Vacation and Some Questions

Well, a week off. Due the inability of our family to make a definite decision in a reasonable amount of time, we waited until low rates for airlines and such had passed (and the time is somewhat fixed by this being the week of spring break). Our first choice had been to go to Sante Fe for the break. But instead we are driving to St. Louis for the week, in part just to get away we a have no clue what we are doing. Any suggestions of “things to do” in the St. Louis area would be appreciated.

On the drive, I read one of the “econ” books recommended/linked Friday (I think). It was purported to give an overview of economics. Anyhow, I have a question for those who might have a more substantial background in economics. In the micro-economics section they show a plot of supply/demand curves. These curves plotting price and quantity (if I remember correctly). The slope at the intersection points seem to be termed “elasticity”. What also seems to be assumed is that these curves are monotonic, smooth, and well behaved. These assumptions however do not seem to be realistic. An example of non-monotonic behavior would be the assumption that if a price there will be higher demand or that more of a thing will be sold. But product that prides itself on being “high quality” will not necessarily sell at a lower price because that lower price nobody would believe that high quality would be possible. High price can also signal elite/elitist products. These products would not sell more, their cachet is in part inseparable from their high price.

So here’s my question. Are these curves assumed to be mathematically well behaved in these ways. If they are not, what breaks done in their models?

6 Responses to Vacation and Some Questions

  1. Yes the curves are assumed to be well behaved but what you should remember is the assumption that all else is held to be equal. A product may raise its price but experience no drop in sales if at the same time it increase its quality (or perception of quality among consumers). Since nothing ever stays the same, the supply demand curve captures a relationship between two variables (price and quantity….but you can also make a demand curve between income and quantity or variations of that) that you can never really see in real life. You can jot down quantity sold at various prices but don’t expect the points to sketch out smooth curves, ever. In fact, if you think about it the price and quantity data point is an intersection of two different curves. If tomorrow there’s a different point it means one or both curves changed so collecting points won’t show you the actual curves themselves!

    If the book you have is an intro to the topic, you probably got the story version of the supply-demand curve (i.e. if peanut butter drops in price, you’ll buy more of it, if it increases you’ll buy less but the peanut butter churner will want to spend more time making peanut butter if he gets a higher price and so on). An intermediate micro book will go into more rigerous detail on where the curves come from.

    Namely it begins with the idea of an indifference curve. Give someone a choice between two packages of two goods….like two eggs versus two teaspoons of butter, package A, versus three eggs and one teaspoon of butter, package B. A person will prefer one package to another. However there will be sets of packages where they are indifferent…equally happy to get either. These will sketch out an indifference curve. A person will be happy to choose any combination that is on a particular indifference curve, but would rather choose any other package from a higher curve. Now toss in a budget (say $50) and a price for each good. This will create a straight line representing the various combinations of goods the person can buy using their budget. Any point under the line represents not using all their budget, any line over it represents a package that is unavailable to them from their budget. The person would opt for the package represented by the tangent point of the highest possible indifference curve to the budget line.

    Now take one of the goods and alter its price up and down, that will move the budget line back and forth. The various tangent points will map out how much of that product a person will buy. It will then sketch out your traditional demand curve.

    In terms of price ‘signaling’ a superior good….you might look into the concept of an inferior good, which is a good where demand falls as *income* rises (note again that the standard supply-demand curve assumes the only thing allowed to move is price and quantity, all other things like income, tastes, the prices of other goods etc. remain unchanged). So as incomes increase, more Cadillacs will be sold than Kias. However, I doubt you could show that Cadillac sales would not increase if prices were cut.

  2. St. Louis for the week, in part just to get away we a have no clue what we are doing. Any suggestions of “things to do” in the St. Louis area would be appreciated.

    Get the fuck out of St. Louis, the zombie outbreak has started there. Load up on fuel (hope to God you’re driving your super-high MPG car) and ammo and get out now! Do not pick up any hitchhikers (esp. those with recent flesh wounds or exhibiting flu-like symptoms). Go man, go fast!

  3. Boonton,

    So as incomes increase, more Cadillacs will be sold than Kias. However, I doubt you could show that Cadillac sales would not increase if prices were cut.

    No. If you sold Cadillacs for the price of a Kia the public perception of what a Cadillac was would be a US made Kia … not an exclusive car … and subsequently their sales might very well drop.

    The point is “high price” is seen as a signal of class/quality and dropping that may negatively impact sales. To put highlight another example, at our company we were bidding against another vendor for a job. We almost didn’t get it. The biggest thing against us was our low price. It was felt we either couldn’t do it for that price or that we were not experienced enough to know how much the job would cost us to do. The point is that there are indeed times when a raising the price can increase sales.

  4. Boonton,
    Look at it this way. If you were trying to hire an artist/specialist to work on your car or house and his estimate was for 100 hours of work and you had two offers one asking $100 an hour and one for min. wage you’d very likely not go with the min. wage figuring quality suffer with the cheaper. High price is a market signal, which the naive curve seems to ignore.

    The point is that right around the nominal price point the curve is well behaved, but the curve toward lower price is not likely to be monotonic. At some value it is likely that the curve will curve down again at a low cost region.

  5. No. If you sold Cadillacs for the price of a Kia the public perception of what a Cadillac was would be a US made Kia … not an exclusive car … and subsequently their sales might very well drop.

    I serously doubt this. The number of Cadillacs sold would almost certainly leap up if, say, Cadillac did a 40% price cut on all models. Now that doesn’t mean Cadillac will get more sales in the sense of total revenue. For that to happen the demand for Cadillacs would need to be rather elastic. If it was inelastic they would sell more cars at a 40% price cut but they wouldn’t sell enough to offset the fact that they were getting less per car.

    In your example of bidding, you have a much more complicated issue of asymetrical information. The customer might know the quality of your competitors but doesn’t know your quality. Your low bid, then, might be read as a signal of a company seeking to score a contract that might be too much for them to handle. In the customer’s mind, then, there’s two different products at play. There’s the cadillac, which is what your competitors were offering and there’s the Kia which is what you were offering. If Kia tried to charge Cadillac prices, they’d lose nearly all their sales. The customer was looking for a Cadillac, not a Kia so your low price was unimpressive to them. Of course you will say this perception was unfair, you were in fact offering a Cadillac at a Kia price! But that’s a failure of your marketing department to build a reputation sufficient for your customer to make an apples to apples comparision.

    The point is that right around the nominal price point the curve is well behaved, but the curve toward lower price is not likely to be monotonic. At some value it is likely that the curve will curve down again at a low cost region.

    I think this is a violation of the assumption that all other variables will be held equal. You’re assuming the consumer is aware of the quality of the product in the ‘normal price zone’ but becomes doubtful when it deviates from that zone. This may be true in real life in many cases (but not all, you may doubt the guy trying to sell gallons of milk outside of his van for $0.25 a gallon but what about when Borders went into bankruptcy and was selling its book inventory up to 75% off?), but isn’t the point of the demand curve. The point is to illlustrate the strict relationship between two variables, price and quantity. Again analyze the case assuming the consumer *knows* the Cadillac on sale for 40% off is exactly the same as the Cadillac that was formerly on sale at the regular price.

  6. Also don’t forget the foundations here, the demand curve is derived from indifference curves. Indifference curves are constructed out of offering a person a choice between packages that contain different mixes of two different goods. In the indifference curve their is no nominal price for the goods, the only prices come in the form of having to give up some other good to obtain more of a certain good

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