Some
people do not consider economics an exact science. They believe that economics,
unlike natural sciences such as physics or chemistry, is ambiguous in
explaining phenomena, and is often off target at least three times out of ten,
hence cannot be on a par with natural science. When lecturing students in
class, how would you respond to such question?
The
banknote example that I quoted to freshmen during lecture is reportedly often
used in colleges in the United States. I held a coin in hand, released my hand,
the coin fell, then I said to the students: “With no powerful magnet above,
when I release my hand, the coin will fall. Who dare to make a bet against it?”
There was no response from the students. “The odds are ten to one, who would
like to bet?” No response. “How about a thousand to one?” No response. “Ten
thousand to one?” Again no response.
I put back
the coin, took a $100 note from my wallet, and said to the students: “If I
place this banknote in a prominent place on a sidewalk, with no wind or police,
this banknote will disappear. Who would like to make a bet against it?” No
response. “How about ten thousand to one?” Again no response.
I
therefore told the students that under my specified conditions, the banknote
will vanish on the street. Only can it be explained by economics, but not by
physics, chemistry, biology, psychology, nor sociology. In fact, the accuracy
is exactly the same between the disappearance of a banknote as explained by
economics, and the fall of a coin as explained by physics. Physics applies the
law of gravity to explain the fall of a coin, while economics applies the law
of demand to explain the disappearance of a banknote. That’s right, with
neither police nor many pedestrians around, the option forgone for picking the
banknote for own use decreases. This is the same as specifying under what
conditions a coin will fall.
If we
cannot stipulate the relevant constraints, problems will often arise when we
try to explain human behavior. Yet is natural science not like this? The
accuracy of science never refers to how many decimal places there are, but
rather the concurrence of observers. The fact that you dare not make a bet with
me signifies concurrence. In the chapter on “The
Utility Concept”, I had already pointed out that measurement is merely the
assignment and ranking of numbers, as well as discussing the two kinds of
numerical measures.
It is time
to employ some real-world examples to demonstrate the application of the law of
demand. I must point out at the outset that we have not yet discussed
production, the different structures of the market, the organization of the
firm, the different types of property rights, etc., therefore only relatively
straightforward examples are chosen here as casual demonstrations of the law of
demand. But first, let me overrule certain textbook examples proclaiming that
the law of demand had been refuted.
You meet
on the street a stranger. He says to you: “Dear friend, I have a genuine
2-carat diamond of very high quality that comes with a certificate. Its market
price is at least $300,000, but since I am in urgent need of money, how about
selling it to you for $5,000?” He then showed you the sparkling diamond. You
would certainly not buy as you would never trust a stranger on the street. Even
if the diamond is indeed genuine, since you do not know how to appraise, you
would still not believe so. If you happen to be an expert appraising that the
diamond is indeed genuine, due to its unknown history, you may still decline to
buy. Or maybe like some other people, you would not even bother to have a look,
since you believe that something worth $300,000 would not be selling for
$5,000.
You may,
however, be willing to pay $300,000 for the same diamond in an
elegantly-decorated branded shop. Your behavior has not refuted the law of
demand, though, since due to difference in information, you trust an
established shop instead of a stranger on the street.
For almost
any good, accurately assessing its quality is no easy matter. We often have to
spend a lot of effort before becoming an appraiser of a certain good. To become
an appraiser of several goods may demand your whole lifetime. And becoming an
expert in everything is impossible. When I was young, I was very knowledgeable
about cameras and color processing of different lenses. But with today’s
technological changes, I now need to seek advice from friends before buying a
camera.
In
general, given ignorance and our past experience, for the same kind of goods,
we often believe the higher the price, the better quality it has. Such
assessment is not necessarily right, yet the chance of being right is not bad.
Similar to me, you would likely assume, given market differentiation, the good
with a higher market price ought to have better quality.
Under the
aforementioned circumstances, we do often buy when the price is high, and not
buy when the price is low, particularly in relation to cheap and insignificant
goods that do not warrant our attention. For instance, I very seldom use
ball-point pen, but if I do, I would choose the cheapest type made of
transparent plastic, since I prefer seeing the remaining ink inside. One day, I
asked my secretary to buy me the cheapest ball-point pen. She came back with a
$3 one. I said: “Not this one. I want the transparent one.” She replied: “The
transparent one only costs about $1!” She obviously believed that the
higher-priced pen meant better quality, and for me, a professor who relies on
writing for a living, my choice would unlikely be the cheapest one.
Owing to
insufficient information, price is frequently used as a yardstick for quality.
This certainly does not contravene the law of demand. Such behavior of
assessing quality by price is not only real but important. It is unjustifiable
that economists very often ignore this phenomenon. I myself have devoted many
years working on bargaining behavior in the market, reaching an ultimate
explanation by using quality assessed by price as the starting point. This
phenomenon is most apparent in the antique market: lowly-priced is often
perceived to be fake. I will analyze bargaining behavior which involves the
constraint of transaction costs in Volume
II.
Back in
the 1960s – 70s, oil imported into the United States was controlled by quota.
Unsure if related or not, a bizarre phenomenon in the prices of gasoline has
hitherto been unexplained. That is, the retail prices of gasoline followed
cyclical movements that were as orderly as the teeth of a saw. The hike in
price was a one-off rise by about one-third; the fall in price was a gradual
decline over a span of about two weeks. As such, many customers, realizing the
regularity of gasoline price changes, deferred buying when price first started
to fall until it had fallen further.
Price
change can lead to expectation of continuing changes in the same direction,
thereby affecting demand (shifting of the whole demand curve). Neither has this
refuted the law of demand.
Let’s
return to the sawteeth-pattern phenomenon of gasoline price changes. I debated
at length with Reuben Kessel (deceased in 1975) who was renowned for his
natural talent. He only agreed with part of my suggested explanation – if the
government had allowed vehicle users to store gasoline in large container (that
was illegal) when price was low, the sawteeth pattern would not have existed.
However, that did not explain why such pattern existed.
As can be
seen from the several examples above, handling the so-called “ceteris paribus” is no easy matter.
Conversely, from the way “ceteris paribus”
is handled, the caliber of an economist is often revealed. The difficulty is
that we cannot arbitrarily use “ceteris
paribus” as an excuse to remedy an implication that has been refuted by
facts.
With
econometrics so popular these days, regression analysis can assist in handling
“ceteris paribus” to a certain
extent. The problem is this analysis has too many pitfalls making it
unreliable! At times people employing this analysis are trapped without
knowing.
The most
reliable approach is to keep on pondering. We have to derive certain
implications refutable by facts in order to safely avoid the perplexity of “ceteris paribus”. To achieve this, our
focus has to be placed on test conditions or constraints: this condition should
be inserted, or that condition should be withdrawn, shuffling conditions here
and there in the hope of generating certain testable implication, and being
refuted has to be acknowledged. These test conditions or constraints cannot be
castles in the air. They can be simplified, yet must be essentially congruent
with reality.
No comments:
Post a Comment