looks like you'll have to work for a lot less money and like you'll have to take a lot less desirable job.

So, how flexible are you?

You'll remember that the law of elasticity says that if you're flexible, you pay less, and if you're inflexible, you pay more -- but in this case we're talking about not what you pay but what you give up.

If you take a lower-paying job, you pay by giving up what you consider to be your real earning power or what you think you deserve to be paid. Taking a job as a bike messenger or short-order cook will also require you to work in a job for which you consider yourself to be far overqualified.

Again, you are paying by giving up. By accepting one of those jobs as a bicycle messenger or short-order cook (or both, if that's what it takes to make ends meet) you are giving up (lowering) your standards when it comes to the type of employment for which you consider yourself to be suited.

Law #4: The Law of Self-Interest

Now, it's decision time...and it's a decision that only you can make. Will you (1) go without work until the right job comes along or (2) take a job that pays less than you're accustomed to earning and for which you are also drastically overqualified?

If you are like most people, the right answer will be immediately apparent to you. Ironically, that's why this is called the law of self-interest. Just because the right answer is obviously right to you doesn't mean it's the right answer for everyone.

If you're young and unmarried, the right answer might be to take all your money out of the bank, buy a backpack, and hitchhike through Europe until the economy improves. After all, what have you got to lose?

On the other hand, you might be the parent of three and the proud owner of a large mortgage. In the face of possibly losing your home and not being able to feed your children, the apparent right answer would probably be to work days as a bicycle messenger and nights as a short-order cook, if that's what was required to take care of your family.

Law #5: The Law of Economic Reality

As the law states, no matter what the situation, some combination of laws 1 through 4 will apply -- as you have just seen.


These laws are sort of like suntan lotion. You no longer ask, "Do I need it?" when you're in the sun. Instead, you ask, "Which one do I need?" You can choose not to use any at all, but you know you're going to fry, and you may pay for the damage for the rest of your life.

Same thing in economics. You can go through life without applying the laws of economics, but guaranteed, you're gonna get burned.

So let's try out some case studies:

The Case of the Overpriced Mazda

Chances are that if you want something, so does everyone else. And if everyone else wants it, too, then the folks who're selling it know they can raise their price.

Since you all want it so badly, you'll pay the higher price. So the sellers will raise their price again. And most people will still pay it (but a few won't). The sellers will raise again. Most will pay. The sellers will raise. A few less will pay...etc. Until the sellers raise the price too high and most people decide they don't want it that bad. So the sellers will lower the price. More will buy, but not enough. So the sellers will again lower the price. And even more will buy. And the sellers will lower the price. And even more will buy. Eventually, the price will be back to about where it started, if not lower.

A good example of this?

The Mazda Miata.

When this flashy little sports car was introduced in 1989, it took the auto world by storm. There was nothing else on the market like it and Mazda dealers were immediately able to sell the car for more than the sticker price.

Well, that lasted for a while. Only those who could afford the luxury of paying more than the suggested retail price could afford to have a Miata. Soon, all those who were willing to pay a premium for the car had one.

So, naturally, Mazda dealers began to sell the cars for exactly the sticker price -- not a penny more, not a penny less.

Pretty soon, everyone who was willing to pay sticker price for a new Miata had one.

Now what?

Mazda dealers began to treat the Miata like any other new car on their lots -- they made deals for them. Demand had dropped; therefore, so did the price.

The Case of the Freebie Cell Phone...or the Inverse Miata


Suppose someone's got something to sell, but at the asking price, no one wants to buy.

What's the seller to do?

Lower the price until a few people buy. Then lower it again until more buy. And then lower it again until even more buy.

It may have all begun with the invention of the copy machine. Before businesses had photocopiers, they had mimeograph, or ditto, machines. The machines were horrible and messy and slow but better than nothing -- and nobody knew any better.

Along came Xerox. They had invented a machine that would take a picture of whatever it was you wanted to copy, and it would print that picture on another piece of paper. And it did it really fast.

The problem was that not only was the machine really fast but it was also really expensive. So expensive, in fact, that no one was willing to pay it. The only way Xerox could get people to replace their slow and messy ditto machine with the clean and fast Xerox copier was to give the copiers away -- and then charge anyone who took the machine a nickel for every copy they made.

Fast-forward to the present. Go into any electronics store in the country and they'll give you a free cell phone. But only if you sign up for a year's worth of service.

Just like Xerox, the cell phone companies know there's a lot more money to be made on your monthly bill than there is on the phone. So much money, in fact, that they can afford to give the phone away.

Want a low-tech example of the same principle at work?

Take the razor. There was a time when guys shaved with standard-size razor blades. You bought the razor of your choice and the blades of your choice and shaved to your heart's content. One size fit all. Today, you buy a fancy Schick razor or a fancy Gillette razor or a fancy whatever-else-brand-you-want razor, and you get it pretty cheap...but once you choose your razor, you have to buy the matching blades. Schick's blades don't fit Gillette razors. Gillette blades don't fit Wilkinson razors. Suddenly, you've become a customer for life...or at least for the life of your razor.

The concept at work here is called bundling. If the copy-machine salesperson, cell phone company representative, or razor company can count on you as a captive paying customer in the future, it's well worth their while to give you the copier, cell phone, or razor for free.

The Case of the Supermarket Sneakers

As you know, for at least one of your authors a sneaker is a sneaker is a sneaker.

I buy my sneakers at Kmart. I buy them there because they only cost $5.99 a pair.

You, of course, are appalled.

You buy only those sneakers with Pete Sampras's or Michael Jordan's autograph on them. You like the way they look, and, you reason, they also make you a better athlete.

You're accustomed to laying out $150 a pair.

The point of this case study is not to prove that one of us is wrong but to find a rationale that will allow both of us to be right. After all, only you can know what sneaker will best serve your own interest, and only I can know which will serve my own interest.

Although on the surface buying a pair of sneakers may seem like a fairly innocent, inconsequential, and meaningless event in one's life, in reality the decisions you make at the shoe store (or sporting goods store or Kmart) tell economists a lot about you...and collectively, the shoes we buy tell economists a lot about us as a society. First of all, in many parts of the world choosing which pair of sneakers to buy is an inelastic buying decision. If you are poor you buy the cheap ones and consider yourself lucky to have a new pair of shoes at all. In this country, however, many people are wealthy enough to be able to consider sneakers that range in price from $5.99 to the sky's the limit. And there are buyers for sneakers at every price point along the way.

If you and I were to debate our sneaker choices, you might say you like your Pete Sampras shoes because they make you feel significantly better. I, on the other hand, would reply that I once tried on a pair of Pete Sampras sneakers and I didn't think they felt much different than my "blue light" specials. Neither of us is right in this debate, by the way.

Rather, by buying your $150.00 Pete Samprases, you are saying not only that you feel better in them but also that they make you feel $144.01 better than a pair of my $5.99 sneakers would.

Well, if that's the case, I might ask, why don't you buy the $200 Michael Jordan sneakers and feel even better yet?

You might respond by explaining that you couldn't afford the additional $50 or that you wouldn't feel right spending that much money for a pair of sneakers -- but what you'd really be saying, in economic terms, is that you don't think the Michael Jordans will make you feel $5O better than the Pete Samprases.

Ah, but is there a price you could put on the degree to which the Jordans make you feel better than the Samprases? One way to tell is to see how you respond the next time you go in to buy a pair of Samprases and see that the Jordans are on sale.

But let's get back to me and my Kmart sneakers. Because I think there's no difference between my sneakers and yours, and because price is my only buying criteria, I might scoff at you and believe you are buying those expensive shoes only for the status you think they will bestow on you.

I might be right. You might feel better because you believe people will see that trademarked symbol and admire you for choosing it. Or you might believe that you'll gain the upper hand over an opponent on the tennis court because he or she will see that status symbol and assume you are a better player than you are and give you the mental edge.

Are image, status, and a possible mental edge worth $144.01?

This is a question that only you can answer for you and that only I can answer for myself.

Copyright © 1999 by Denis Boyles

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