Saturday, 8 September 2012

The Terrible Law of Demand

Most people begin their journey into the wonderful world of economics by stepping on demand. Also, this is the first step in into "Microeconomics" which basically is like standing in a garden and looking at one blade of grass. Microeconomics is easy, logical and definitely very interesting to beginners. It looks at one person going to a market and buying one or two things. It can also look at one person making something that can be sold to another. Microeconomics has grown a lot over the centuries and is now a very terribly complicated science. It uses difficult mathematical theorems and crazy assumptions to find what is "rational". By rational it means what is "common sense". So basically so much of work in Microeconomics has only told us how people apply "common sense" in everyday life. Great!

The other large part of Economics is Macroeconomics. Macro as we all should know stands for something that is large or gigantic. When we stand in the garden and study the entire neighbourhood, we are studying macroeconomics. I think they are two sides of the same coin, microeconomics studies how one person behaves and macroeconomics studies how all people behave. 

Its interesting how each science defines it own definitions of certain everyday terms. "Abdullah went up to his father and demanded he let him go the football match", here demand indicates that Abdullah really badly wants to go for the football match but in the economic sense it means something else. Economists use "Demand" in the sense of buying and selling. How much do people of Japan want fish is the demand for fish in Japan. Wait! There is a catch. This is where the economic term deviates from the everyday sense. Demand in economics is incomplete without the power to demand it. This means that if Abdullah cannot convince his father, he is not demanding but merely wanting his father to let him go. In this case, the power to demand is money. If a person cannot afford something, he cannot demand it. Hence demand is incomplete without purchasing power. 

So let us assume Abdullah is able to convince his father to a certain extent to let him go for the football match, he is able to demand. Now let us look at other part of the trouble. What does the father want in return? By this I want to bring your attention to the Price of something. As we all know, the price of apples is how much one pays for apples. Have you heard of the saying, "The best things in life are free", if so, I am referring to the things that aren't free. These second-best things in life have a price because they are not easily available. The beautiful sun on a beach is free because nobody can stop anyone from enjoying it. If someone covered the Earth with a blanket, she could charge a price on the enjoyment of the sun. Hence, the price of a something comes because it is difficult to obtain it on our own. This is Scarcity. When something is scarce or limited or not available easily, it has a price for it. 
Abdullah's Dishes
Price for a Football Match

The Law of Demand or the Law of Common Sense, says that for higher price people demand lower amounts and for lower price people demand higher amounts. Is this not evident? If the price of lollipops became lesser, would you not like to buy a little more. If the price of petrol increases tomorrow, won't your demand fall and won't you try to manage with a little less. There are many reasons for this to happen, and many Economists have tried to make sense of the obvious. 

One, because the money you hold in your pocket remains the same, you realise you can afford more lollipops if they are cheaper. If by bad luck they are more costly, you realise you cannot afford that many of them. This is called the 'Income Effect'

Two, you look at the candy jar beside the lollipops. Normally you would buy some candy and some lollipops, because you like them so. Suppose lollipops have become costlier. Now you look at the lollipops twice and decide to take more of candy, because you can eat more. This is the 'Substitution Effect'.

Three, looking back at the demand for fish in Japan. If the fishes for some reason become more costly, lesser people can afford them. If fishes become cheaper, more people can afford them. This effect has no name, but I'd like to call it 'Now-I-Can-Afford-It-Yay! Effect'. 

Think of it like this : Demand is the ugly princess, and Price is the beautiful princess.There is a tower where Demand keeps avoiding the beautiful one. The terrible law that we have just understood makes this happen. As Price climbs graciously to the topmost chamber, Demand descends to the bottom most. Price sometimes likes to come below to meet friends in the lower rooms, then Demand hurries to the upper chambers in tears. We must understand that Price is a free princess and Demand is the fleeing one. Demand avoids Price, but Price does not avoid demand. Pardon my crude anology, but it is easy to think of them like this.

According to me, Demand is beautiful concept. Economists study how it changes not only with changes in price but also in income, price of other things, taxation of government and many more. I have found that what people want is dependant on so many things, what I want is dependant on so many things. Here, Economics has helped me learn a little about myself and my wants. Economics goes on to teach us about other things about ourselves like our preferences, our reaction to various events and even what happens in our marriages!

Economics is for Everyone!