Magazine article Teaching Business & Economics

Re-Thinking Microeconomics

Magazine article Teaching Business & Economics

Re-Thinking Microeconomics

Article excerpt

Let's take the demand curve, which all students are taught slopes downwards from left to right, showing an inverse relationship with price. At first sight there is little to object to here as intuitively we feel that in general if price rises people will buy fewer units of the product, but all is not quite as simple as it first seems. This theory is now often taught in ways that are misleading because rather than show demand curves in principle (using letters to denote changes on the P & Q axes) we put in numbers and give the impression that we are deriving demand curves from observable real world data, often compounding the error by actually using real world data that show inverse relationships between quantity sold and price. Whilst it is true that when we graph such observations we are drawing a line that shows an inverse relationship between price and quantity, if that line is drawn from observed real-life data then one thing we can be sure about is that this is not an economist's true demand curve. This is because an economist's demand curve is drawn ceteris paribus, assuming that any other variable (e.g. income, tastes) apart from price is held constant but in observed data this is not the case so it is misleading to call an observed inverse price quantity relationship a demand curve, it isn't, it's just an inverse relationship which may or may not be affected by other factors.

This has implications for elasticity calculations if they are based on real world data because although we can observe a change in quantity demanded after a change in price what we can never know is exactly how much of that change in demand was due solely to the change in price and how much to simultaneous changes in other factors, including that most elusive of variables 'tastes'. Thus there is a disconnect between the pure theory concept and the reality of business application.

A particularly odd exercise imposed upon economics students in some exams is getting them to calculate price elasticities of demand from demand schedules. Whilst there may be some merit in this as an intellectual exercise (just as doing Sudoku puzzles is good as a mental workout) it is hard to see how this is useful in understanding real world consumer and business behaviour even for simple products like milk let alone more complex products such as designer clothing or high-end cars.

With this in mind the introduction of the concept of point elasticity of demand into A level syllabuses is particularly odd, this is a purely theoretical concept which cannot be derived from real life data. I assume that the purpose is to beef up the maths content of the course a bit, but what is the point of this? Universities which stress the mathematical aspects of economics will still demand A level maths as part of their entry conditions so putting a bit more maths in the course won't help on that front and as for engaging students with real world economics this is not going to help because it is partially the sort of thing that has rightly got economics a bad name. The whole exercise is worryingly close to the medieval scholastics arguing about the number of angels dancing on pinheads. By including point elasticity of demand calculations we are dangerously close to parody: 'How many economists can disagree about the point elasticity of demand of a pin in Adam Smith's factory?'

All of this is bad enough for simple products like milk but when we start to examine the factors that influence demand for highly complex products such as a particular model of car, one only has to spend a few minutes reflecting upon car-buying behaviour for it to be instantly clear that pure price elasticity of demand is impossible to isolate and measure. In the real world what businesses want to know is how will a marketing strategy that includes price changes affect total sales revenue for my product? Businesses would love to know the quantity and revenue implications of price changes but is the pure concept of price elasticity of demand (or for that matter income elasticity or cross elasticity) useful? …

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