No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Three: Demand 66 our actions will lead to a better state of affairs than any other alternative. We may be right in the end, or may be disappointed ex post (after the fact). The results, good or bad, will ultimately shape our expectations of future actions. Expectations, as we will see, are a crucial factor in the concept of demand. A DEEPER DIVE INTO CONCEPTS FOR DEMAND Let’s take a look at a question regarding demand in order to get a little more prepared for this chapter. Say that your favorite brand of t-shirts is currently on sale for 50% off. What will happen to your demand for this t-shirt? If the price goes down then the demand goes up…doesn’t it? Maybe…maybe not. I will highlight the imprecision of saying “demand” later on in this chapter and explain why we should use the term “quantity demanded,” but aside from that, we still can’t really make a decision about demand from just a price change. In chapter 1 I highlighted the critical assumption of ceteris paribus , or all else equal . If this assumption doesn’t hold then we can’t say much about what will happen when one variable changes, since other variables could change as well. Say the assumption doesn’t hold and in fact all prices have fallen by half—as well as your income. Will demand (or more accurately, quantity demanded) change in this situation? If nothing else has changed, then quantity demanded will not change. Why not? The answer is that demand cannot be separated from the concept of opportunity cost. With what happens in our everyday lives, we should all be familiar with this. You choose to play football, but that means you can’t be in the band. You may choose to go out on a date with Sarah, but that means you can’t go out with Grace. You choose to follow Christ, but that means you can’t follow your sinful flesh patterns. You choose to go into the army after high school, but that (at least temporarily) precludes going to college. There is a cost to every choice, and to demand something is to forego something else. If the price of jeans goes down, you must consider the opportunity cost of choosing jeans. If your next best alternative was tennis shoes, and their price also went down by the same proportion, your opportunity cost is the same. (There could be an income effect (discussed later), which might change our internal assessment of the opportunity cost. But we’ll assume no income effect for this example.) Since the relative price of jeans to tennis shoes has not changed, then what you would have to sacrifice to make a choice has not changed. With opportunity cost the same, your demand will not change. Relative prices are simply prices relative to other alternatives. We need to think about relative price changes, not just price changes. Relative prices help us think about the DEMAND CANNOT BE SEPARATED FROM THE CONCEPT OF OPPORTUNITY COST To demand something means we must choose between alternate means to satisfy a given end. The concept of choice, by definition, means we must forego something. The decision to choose one good is inextricably linked to the value we place on the next best alternative. If the marginal utility of one good changes, we still need to assess the marginal utility of the next best alternative to say what will happen to demand. The marginal utility is the benefit, but it must be compared to its opportunity cost, the next best alternative (and its marginal utility). relative price: a price of one good or service in terms of another ex post: after the event