In This House, We Believe Demand Curves Slope Downward to the Right VI
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!
Prohibition
The price elasticity of demand goes 90% of the way toward explaining Prohibition’s failure and the concomitant success of bootlegging gangsters.
The demand for alcohol was very inelastic. That’s virtually enough to explain Prohibition’s failure. Though supply contracted under Prohibition, the best estimates suggest that the decrease in quantity demanded was small. Peoples’ habits went underground.
When demand is inelastic, a supply-induced price rise also increases the total revenue that sellers earn. That’s the piece of the puzzle that explains gangsters’ wild success. First, the enormous revenues attracted the seedier element—say, those already involved in criminal acts—to the bootlegging enterprise. But these massive revenues also capitalized underground producers. They could afford investments in weaponry and—another important cost of doing business—paying authorities to look the other way.
The result was a violent thirteen-year experiment.
