My students have played a short supply and demand experiment in class this year. The experimental design goes back to the work of Chamberlin (1948, JPE) and Vernon Smith (1962, JPE). I have used the beautiful online design developed by Heinrich Nax, Diego Gabriel Nunez Duran, and Bary Pradelski at the ETH Zürich. I ran three sessions and had 60 students participating in each. I am afraid I did not pay any money, so if you are interested in the experiment you may want to go back to the original Vernon Smith (1962) experiments and the literature that followed, in which subjects are almost always given (some) monetary incentives. The results I got with my students were not that different, however, to what researchers found with monetarily incentivized students.
Suppose you observe different prices for the same good at different times. Why would that be? How can we explain this? In fact there are lots of possible explanations for this, but they can mostly be grouped into two categories of explanations: explanations based on changes of the demand(function) for the good and explanations based on changes of the supply(function) for the good. [Another explanation could be that there are changes in the market structure, which is a point I will get to in a later lecture.] Let me give you what I believe are good examples for the two cases. First, Styrian white wine in different years. Second, Upper Styrian hotel rooms and apartments in winter versus summer.
As a teacher of economics, I am always looking for good examples of economic illiteracy – a newspaper article or maybe a speech by a politician evincing a deep ignorance of simple economic principles. Unfortunately for me, such pieces are few and far between. Imagine, therefore, my delight when I read the following headline:
At first, I was convinced that the author was just kidding, that this was a good piece of satire. But no. This is serious.
Here are some highlights:
When nearly 100 drugs became scarce between 2015 and 2016, their prices mysteriously increased more than twice as fast as their expected rate, an analysis recently published in the Annals of Internal Medicine reveals. The price hikes were highest if the pharmaceutical companies behind the drugs had little competition, the study also shows.
The authors—a group of researchers at the University of Pittsburgh and one at Harvard Medical School—can’t say for sure why the prices increased just based off the market data. But they can take a shot at possible explanations. The price hikes “may reflect manufacturers’ opportunistic behavior during shortages, when the imbalance between supply and demand increases willingness to pay,” they conclude.
Now, this would all be really funny, if it wasn’t the product of a group of highly respected researchers in medicine from top universities published in a peer-reviewed medical journal. But it becomes a public health issue when people end up making policy conclusions on economic illiteracy:
To combat potentially exploitative hikes, the authors offer a recommendation:
If manufacturers are observed using shortages to increase prices, public payers could set payment caps for drugs under shortage and limit price increases to those predicted in the absence of a shortage.
Yes, you guessed it: price controls are the obvious solution to a shortage-induced price increase. Face, meet palm!
In the last class (summary) we have discussed trade and that, under certain conditions, trade leads to Pareto improvements (which means that at least one person is better off and no one is worse off). I now want to discuss what economists call a market, market prices or, better, market values, and a market allocation. The difference between the idea of a market and bilateral trade is that bilateral trade is, well, bilateral (i.e. always between two people), whereas a market is, at least in some form, a central meeting place in which all participants interact at the same time in this one place by making offers and counteroffers to possibly many other participants. We have two options of how to deal with such a market. One is to try to capture the dynamic protocol of interaction that underlies the market place. This is difficult and probably depends on the exact market we are interested in. So we will not do this here. I also do not know of any very convincing general model of this kind, but there are some for special cases. The other option is to state what we think will be the likely outcome of any such market interaction. Note that what we write down next is an assumption or definition and not derived from any more basic set of assumptions.