[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Prices are the way participants in the economy communicate with one another.
Assume a drought hits the country, drastically reducing the supply of corn. Households
will need to lower their consumption of corn or there will not be enough to go around.
But how will they know this? Suppose newspapers across the country ran an article
informing people they would have to eat less corn because of a drought. What incentive
would they have to pay attention to it? How would each family know how much
it ought to reduce its consumption? Alternatively, consider the effect of an increase
in the price of corn. The higher price conveys all the relevant information. It simultaneously
tells families corn is scarce and provides incentives for them to consume
less of it. Consumers do not need to know anything about why corn is scarce, nor do
they need to be told how much to reduce their consumption of it.
Price changes and differences present interesting problems and puzzles. In the
early 2000s, while the price of an average house in Los Angeles went up by 76 percent,
the price of a house in Milwaukee, Wisconsin, increased by only 32 percent.
Why? During the same period, the price of computers fell dramatically, while the
price of bread rose, but at a much slower rate than the price of housing in Los Angeles.
Why? The “price” of labor is just the wage or salary that is paid. Why does a physician
earn three times as much as a college professor, though the college professor may
have performed better in the college courses they took together? Why is the price
of water, without which we cannot live, very low in most cases, but the price of diamonds
very high? The simple answer to all these questions is that in market economies
like that of the United States, price is determined by supply and demand. Changes
in prices are determined by changes in supply and demand.
Understanding the causes of changes in prices and being able to predict their
occurrence are not just matters of academic interest. One of the events that precipitated
the French Revolution was the rise in the price of bread, for which the
people blamed the government. And gas price increases were a topic of political
debate in the 2004 U.S. presidential election.
Demand
Economists use the concept of demand to describe the quantity of a good or service
that a household or firm chooses to buy at a given price. It is important to understand
that economists are concerned not just with what people desire but with what
they choose to buy given the spending limits imposed by their budget constraint
and given the prices of various goods. In analyzing demand, the first question economists
ask is how the quantity of a good purchased by an individual changes as the
price changes, when everything else is kept constant.
THE INDIVIDUAL DEMAND CURVE
Think about what happens as the price of candy bars changes. At a price of $5.00,
you might never buy one. At $3.00, you might buy one as a special treat. At $1.25,
54 ∂ CHAPTER 3 DEMAND, SUPPLY, AND PRICE