In This House, We Believe Demand Curves Slope Downward to the Right V
This series of posts is adapted from an essay originally published on my personal blog, A Fuller's Soap.
During graduate school lecturing, a friend who I won’t name once joked, “We’ve covered downward sloping demand curves—what else is there to teach them?”
Less flippantly, Armen Alchian was once asked about what he taught in his PhD Micro course.
He replied to the effect of, “I teach the theory of demand.”
“And after that?” his conversation partner persisted.
“I teach the theory of demand,” Alchian replied.
See for yourself just how much of his magisterial Universal Economics he devotes to the law of demand.
The problem, for those of us (all of us) who are less gifted than Alchian, is that we can leave students with the sense that they’ve mastered the law of demand if they but memorize the inverse relationship between “p” and “q.” Deep understanding only occurs when students become capable of making pattern predictions about markets, predictions informed by what the law of demand says.
So, if the only economics you knew was the law of demand, how far could you get? As I tell my students in Econ 101, very, very far.
In what follows, I acknowledge a debt to McKenzie and Tullock’s, The New World of Economics, for several of the examples. In other cases, I’ve forgotten the source. My presentation is intentionally short in order to get the gist across, so yes, I’m leaving out details. But you get the point: In this household, we believe that demand curves slope downward to the right.
Paul Samuelson was once asked for an insight from economics that was at once true and non-obvious. He offered the law of comparative advantage. If I had just a few minutes to convince someone of the power of economics, I’d offer these examples of the law of demand as succinctly as I could. What perhaps distinguishes the law of demand from comparative advantage is that the law of demand is even obvious!
Sin Taxes
Tax policy can pursue pecuniary or anti-consumption goals, but not both.
If the goal of a sales tax is to raise money, it must be placed on a relatively inelastically demanded good. If the goal is to quash consumption, success will only obtain if buyers are highly sensitive to price changes—elastic.
It’s obvious, even trivial, that taxes can reduce a good’s consumption. But is that actually the stated goal of sin taxes? Usually, the stated goal is something like: “make people healthier (by making cigarettes more expensive).”
Yet, when governments increase taxes on cigarettes, ceteris paribus, marginal consumers switch to other substances which might be worse for their health. Alcohol is a common substitute. Most of these “marginal switchers” come from the ranks of the young, whose demand for cigarettes is more elastic, on average, than are the demands of the old.
Want to create a community full of alcoholics?
Tax, at exorbitant rates, other substances with addictive qualities.