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

Chapter Three: Demand 69 a change in income, we call that good a luxury . Later on I will introduce the concept of income elasticity of demand where we will talk more in-depth about the concept of how much demand changes as other factors change. THINKING ON THE MARGIN To illustrate how we think on the margin, and how marginal benefits and marginal costs affect our decision making, consider this example. Imagine you have a 10:30pm curfew. Let’s say there are two possible punishments for breaking curfew. The first is being grounded the next weekend. The second is, for every 15 minutes you’re late, you’re grounded one night. Now one evening you look down at your watch and its 10:35—and you’re 10 minutes from home. What do you do? The marginal benefits and costs will drive your decision. Under the first rule, you’re grounded next weekend regardless—so you might as well stay out all night! Economists would say that the marginal cost of staying out later is now zero. Under the second rule, you’ll want to hit the road immediately, and not make the situation worse! Of course, as outstanding young men and women, you’ll want to head home immediately anyway, but parents (and residence hall directors) had better be aware young people are also fallen and design the marginal costs appropriately! Of course, in order to have a demand , you have to demand it! I mean, you have to desire a good. Our individual tastes and preferences are a strong driver of demand. What is the latest fad and “must have” this year may be in the scrap heap next year. Conversely, taste and preferences for many goods (such as food) may not change much at all. Face it, you have to eat. But you don’t have to eat anything in particular. Some food items could see significant change in their demand over time. For example, lard used to be heavily used for cooking, but healthier vegetable oils have significantly reduced the demand for it, as well as the pigs that supplied it Expectations also affect demand. If you expect prices to rise in the future you may increase your demand today. Why not stock up while the price is cheap? Similarly, if you expect the product to be unavailable for whatever reason in the future, you may buy today. People often stock up on groceries before each winter storm or hurricane. After President Obama was re-elected in 2012, many Americans (rightly or wrongly) feared he would institute stricter gun control. So what would economic theory suggest? You guessed it—people went out and bought guns and ammunition. Expectations of future price changes also invite speculation, and the opportunity to profit from changes in prices. (While speculation is almost always viewed negatively in public discourse, we will see in chapter 5 that speculation serves a very valuable social purpose.) If a wheat trader expects prices to rise in the future at a rate greater than what she could earn by selling today and investing the profits, she will hold the income elasticity of demand: measures how responsive the quantity demanded of a good is for a given change in income; more formally, it is equal to the percentage of change in quantity demanded divided by the percentage of change in income luxury: a normal good for which demand increases greatly as income rises