Title Marshallian Crosses Subject Economics

Contents 1 Introduction and Summary 2 Alfred Marshall Who was this Economics Genius 3 Economics Law the Marketplace and the Market 4 The Theory of Supply and Demand for Price Optimization 5 Applications of Supply and Demand 2 3 4 6 20

7 Conclusion 8 References 9 Definitions of Words Used. 1 Introduction and Summary.

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This essay starts with a brief biography of A. Marshall the brilliant economist who thought of and popularized the idea of supply and demand to optimize price along with other theoretical contributions. He was only brilliant once though a fact regretted by many. The next section deals with economics at large and its relevance to our daily lives. Buying and selling has existed for millennia and has 1

formed the basis of wealth creation but todays market is different to the marketplace of old. What is todays market what does it accomplish how does it accomplish its task how good is it and finally what are its failings. The following section deals with the core issue of economics supply and demand. What is demand - as a definition a law a mathematical function and at market a demand schedule and a demand curve. Movements up and down the demand curve as well as shifts of the demand curve are discussed and the reasons for such movements. Supply is treated in exactly the same way as demand. When the two curves are plotted together the intersection is the equilibrium price for that good the price when buyer and seller derive maximum benefit. The next section details examples of the use of supply and demand to predict the effect of immigration on hourly wage rates and to explain why productive efficient farming can lead to protesting angry farmers. The last section deals with a worked example the apartments in Portimao. Because of unfound expectations around 6,000 apartments have been constructed many of which remain empty and unsold. Demand has not kept up with the new supply so now there is a large surplus. The essay ends with a conclusion. References of the articles and books used are quoted. Finally a small dictionary of terms used ends this work.

1 Alfred Marshal Who was he?

1842-1924 Marshallian curves are named after the world famous economist who conceived and popularized their use in price optimization. Alfred Marshall was born and brought up in London. Against his fathers wishes he studied mathematics and physics at Cambridge University [the maths Tripos] where he was a truly brilliant student. On graduating he became a lecturer in Moral Sciences specializing in political economy and later in 1884 he became Professor of Political Economy. In 1890 together with his wife he published his great work Principles of Economics (Volume 1). It covered a wide range of subjects and had taken 10 years to write. For him economic laws were social laws not natural ones. They described the actions of everyday people going through life. The book met with world wide acclaim and made him the preeminent economist of his day. His fanatical attention to detail together with his temperament meant that many planned works including volume 2 were never completed. Nonetheless he is considered one of the founders of neoclassical economics and made lasting and telling contributions to economic theory in several fields. He made economics a respected scientifically based discipline and his equally brilliant students Keynes and Pigou followed in his giant footsteps. His demand functions are still used in academic papers today 1)

2.Economics and Law What is the Connection.

As law students we have good reason to study roman law the history of law etc but the study of economics is vital for all our futures. When we begin practicing as lawyers every single case we will ever deal with will have one common theme money. Deaths divorces theft insurance compensation are all in the end about just that. Since money is an important part of economics this is where to start. Every human being has 3 basic needs food clothing and shelter. Sadly an estimated 1 billion(!) people still do not have enough to eat. 2) Every human being also has desires and these desires can never be met because they are never ending. No country is rich enough to satisfy all its citizens desires to live like millionaires. The economic resources of every country land labor and capital are limited. Economics then is the study of how to manage these scarce resources for the benefit of society with the ultimate objective of growing Gross Domestic Product. Increased GDP translates into higher incomes which in turn mean better health care better education more recreation and even happier wives. For a millennium or longer the market was the marketplace or fair where all economic activity took place and where buyers met sellers to do business. A large percentage of the population (50 and more) was employed on the land and agricultural produce was responsible for 80% or more of a countrys GDP. It was only when agriculture began to be freed of labor in the 19th century that a modern market economy began to appear. Most societies today are mixed market economies part government decisions part regulated free market. The market has become a complex mechanism for coordinating people activities and businesses. It is hardly ever a place it is everywhere it is a means whereby buyer meets seller and everything has a price, the value of the goods in terms of money. It is todays market which makes choices about how best to use the available resources to try and satisfy the desires of its consumers by answering three basic economic questions - what goods to produce how to produce them and how should the cake be divided up. And this is done painlessly and easily. What is simply what consumers choose in their daily lives which translates into profits for successful companies making desirable goods. How is by adopting efficient production methods cost reduction staying with or ahead of competitors to maximize profits. For whom depends on peoples incomes, their own market value. It was Adam Smith the first modern economist in his book 4

..The Wealth of Nations who observed that an efficient perfectly competitive market economy will squeeze as many goods and services as possible out of the available resources 3). But there are many areas where markets do not lead to an acceptable outcome. A monopoly is one example. Inequitable income distribution is anther. Bankers from Merrill Lynch or Lehman Brothers who nearly caused another Great Depression taking home pay worth millions of dollars. And because of the world wide integration of financial markets and the use of little understood financial instruments the whole world is suffering from their greed. All of the above has been made possible because of one very ancient invention money. Money makes the world go round. Everyone trusts and accepts money. Money is the medium which seals the millions upon millions of contracts between buyer and seller every day. We have gone from hunting gathering bartering and grunting to specialization miniaturization internationalization mass production and six sigma - a very long way in so short a space of time. 4)

3. Theory of Supply and Demand for Mass Markets Marshallian Crosses 5) 5

House prices have gone down recently in Europe where before they had just kept going up, the price of oil keeps going up and down regularly while the price of computers has gone down and down. What are the reasons for these price variations. Economics has a powerful tool to explain these price movements and it is the theory of supply and demand. Quite simply changes in supply or demand gives rise to changes in output and therefore price. What then is demand ? Demand is the willingness of a consumer to purchase a good or a service within a certain period of time. This willingness can be stated in the form of the law of demand. It is one of the most famous laws in economics and one on which economics is based on and for consumers it is part of life and is put into practice on a daily basis . Briefly the law statesThe price P(x) of a good is related to the quantity demanded Q(x) for that good all other things being equal more specifically as the price goes up demand goes down and as the price goes down demand goes up. (Veblen and Griffen goods excepted ) Economists believe very strongly in this law since it is so plausible. When grapes are in season and the price is low consumers buy them by the ton but out of season their purchase is more limited. Another example is shown in the figure below . 3)

Figure 1

Figure 1 shows the number of computers bought since 1963 (x axis) and the price paid (y axis). It is as example of how the price of chips in computers has decreased exponentially while their processing power has increased similarly leading to the todays explosive demand for billions of computers. It is an example of a demand curve. This price P(x) demand Q(x) relationship can be expressed mathematically P(x) = f [Q(x) ] or alternatively Q(x) = f [P(x) ] This is a function a relationship between two variables. It is a demand function since it relates price to demand. It is a general demand function since it covers all consumer goods such as chalk cheese houses cars but each good will have its own unique function. It applies to individuals as well as mass markets since markets are made up of individual consumers.

Demand of course is not just a matter of price. A large number of other factors will influence the quantity demand for a good at a given price. They are: - the average income of a consumer or group income, probably the most important element of demand. When people have more money they tend to spend it. (Y) - the price and availability of substitutes (Ps) - the number of consumers in other words the size of the market (N) - special tastes of consumers such as cigarettes or alcohol (Z) - special influences such as availability of credit, consumer expectations, educational level, changes in weather or geography ( S ) When these other variables are introduced the function becomes more complex ) Q(x) = f P(x) [Y Ps N S Z] con 6)

However the purpose of this and most studies is quantity demanded Q(x) as a function of price P(x) two variables (a partial equilibrium), and so all the other variables that affect demand are taken as being constant. The actual relationship between price and quantity demanded is given by the demand schedule this is a table or list showing the number of unites of a good that a potential buyer will purchase or has purchased at a number of varying prices during a particular time period. Take shoes as an example. Below is a table of the number of shoes a shop sells in a week at a given price. The price has been arrived at by market analysis and pricing experiments.

Table 2. Demand Schedule for Shoes.

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When the numbers in Table 2 price P(s) and quantity Q(s) are plotted on a graph a curve is obtained, the demand curve.

Figure 2

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The curve in Figure 2 is a linear demand curve a straight line. Any straight line on a graph can be described mathematically by a function of the form y=mx +c Therefore by analogy the demand function for shoes is P(s) = mQ(s) + c or more precisely P(s) = 140-4Q(s)

------------The demand function summarizes the relationship between the demand schedule and the demand curve----------------------------The slope m (-4) is negative since the relationship is inverse and is an important metric for calculating price elasticity. c (140) the intercept on the y axis is the price when demand is zero and c/m (35) the intercept on the x axis is where all the other variables are held constant. Most demand functions and demand curves are much more complex. A change in demand brought about by price alone means movement up and down the curve - a change in quantity demanded. The figure below is a demand curve for plastic ducks showing movement along the curve.

Figure 3 Demand Curve for Plastic Ducks

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Suppose our original P(ducks) =P1 and demand Q(ducks) =Q1 The demand for plastic ducks is referred to as elastic. That means demand is sensitive to price change a small change in price up or down will effect a big change in demand down or up. [The price elasticity of demand Ed = % change in quantity/% change in price ] 10

A decrease in price to P2 increases quantity to Q2 Total revenue equals price times quantity (TR =PQ.) Before price increase TR1 =P1Q1 After price increase TR2 = P2Q2 However Q2 is Q1 thus P2Q2 Q1P1 So by reducing the price total revenue TR increases By analogy increasing the price reduces revenue In general - if the elasticity of a good equals one [Ed = 1] then price movements along the demand curve will have no effect on revenues (demand is unit elastic) - if the elasticity of a good is less than one [Ed 1] revenues will decrease as the price decreases and increase as the price increases (demand is inelastic) Most day to day consumer goods are inelastic - if the elasticity of a good is greater than one[ Ed 1 ] price increase will decrease revenue and price decrease will increase revenue (demand is elastic)

Picture 1 Plastic Duck

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When there is a change in demand bought about by something other than price for example peoples income increases and they buy more ducks then the whole demand curve shifts in this case to the right. The curve has shifted.

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Figure 4 Shifted Demand Curve for Beer.

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All distilled alcohol now goes into transport while wine has been wiped out by disease so practically the only alcohol now available is beer. Hence there has been a shift in the demand for beer. Supply the counterparty to demand can be treated in exactly the same way as demand above What then is supply ? Supply is the amount of a commodity available for meeting a demand or for purchase at a given price. The law of supply states that, all other things being equal, as the price P(x) of a good increases so will the quantity supplied Q(x) increase. Mathematically the general supply function has the following form P(x) = f [Q(x) ] or alternatively Q(x) = f [ P(x) ]

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Table 5 Supply Schedule for Wheat

Figure 5 Supply Curve for Wheat.

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Figure 5 shows linear dependence a straight line. It also shows that the slope m of this line is positive since both variables P(x) and Q(x) increase or decrease in step. Again mathematically the function of a straight line is y=mx +c . So the demand function for wheat is P(w)=mQ(w) + c or more precisely P(w) = 1+0,1Q(w)

When price alone changes supply movement is up or down the supply curve. But supply is dependant on a number of other factors not just price input costs, can shift the curve left or right depending on whether the costs increase or decrease production. - number of sellers will result in more supply, curve will move right. - technology means efficiency which means increased supply - prices of related goods may cause a left shift since resources are allocated to other more profitable sectors. - expectations, reduced supply in anticipation of a price increase. Increased supply during specific periods of the year to anticipate demand. When one of the above factors changes supply the whole supply curve will move left or right (shift) depending on whether supply has increased or decreased.

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Figure 6. Supply Curve for Carp at Christmas Time in Poland

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Figure 6 shows a shifted supply curve for carp (increased number of sellers and expectations). In Poland at Christmas carp forms a very important part of Christmas Eves dinner. No meal is complete without this specific fish Command economies like those that existed in Eastern Europe between 1945 and 1990 were a tragedy especially for consumers. Demand for consumer goods was never ending practically infinite but supply was minimal or non existent. Cars telephones apartments everything and anything. Even food production was limited although no one ever went hungry. Exotic fruit such as bananas or oranges were never seen while a tin of sardines was a great delicacy. In a normally functioning market economy supply and demand are Siamese twins 2 sides of a coin one cannot exist without the other. Consumers buy on price and producers supply on price. So market equilibrium comes about when supply balances out demand. At the equilibrium price the amount buyers want to buy exactly equals the amount producers want to supply and sell. To quote 3) Market equilibrium comes at the price at which quantity demanded equals quantity supplied. The equilibrium price is called the market clearing price all the supply and demand orders are fulfilled. 14

And the equilibrium price comes at the intersection of the supply and demand curves. Below the intersection point demand will be greater than supply and there will be shortages above this point demand will exceed supply and there will be a surplus. This is shown in Figure 7. below. The demand curve and the supply curve for boxes of cereals

Figure 7. Supply and Demand Curves for Cereals vs. Price

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Only at equilibrium can both the buyer and seller can go home for a good nights rest. Above the market clearing price the following scenario will occur .

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Figure 8 Supply and Demand Curves for Piglets In figure 8 at price P1 the demand for piglets is Q1 but the seller wants to sell Q2 piglets. Result surplus. Below the equilibrium price another situation arises

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Figure 9 Supply and Demand Curves for Piglets

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In figure 9 demand for piglets at price P1 is Q2 but the supplier will only supply Q1. Result shortage. No more pork chops today.

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Supply and demand curves apart from determining optimum price can also be used to predict what will happen to the equilibrium point when there is a change in demand or supply

Figure 10 Demand and Supply Curves for Oranges vs. Price Effect of Demand Change.

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Algarve oranges are delicious. Recently scientists discovered that they contain Rejuvenol a chemical which makes wrinkles disappear. Figure 10 shows the increase in demand the right shift in the demand curve as a result of the news. The curve has shifted from DD to DD The equilibrium point has moved from E to E Some months later a correction was added at least 5 kilograms of fresh oranges had to be consumed each day for the process to work. The demand curve shifted back from DD to DD The equilibrium point also moved back from E to E Summarizing the above for a good that is price inelastic when demand increases price up quantity up TR up. when demand decreases price down quantity down TR down when supply increases price down quantity up TR down when supply decreases - price up quantity down TR up 17

Interpreting supply demand data needs caution. To take an example suppose the price of your daily hot breakfast croissant goes down considerably(2 for the price of 1) Is this because of a change in the demand side or supply side or a change in both. More data is needed before a conclusion can be drawn. If the price has decreased together with an increased supply the probable cause is an increase in quantity demanded movement along the demand curve (a bumper harvest ) This is shown in the figure below .

Figure 11 3) Demand and Supply Curves vs. Price for Croissants Movement along demand curve as one explanation of price decrease. Equilibrium has moved from Eto E because of a shift in supply Alternatively if price has decreased along with an a decrease in demand the probable reason is a left shift in the demand curve (croissants are very fattening with butter. ) By following the equilibrium point the reasons behind a price increase or decrease can be understood more easily.

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Returning to where we stopped in section 3 we stated that it is the market that decides the what the how and the for whom And it is with the 2 instruments of supply and demand that this rationing is achieved. The rewards are huge (Bill Gates) but failure is bankruptcy and possible ruin for the whole family. In a very few case it can mean the life of a billionaire until the culprit is finally caught. I still cant believe it. He was such a fine outstanding member of society . Everyone thought very highly of him.( Bernard Madoff and his Ponzi scam.)

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5. Applications of Supply and Demand. The ever emotive problem of immigration and its sister race relations is a continual headache for all western societies. Politicians can loose their votes and racialist parties such as the BNP can become very popular finding the right answer to the question to allow or not to allow more immigration. But does immigration do what people fear reduce hourly wage rate ? The economist would answer maybe. If immigration is directed to areas of unemployment then the result is an increase in work force and a decrease in hourly wage rate (shift in the supply curve).If immigration is directed to areas in economic expansion which is the norm then there will be no effect since the excess supply will be absorbed by a shift in the demand curve. Another very good example is the paradox of the highly motivated efficient productive farmer who is the poorer as a result. Farmers claim to be poor some possibly are but most are not. For their size 3% of the total workforce they have a very big say in their own welfare. When confronted their protests are very effective and spectacular tons of rotting farm produce on highways or in front of city hall. But their efficiency and productivity has not brought them the expected rewards.

Figure 12

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Agricultural Output and Demand vs. Price Before and After Enormous Productivity Increases Figure 12 shows a plot of agricultural food production and demand vs. price for the industrial nations of Western Europe and North America. Over many years farm productivity has soared mechanization super efficient seeds fertilizers pesticides herbicides have all combined to give yields of 150 bushels per acre (approx 4 tons) for wheat. This is shown by the supply curve shift from SS to SS Demand has not kept pace it has shifted only slightly right from DD to DD. People cannot eat everything that is being produced. The result of the supply and demand curve shifts is that a new equilibrium E has been established (E moved to E) This is very bad news for the farmer. Demand for wheat a commodity is inelastic (section 3) so that when price goes down total revenue TR goes down. The poor farmer sits on his mountain of grain and wonders what have I done wrong. The answers to his problem are not in his hands. He must be paid to produce less (production quotas) or the government must intervene to buy up all his produce at a guaranteed price (a further shift in the demand curve) to stabilize the market and prevent protest. The famous EU butter mountain is an excellent example of this policy in action.

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7.

Conclusions.

Economics is still a very young science - mathematics and physics have been around for thousands of years while economics is barely 200 years old although it fair to say that basic economics has been practiced since homo sapiens time . It has a lot of catching up to do. Unfortunately our very existence lies in the hands of economists in their theories and their models. The near total economic meltdown of the worlds economies last year was prevented by Ben Benacke Chairman of the Federal Reserve who was the right guy in the right place at the right time. Keynes had all the answers in his 1936 book The General Theory of Employment. We were very lucky. Unfortunately again there were only one or two prophets warning us that the American economy was heading for a mega crisis. But no one was listening. No one had a model for what was about to happen. The complex financial instruments (cdss cdos) used but little understood were just another example of our faith and ignorance. Now after 30 years of spectacular economic growth lean times are awaiting everyone. 10 % unemployment in the USA the economies of Greece Italy Spain and Portugal in a fragile state and mountains and mountains of debt to be paid back by future generations. The future looks uncertain. Greed is good, might is right. Economics still has a way to go.

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8 References. Alfred Marshall (http//en wikipedia.org/) Concise Encyclopedia of Economics Alfred Marshall (www.econlib.org/) Economic History of Economic Theory and Thought. (www.economictheories.org/) Alfred Marshall Biography 1842-1924 (social.jrank.org/pages/2408 ) 1.Marshals Theory of Value and the Strong law of Demand Brown and Calsamiglia. Feb 2003 . Cowles Foundation Discussion Paper. Economy Professor Alfred Marshall (www.economyprofessor.com) 2. The Economist November 2009 Economics for Dummies (www.strom.clemson.edu/) 3. Economics Samuelson and Nordhaus 18th International Edition Adam Smith (http//en wikipedia.org/) Money in the Middle Ages ( www.boisestate.edu/) The Middle Ages : the Feudal System (library.thinkquest.org/ Top 10 companies that have gone bust (www.helium.com) 4.History of the Market System (www.zeromillion.com/) 5.Principles of Economics Alfred Marshall (www.econlib.org/) Concise Encyclopedia of Economics Demand (www.econlib.org/ ) 6. Economics Study Guide (www.pinkmonkey.com/) 7. Pricing in Mass Markets. 3.2 Demand (www.mbs.edu/) 8. Investopedia (www.investopedia.com/) 9.( www.frenchduck.com/) Pricing in Mass Markets 3.3 Price Elasticity ( www.mbs.edu/) Spark Notes :Elasticity :Elasticity (www.sparknotes.com/) 10. Pricing in Mass markets 3.4 Supply (www.mbs.edu/) 11. NetMBA (www.netmba.com/) Glossary of Political Economic Terms (www.auburn.edu/) Supply and Demand (http// en.wikipedia.org/) Building the Demand Curve (http//en wikiversity.org/) Law of Demand (http//en.wikipedia.org/) Demand Curve (http//en.wikipedia.org/) Personal recollections of life in Eastern Europe

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9 Definition of Words used Aggregate total , sum of individual components. BNP fascist political party; the British National Party Capital One of the 3 factors of production - durable produced goods that are in turn used in production CDS credit default swap , a contract ,a derivative a complex financial instrument which is to insure against default. CDO collateralized debt obligation, a type of structured asset backed security. Change in demand see text Change in quantity demanded see text. Command economy a centrally planned economy where all economic decisions are determined by government directive. Communism previously a one party state that owns and controls all the means of production. The Chinese version is somewhat changed. Elasticity see the text. Griffen good a consumer staple whose quantity rises as its price rises. Gross Domestic Product (real ) the quantity of goods and services produced by a nation in a year. Land one of the 3 basic factors of production taken to include agriculture industrial and natural resources taken from above or below , wind oil etc Market market clearing price market economy - see text. Macroeconomics analysis of the behavior of the economy as a whole with respect to all aggregate economic variables. Microeconomics analysis of the individual elements of an economy. Ponzi scheme a fraudulent investment paying large returns using fresh money coming from new investors who have been deceived. 6 Sigma A method of changing a companys production or business so that its long term defects fall below 3,4 per million. Scarcity something that is not freely available. Substitutes goods that compete with one another. The Federal Reserve the American central bank. Veblen good a high status good where the high price is part of the attractiveness of the good. Reducing price reduces demand.

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