By John F. Sase, Ph.D.
Gerard J. Senick, Chief Editor
Julie Sase, Copyeditor
"Education can help us only if it produces 'whole men.' The truly educated man is not a man who knows a bit of everything, not even the man who knows all the details of all subjects (if such a thing were possible). The 'whole man' may have little detailed knowledge of facts and theories; he may treasure the Encyclopædia Britannica because 'she knows and he needn't,' but he will be truly in touch with the center. He will not be in doubt about his basic convictions, about his view on the meaning and purpose of his life. He may not be able to explain these matters in words, but the conduct of his life will show a certain sureness of touch which stems from this inner clarity."
- Ernst Friedrich Schumacher, "Small Is Beautiful: A Study of Economics as if People Mattered" (Frederick Muller Ltd., 1973)
In the past five episodes, we laid out some basics of economic scarcity, resources, needs, wants, and production that Detroiters must "grok" as we rebuild the economy of the city. For successful work to thrive, our approach must include everyone in the metropolitan area. We have subtitled our episodic series "Economics for Everyone" while using the basics of economics as the theme.
In this episode, we continue our foray as strangers in this strange land. Our parallel intention with this in-depth approach is to provide background for attorneys and other professionals to develop their primers for sharing with their staffs and with jurors in cases involving economic issues. Ultimately, we hope that our primer will help to redirect any remaining negative energy that others have focused on Detroit by educating our readership on how the principles of economics work in reality. In doing so, we hope to foster a greater positive spirit concerning the City of Detroit.
We will discuss marketplaces and the process of how we buy and sell to exchange goods and services with one another. At the center of market economics, we find the mechanism of supply and demand. College sophomores often view this subject as intimidating. Usually, instructors present it in a very technical manner; some instructors even teach supply and demand with nothing but math and graphs. However, by using common sense, simple illustrations, and clear, plain language, anyone should be able to comprehend this important topic for economic growth and redevelopment.
The first myth about economics is that consumers and producers focus on markets as only physical spaces. Though we tend to think of the general concepts of economics in terms of markets that resemble Trader Joe's grocery store or the Gibraltar Trade Center, markets also may exist in cyberspace. Examples include online trading with Wall Street, web sites such as Ebay.com, or call-in television marts such as the QVC Shopping Network. Therefore, we should recognize markets as existing whenever or wherever transactions occur in which we exchange goods or services.
Attorneys engage in matters of markets as they pertain to contracts, profits, wages, and other aspects of their practices and their clients. In order to understand markets, let us step back and consider what markets are not. If a person approaches us at an airport and hands us a flower without a direct request or expectation of receiving something of comparable value in return, we do not experience a market-defining exchange. Instead, we have a transfer - a one-directional gift-giving. However, if the two of us meet and hold out items of value to one another, we may wish to exchange our item for what the other party has. For example, if I walk into our global village holding a catch of trout that appeals to you and you hold a chicken that looks good to me, we may arrive at an exchange that we mutually consider a fair trade. In this case, we engage in a two-way action, a transaction in which we give to one another. This transaction involving goods of equitable value constitutes and defines our market activity.
Direct exchange of goods or services occurs most often within the family circle or an intentional community. For example, given a household in which two children each have regular weekly chores, one child may volunteer to do the dishes if the other agrees to take out the garbage. This form of exchange involves barter between two individuals who have a double coincidence of wants. In other words, you want what I have to offer and vis à vis. In society at large, though, traders often lack a double coincidence of wants (DCW). As a result of the lack of balance, the direct exchange does not work smoothly. The recourse may require a series of side trades in order to arrive at a DCW. For example, you accept my leg of lamb and I take your chickens, which I may not need or want, with the expectation that I can trade the chickens with a third person who has something that meets my desires.
Across the millennia as economies and legal systems have developed, the solution to this trade conundrum has been the development of tokens, markers, and IOUs. We commonly accept that these items or actions stand in place of ones that hold real value. These can serve as satisfactory tools for exchange. Symbols such as pieces of paper printed with ink may not possess any inherent value. However, this characteristic appears irrelevant if the symbol merely provides a transitory medium that anyone involved in complex rounds of exchanges accepts as a marker. Commonly, we have come to call these markers "money."
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Money, money, money
The English word "money" may have evolved with the Roman goddess Juno [the] Monetas, as pre-Christian Romans appear to have minted silver coins in or near her Temple of the Moon in Rome. Our moon has served as a tool for counting as well as marking monthly cycles since ancient times. Also, silver was associated with the moon (as gold was associated with the sun) in the myth and magic of classical Greece and other earlier cultures. Underscoring this relationship, the most widely accepted silver coin in ancient Athens had an owl and a crescent moon on one side. Alternately, etymologists suggest that the word "money" may have originated with the proto-Polynesian words "mani" (beads) or "mana" (life force or power). The root word entered the Rg-Vedic language as "mani" (jewel, gem, pearl) and passed through Mediterranean culture as the word "nomos," which denoted the scales of justice for weighing in classical Greece (etymonline.com).
A monetary system of money provides another quality in that we can use money as a commonly understood measure of value for myriad products. For example, if I were to ask you how many fish one chicken is worth, you may not have a clue. Let us agree that one chicken equals the value of three fish. Then we may use our paper markers in accordance and agree that two pieces of paper represent each fish and that six pieces represent each chicken. We close this discussion about the value of commodities themselves while addressing one additional issue. By the fourth day following the trade, any unpreserved fish that we carry around our village may lack freshness while drawing a following of feral cats. They may represent the only creatures in the village that hold any interest in the aging product. In short, fish do not maintain their intrinsic value as a trade good because they do not constitute an adequate store of wealth.
A pricing system develops once we establish the relative value of fish, chickens, goats, shirts, shovels, and anything else that we might exchange in terms of our special pieces of paper. We can observe the resulting market behavior as the price of each good rises above or falls below its known average trade-value. In effect, we expect to find that those who have some of this particular good to offer will have a greater desire to part with it when the price rises above average than when the price falls to the low side. However, there exists an exchange price agreeable to the ones providing the good and to the others who desire to possess it. The former group will supply just enough of the good to meet the demands of the latter party interested in obtaining it. Therefore, when achieving a mutually agreeable price, the quantities offered and requested will equal one another as the market goes toward a steady state of equilibrium. This logic represents our basic laws of supply and demand.
Nevertheless, this state of equality may change for reasons that have little or nothing to do with the agreed price. A change in the non-price variables may lead to divergent increases and decreases in the equilibrium-price and -quantity. Though the quantities exchanged between buyers and sellers may increase or decrease, the price may remain unchanged. Therefore, we will explore the seven major influential variables in the next section. Two of these variables affect the behavior of sellers supplying the product and five different ones that lead buyers to purchase a different quantity of this product collectively. These actions reflect one of the basic social contracts around which commercial law has developed.
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Supply "is" cost
First, we consider two major variables that affect supply - the number of producers and the changes in their costs. In a normal market, we expect several producers to remain situated at any given time. At the bottom margin, some suppliers enjoy lower costs that allow them to break even at low price-points. This ability may result from greater experiences or business skills. Alternately, other suppliers only manage to break even when the price rises to a higher point.
In contrast to the first group, these higher-cost producers may not possess the skill and experience developed by the lower-cost group. This difference results in reduced cost-efficiency. In short, a greater number of suppliers exist who have the ability and willingness to offer their goods only at higher prices. Given this status quo, greater quantities enter the market at any price-level when a similar mix of new sellers arrives on the scene. In contrast, the number of goods available decreases in this market when producers exit it permanently.
Beyond the size and number of active producers, the reason for which supply increases or decreases points to some change of direct cost. Effectively, we recognize that the measurement of the costs involved in producing and selling a product constitutes the measurement of supply. The question that we must ask is, "Does a change in a specific variable cause the cost to increase or to decrease?" Once we can identify a variable and its direction of the cost-change, the resulting movement of supply appears obvious. Under normal conditions, the cost and quantity supplied move opposite of one another. When a cost increases, supply decreases - conversely, supply increases when the cost decreases.
There are two ways in which we regard this cause/effect process. For example, we can bake, wrap, and sell loaves of bread at a given price. However, we may not be able to sell as many loaves when our cost per loaf increases. We can sell more loaves when costs decrease, though selling more may not result in increased revenue or profit because of a lower price. Our second viewpoint of this economic phenomenon requires that we consider what happens when we desire to sell the same number of loaves, though we must increase or decrease the price accordingly to break even. Let us say that we sell each loaf at $2, a price that covers our costs in a way that leaves our employees with a fair wage and us with a fair profit. However, if our cost of producing a loaf increases by 50 cents, then we must raise our price to $2.50 lest we lose money and go out of business. Alternatively, if we can find a way to reduce our cost of production by 50 cents, then we could afford to lower our price to $1.50 and be as well off as before on a per-loaf basis.
Now we can ask the question, "What variables affect the cost?" Though we can cite many, the universal ones include wages and benefits paid to employees, taxes paid to a government, the cost of several raw materials, and gains from improved technology and know-how. For the first three, labor, material, and taxes, any increase in their dollar amounts causes costs to increase and supply to decrease. If the wages or benefits paid to a worker rise, costs will rise unless an increase in productivity offsets the pay increase. For example, if it costs 10 cents to wrap one loaf of bread and we pay our employee, Pat, $10 per hour, then we expect him/her to wrap 100 loaves per hour to cover his/her wages. If we increase his/her wage to $12 per hour and Pat continues to wrap 100 loaves per hour, our cost of wrapping increases to twelve cents per loaf. For everything else to remain the same, we would have to increase the price per loaf by two cents. However, if Pat increases his/her wrapping to 120 loaves per hour, s/he meets his/her raise through his/her increased productivity, and our cost of wrapping a loaf remains at ten cents. As a result, both parties benefit: Pat earns 20% more per hour, and we do not need to increase our price to cover the additional wage-cost.
We can construct a similar scenario for taxes, raw materials, or any other costs of doing business within a system of law. An increase in any of these variables will raise costs unless they produce offsetting benefits. For example, increased taxes paid to our local or state government may result in an equitable benefit through improved road-maintenance that reduces delivery time-cost as well as repair costs to our vehicles. Such a benefit offsets the tax increase. Likewise, if both the quality and the price of raw-material increases in a way that decreases scrap, this event may result in savings on overhead and labor due to lower scrap-rate downtime. Let us consider another example made famous by the American mathematician and physicist W. Edwards Deming: If a sewing establishment switches to the more expensive thread of higher quality, the business should expect to reduce the non-productive time of rethreading the sewing machines because cheap thread breaks more often. As Deming explains it, quality control starts with inputs, not outputs.
In understanding the root cause of supply-change and its corresponding effect on cost, the odd variable out is technology. We generally consider an increase in technology as an improvement and a cost-reducer. Naturally, we do not expect an improvement to lead to an overall rise in cost. Instead, better technology should lead to a decrease in cost and a resulting increase in our supply of the final product. The most relevant way to understand the behavior of technology rests with whether or not an improvement reduces cost while not running afoul of patent law. The rational process in deciding whether or not to acquire new technology requires estimating the expected increase in production per day, in contrast to the relative reduction in the cost of maintenance and repair. To illustrate this point, let us consider the electric light-bulb. Modern fluorescent, halogen, and LED bulbs are more expensive than their incandescent counterparts. However, these newer technologies result in lower energy-costs along with longer bulb-life. In business, a bulb with double the life expectancy of the older type of bulbs only needs to be changed half as often. The savings in terms of paying to replace a bulb may justify paying a higher initial cost for the newer type of bulb.
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Demand "is" revenue
Let us turn our discussion to the matter of customer demand for a product as well as the thought processes and resulting decisions that buyers make. In this section, we will discuss the five major variables that affect demand for a product. The first one is the number of buyers in the market. In respect to our supply-side analysis, let us return to our bakery example and hold our loaf-price constant at $2. On a typical visit, each customer tends to buy one loaf of bread. Between ten and eleven a.m., twelve customers come into our shop; each of them buys one loaf. However, many of our customers do their shopping during their lunch hour between noon and one o'clock. If twenty-four customers enter the shop during that hour and each of them purchases one loaf, we sell twenty-four loaves of bread. Ergo, more customers, more loaves sold.
In considering the other demand-variables, three of them work in the same direction as the number of customers. These variables include the income of the buyer, the personal tastes of that person, and the price of a competing brand. If any of these three variables increase, then demand will increase for the loaf of bread that we are selling.
In general, customers are willing and able to buy more of our product at the going price if their incomes increase. For a fresh example, let us put ourselves into the movie-theatre business. In this type of entertainment concern, we provide a service by selling tickets to our customers that allow them to enter our enclosed space, to sit in a seat, and to watch a film. When they have finished, we still have the film, seats, and enclosed space, our fixed costs, along with electricity, wages, and other variable costs. In this case, we provide a service rather than giving a tangible physical good, like a DVD of the film, to our patrons. As the incomes of entertainment-seekers increase, they purchase more of our service - if they are loyal to us - or similar entertainment, such as live concerts and sporting events. This tendency holds for all "normal" goods and services, for which demand increases because of increases in income.
In contrast, we tend to buy fewer goods that we deem inferior and to buy higher-quality brands as income increases. For example, the food intake of college students often consists of fast food like burgers and tacos, chicken pot-pies, pizza, Ramen Noodles, and some canned protein combined with a box of inexpensive pasta such as Road-Kill Helper. Their choices of products result from low incomes. As their incomes increase, the normal course of events follows a path toward higher-quality meals that are more expensive but also are more nutritious and better-tasting.
Per another variable, our decision to buy products depends upon our tastes or preferences that are influenced by social trends. Many years ago, I (Dr. Sase) noticed that virtually all of my female economics students wore "banana clips" in their hair. These devices were a spring-loaded hair-clamp with two banana-shaped curved pieces of plastic with teeth. When these clips reigned as the height of student fashion, the demand for this relatively inexpensive accessory soared to its apex. After the popularity of this product waned, shopkeepers consigned this 20th-Century artifact to the bargain bins near the front door of neighborhood stores. This event exemplifies the rise and fall of consumer tastes and preferences.
Our third and fourth variables require a more involved explanation. Demand for the brand that we sell tends to increase when competitors raise prices for similar goods that they produce. However, to comprehend the dynamics of this market eventfully, we need to fill in the intermediate steps. Let us imagine that we are one of two major producers of colorful, fizzy, sugar-flavored water. Apart from the packaging and minor differences in the taste of the effervescent liquid, the two brands virtually perform the same. Each of us competitors sells a comparable quantity of our drink at $1 for an eight-ounce bottle. One day, our competitor raises the price of its beverage to $1.50. As a result, our sales of bottles that still are priced at $1 rise sharply. What has occurred? Due to a sudden increase in price, indifferent customers viewed the product of our competitor as excessively priced in contrast to our product. These customers, who decided not to buy the competing brand at $1.50, chose to buy our brand at $1 instead. In summary, our competitor raised his/her price, we kept our price the same, and many customers "substituted" our product for that of our competitor. Customers will make a substitution between brands if it feels economically rational to do so.
Our fourth and final variable is the odd one out. Again, our scenario involves two sets of producers. This time, the demand and the quantity sold of our product increases when the price of a different but related good decreases. Let us imagine that our little company makes fruit jellies. Another company specializes in the manufacture of peanut butter. Everyone who makes peanut-butter-and-jelly sandwiches (PB&Js) are potential customers for both companies. Peanut butter and jelly go together and "complement" one another in sandwiches. For reasons unknown to us, the peanut-butter manufacturer lowers its price from $5 to $4 per one-pound jar. Our sales of one-pound jars of jelly increase even though our price remains the same as before. What has happened? Customers have purchased more jars of peanut butter because of the price reduction and, consequently, plan to make more peanut-butter-and-jelly sandwiches. Therefore, customers need to purchase more jars of jelly in order to complement the additional amount of peanut butter that they buy. In summary, our customers will purchase more of both goods if it seems economically rational to do so.
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Wrapping up the groceries
In the preceding sections, we have focused on the interworking of the major elements of markets. Now, let us put theory into practice. Everyone, from the very poor to the very affluent, in the metropolitan region needs to develop a basic understanding of markets, revenues, costs, supply, and demand in order to continue the recovery of Metro Detroit. For this understanding to take place, a workable social contract must develop. A significant portion of this contract focuses on wages. Due to the way that the world works, those offering their labor for hire need to have a clear understanding of the relationship between the wages that they desire in respect to the value of the productivity that they offer. Those who work for wages and those who have other vested interests in the success of a business that needs productive employees must understand the need for a fair and balanced division of the revenue generated as well as the human responsibility that owners, managers, and employees have to one another.
In order for a city and region to thrive, all parties must work with a basic understanding of the market dynamics of supply and demand. These dynamics include the seven variables outlined earlier: (1) the number of sellers, (2) the number of buyers, (3) costs, (4) incomes, (5) tastes and preferences, (6) the price of a substitutable good, and (7) the price of a complementary product. To clarify these seven variables, we need to understand the cause and effect of relations between the number of sellers willing and able to produce products and the number of buyers willing and able to purchase these products. The interconnections in the social and legal contract of production; the wages demanded by workers and paid by employers; taxes raised for needed public goods and services; and the private funding of education, research, and development in respect to technological progress must harmonize with one another.
In summary, the complete and sustained recovery of our hub-city of Detroit depends upon these elements: dialogue among all groups involved to reach an understanding of the need for relevant education and training as well as the affordable delivery of this education and training to those who need and desire it. Furthermore, we want to develop other industries that complement the existing ones. These industries include automotive and related manufacturing, health-care delivery, and local institutions of higher education. We continue to see progress in these areas with developments such as Downtown, Midtown (e.g., TechTown), and Corktown as well as bio-medical research sites and a global multi-modal freight-hub, among others. We hope that smaller businesses in the fields of art, retail, and hospitality continue to develop and, subsequently, to use available real estate to its optimum. In future episodes, we will continue to delve into the economics of the planet, the nation, Southeast Michigan, and Detroit as well as the financial markets.
Published: Wed, Aug 21, 2019
