Marginal Analysis, Roller Coasters, Elasticity, and Van Gogh: Crash Course Economics #18

Summary

This Crash Course Economics episode introduces microeconomics, focusing on individual market decisions of consumers, businesses, and governments. It explains marginal analysis, where additional benefits and costs are compared to make decisions, using examples like hiring workers and building city parks. The script delves into the law of diminishing marginal utility, illustrating how satisfaction from consumption decreases with each additional unit. It connects these concepts to supply and demand, elasticity of demand and supply, and the diamond-water paradox, emphasizing the importance of understanding microeconomics for better decision-making.

Takeaways

• 📚 Microeconomics focuses on individual markets and decision-making of consumers, businesses, and governments, in contrast to macroeconomics which looks at the economy as a whole.
• 🔍 Marginal analysis is a key concept in microeconomics, examining the additional benefits and costs of decisions, such as hiring more workers or building additional city parks.
• 💰 The decision to hire more workers is based on whether the marginal revenue generated by an additional worker exceeds the marginal cost, including wages and benefits.
• 🌳 Governments consider the Law of Diminishing Marginal Utility when deciding on public projects like city parks, balancing the additional benefits against the costs.
• 📈 The downward-sloping demand curve represents the Law of Demand, where higher prices result in lower quantities demanded, reflecting the decreasing marginal utility of goods.
• 📊 The upward-sloping supply curve represents the Law of Supply, where an increase in price incentivizes producers to supply more goods, essentially showing marginal costs.
• 💎 The Diamond-Water Paradox illustrates that the value of a product is not solely determined by its utility but also by its scarcity and the marginal utility it provides.
• 🍓 The shape of the demand curve for a product like strawberries is influenced by the law of diminishing marginal utility and the availability of substitutes.
• 🚗 Gasoline has relatively inelastic demand due to few close substitutes, meaning price changes have a smaller impact on the quantity demanded.
• 🍕 Pizza, with many close substitutes, has more elastic demand, making it more sensitive to price changes and likely to see shifts in quantity demanded.
• 🛫 The elasticity of supply refers to how responsive the quantity supplied is to price changes, with examples ranging from inelastic (airplanes) to elastic (t-shirts).

Q & A

What is the main focus of microeconomics?

Microeconomics focuses on individual markets and the decision-making of consumers, businesses, and governments, examining how they make choices based on additional benefits and costs.

What is marginal analysis in microeconomics?

Marginal analysis in microeconomics refers to the process of evaluating additional benefits and additional costs when making decisions, such as hiring more workers or building additional city parks.

Why is the demand curve for a good typically downward sloping?

The demand curve is downward sloping due to the Law of Demand, which states that as prices increase, the quantity demanded decreases, reflecting the idea of diminishing marginal utility as more of a good is consumed.

What is the Law of Diminishing Marginal Utility?

The Law of Diminishing Marginal Utility states that as a consumer consumes more of a good or service, the additional satisfaction or 'utility' gained from each additional unit decreases.

How does the concept of 'utils' relate to the concept of utility in economics?

In economics, 'utils' is a hypothetical unit used to quantify the satisfaction or happiness a consumer derives from consuming a good or service, with utility being the subjective measure of this satisfaction.

Why do businesses consider marginal revenue and marginal cost when deciding how many workers to hire?

Businesses consider marginal revenue and marginal cost to determine if hiring an additional worker will generate more revenue than the cost of hiring that worker, including wages and benefits.

What is the relationship between the supply curve and marginal cost?

The supply curve represents the Law of Supply and is essentially a marginal cost curve, showing the additional resources and energy required to produce each additional unit of a good.

Why does the equilibrium price in a market represent an efficient allocation of resources?

Equilibrium is efficient because it is the point where the marginal benefit of the last unit consumed equals the marginal cost of that unit, ensuring that resources are not wasted on producing goods that consumers do not value.

What is the Diamond-Water Paradox and how can it be explained using marginal analysis?

The Diamond-Water Paradox refers to the phenomenon where diamonds, which are less essential than water, are more expensive. It can be explained by the high marginal utility and scarcity of diamonds compared to the low marginal utility of abundant water.

What is the concept of elasticity of demand and how does it relate to the demand curve?

Elasticity of demand measures the sensitivity of the quantity demanded to a change in price. A steep demand curve indicates inelastic demand, where a large price change results in a small quantity change, while a flatter curve indicates elastic demand, where a small price change leads to a large quantity change.

How does the availability of substitutes affect the demand for a product?

The availability of substitutes affects the demand for a product by influencing the substitution effect. If a product has many close substitutes, a price increase will lead to a significant decrease in demand as consumers switch to alternatives.

What is the difference between elastic and inelastic supply?

Elastic supply indicates that the quantity supplied is sensitive to price changes and producers can respond quickly to adjust production. In contrast, inelastic supply means that the quantity supplied does not change significantly with price changes, often due to production constraints or time lags.

Outlines

00:00

📚 Introduction to Microeconomics

This paragraph introduces the concept of microeconomics, contrasting it with macroeconomics. It explains that microeconomics focuses on the decisions made by individual markets, consumers, businesses, and governments. Key questions in microeconomics include employment levels and wage policies. The importance of both micro and macro perspectives is emphasized, highlighting their interconnectedness. The paragraph then delves into marginal analysis, a fundamental microeconomic concept, which involves assessing additional benefits and costs in decision-making. Examples of businesses hiring workers and governments deciding on public parks are provided to illustrate how marginal analysis is applied in real-life scenarios.

05:03

📈 Marginal Analysis and its Applications

This section expands on marginal analysis, discussing how it influences consumer and business behavior. It introduces the Law of Diminishing Marginal Utility, which states that as consumption of a good increases, the additional satisfaction derived from it decreases. The concept of 'utils' is introduced as a way to quantify satisfaction, although it's acknowledged that this is a theoretical construct rather than a practical tool. The paragraph also explores how marginal analysis is used unconsciously in everyday decision-making, such as choosing between rides at an amusement park based on wait times and personal satisfaction. It concludes with an explanation of how businesses use marginal analysis in pricing strategies, such as discounts for additional purchases.

10:07

🍓 Supply and Demand in Microeconomics

The paragraph explores the supply and demand model, a central concept in microeconomics, using the example of the strawberry market. It explains the downward-sloping demand curve, which shows that as prices decrease, quantity demanded increases, reflecting the Law of Demand and the diminishing marginal utility. The upward-sloping supply curve represents the Law of Supply, indicating that higher prices incentivize producers to supply more. The efficiency of markets is discussed, with equilibrium being a state where marginal benefit equals marginal cost, thus optimizing resource allocation. The famous 'Diamond-Water Paradox' is introduced to illustrate the concept of relative scarcity and its impact on value, contrasting the high value of scarce diamonds with the low value of abundant water, despite its essential nature.

🔍 Elasticity of Demand and Supply

This paragraph delves into the concept of elasticity of demand and supply, explaining how sensitive the quantity demanded or supplied is to price changes. It uses the example of gas stations to illustrate inelastic demand, where price changes have a minimal effect on quantity demanded due to few substitutes. The paragraph contrasts this with elastic demand, as seen with pizza, where many substitutes exist, and price changes can significantly affect quantity demanded. Elasticity of supply is also discussed, with examples ranging from the inelastic supply of airplanes due to production complexities, to the perfectly inelastic supply of Van Gogh paintings, which cannot be increased regardless of price. The importance of understanding these concepts for making informed decisions is emphasized.

Keywords

💡Microeconomics

Microeconomics is the branch of economics that studies the behavior of individual markets and economic units such as consumers, businesses, and governments. It focuses on decision-making processes and the allocation of resources. In the video, microeconomics is introduced as a counterpart to macroeconomics, emphasizing the importance of understanding both for a comprehensive view of economic activity. The script uses microeconomics to explore concepts like marginal analysis and the supply and demand model.

💡Marginal Analysis

Marginal analysis is a method used by economists to determine the additional benefits and costs of making a decision. It is central to microeconomics as it helps to understand how economic agents make choices about production, consumption, and other economic activities. The video script illustrates this concept by discussing how businesses decide on hiring additional workers and how consumers might feel about city parks, emphasizing the comparison between marginal benefits and marginal costs.

💡Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that as a consumer consumes more of a good or service, the additional satisfaction or 'utility' they gain from each additional unit decreases. This concept is integral to understanding consumer behavior and is used in the script to explain why the demand curve for goods like strawberries slopes downward, reflecting that consumers are willing to pay less for additional units as their utility from each unit diminishes.

💡Supply and Demand

Supply and demand is a fundamental economic model that explains the price determination of goods and services in a market. The video script discusses this model using the example of strawberries, where the demand curve slopes downward due to the law of diminishing marginal utility and the supply curve slopes upward reflecting the law of supply, which states that higher prices incentivize producers to supply more goods.

💡Elasticity of Demand

Elasticity of demand measures the sensitivity of the quantity demanded of a good to a change in its price. The script explains that if the demand for a product is elastic, a small change in price can lead to a large change in quantity demanded, as seen with pizza, which has many substitutes. Conversely, if demand is inelastic, as with gasoline, a price change results in a smaller change in quantity demanded due to fewer substitutes and a necessity for the product.

💡Substitution Effect

The substitution effect occurs when the relative price of a good changes, leading consumers to substitute it with other goods that provide similar satisfaction. In the script, this concept is used to explain how the demand for strawberries might decrease if their price increases, as consumers can switch to other fruits like cherries or blueberries, which are substitutes.

💡Equilibrium

Equilibrium in economics refers to a state where the quantity demanded of a good or service equals the quantity supplied at a given price. The script describes market equilibrium as efficient because it aligns the marginal benefit of the last unit consumed with the marginal cost of producing that unit, ensuring that resources are allocated optimally.

💡Scarcity

Scarcity is an economic concept that refers to the limited availability of resources in relation to unlimited wants and needs. The video uses the example of diamonds being more expensive than water to illustrate the paradox of value, where the scarcity of diamonds contributes to their high price, despite water being more essential for life.

💡Utility

In economics, utility refers to the satisfaction or happiness that consumers derive from consuming goods or services. The script introduces the concept of 'utils' as a way to quantify this satisfaction, noting that it is subjective and varies from person to person. It is used to explain consumer behavior, such as choosing between different rides at an amusement park based on the perceived utility and waiting time.

💡Marginal Cost

Marginal cost is the additional cost incurred in producing one more unit of a good or service. The script explains how businesses use marginal cost to make hiring decisions, comparing it to the additional revenue that an extra worker is expected to generate. It is also used to understand the upward slope of the supply curve, which represents the increasing marginal costs as more units are produced.

💡Pricing Strategies

Pricing strategies are methods used by businesses to set the prices of their goods or services. The video script discusses how understanding marginal utility can influence pricing, such as offering discounts for additional units of a product, like 'Buy two and get the third half off', to reflect the decreasing utility consumers gain from each additional unit.

Highlights

Introduction to microeconomics as the study of individual markets and decision-making of consumers, businesses, and governments.

The importance of both micro and macroeconomics in understanding economic phenomena.

Explanation of marginal analysis as a key concept in microeconomics, relating to additional benefits and costs.

Business decision-making in hiring workers based on marginal revenue and cost.

Government decision-making in public goods provision, such as city parks, using marginal analysis.

The Law of Diminishing Marginal Utility and its application in consumer satisfaction.

Introduction of 'utils' as a measure of subjective satisfaction in economics.

Unconscious use of marginal analysis in everyday decision-making.

Application of marginal analysis to consumer behavior, exemplified by amusement park visits.

Business pricing strategies influenced by marginal analysis, such as quantity discounts.

Revisiting the supply and demand model in microeconomics with the example of strawberries.

The Law of Demand and its reflection in the downward-sloping demand curve.

The Law of Supply and its representation by the upward-sloping supply curve as a marginal cost curve.

Market efficiency at equilibrium where marginal benefit equals marginal cost.

The Diamond-Water Paradox explained by marginal utility and relative scarcity.

The role of consumer tastes and preferences in determining demand and the absence of a market for panda boogers.

Substitution effect and its influence on the demand curve shape due to available substitutes.

Elasticity of demand and its real-world example with gas stations and the lack of sales.

Elasticity of supply and its impact on market response to price changes, with examples of various products.

The significance of microeconomics in understanding detailed economic concepts and making informed decisions.

Transcripts

Welcome to Crash Course Economics, I'm Jacob Clifford.

And I'm Adriene Hill. We've been talking a lot about macroeconomics: GDP, unemployment,

fiscal and monetary policy. That kind of thing. Now we're going to start talking about microeconomics.

Microeconomics looks at individual markets and the decision-making of consumers, businesses,

and governments. They answer questions like, "How many workers should we hire?" or

"Is increasing minimum wage and good idea?" and "Why is health care so expensive?"

Now you might be thinking, which is more important: micro or macro? The answer is (BOTH) micro/macro.

Actually (BOTH) macro/micro. They're both important.

[Theme Music]

Let's start with one of the most important concepts in microeconomics: marginal analysis.

For economists, the word "marginal" is pretty much the same as "additional". Marginal analysis

looks at how individuals, businesses and governments make decisions. Basically, they're interested

in additional benefits and additional costs.

Businesses do the same thing when they decide how many workers to hire. They compare the

additional revenue that an additional worker will likely generate for their company. And

to the additional cost of hiring that worker: wages and benefits.

If hiring that worker brings in more marginal revenue than marginal cost, then, congratulations!

Someone's got a job!

This also applies in the realm of how people feel about things. Take the development of

city parks: citizens obviously get more total satisfaction from, like, four city parks than

from only three. But that doesn't necessarily mean that the government should build four parks.

Instead, the government looks at the additional benefit or satisfaction generated by the fourth

city park and compares that to the additional cost and here, when we're talking about cost

we're talking about the use of city land, and the tax money spent on building the park.

If the additional benefit is higher, then they build the park. The government keeps

doing this for each additional park. The benefit of the first park is higher than the additional

benefit of the second park, and on and on.

Eventually, the marginal benefit of another park will be less than the marginal cost,

so they stop building parks.

Sure it's nice to have lots of parks, but the difference between having 200 parks and

201 parks is pretty small. This is the Law of Diminishing Marginal Utility. By the way,

when economists talk about consumers, the word 'utility' means 'satisfaction' or happiness

people get from consuming a good, or service, or 201 parks.

So you could reword this as the Law of Decreasing Additional Satisfaction, as you consume additional

amounts of anything, you'll eventually get less and less additional satisfaction.

It's like how the first slice of pizza or cookie that you eat, is awesome, and the second

one might be even better, but eventually, each additional one gives you less additional enjoyment.

Economists have even made up a new word to help quantify satisfaction called 'utils'.

Utils are like happiness points and they are completely subjective.

So one person might get 100 utils of satisfaction from the first slice of pizza and another

person might only get 10 utils.

So the ideas here make sense, right? But the whole numbers thing, this 'utils' idea it

does seem a little contrived. People don't actually make these calculations, do they?

Yeah, they do. You don't write them down or think about your happiness in terms of utils,

but you do likely unconsciously use marginal analysis every day.

Let's go to the the Thought Bubble.

Marginal analysis can explain all sorts of human behaviour. Let's say that Stan goes

to an amusement park. He's unlikely to ride the best ride in the park, the tallest rollercoaster,

over and over and over, the entire day.

Why? Well even if there's a one-time park admission fee and the rollercoaster is free,

there's still a cost - that's how long he has to wait in line.

So Stan estimates his marginal utility of riding the ride and compares that to the wait.

Riding the best rollercoaster might give him the highest utility of all the rides in the

park but it might not be worth waiting in a four-hour line.

A smaller ride gives him less utility but if the line is super short, he'll choose that

one instead. Even if there's no line for the large super-awesome rollercoaster, he probably

won't ride it all day because eventually it gets old.

Marginal analysis explains the behaviour of consumers like Stan, but it also explains

the pricing strategies of businesses.

Assume instead that the rollercoaster charges $5 for each ride. Because Stan gets less and

less utility each time, he might not be willing to pay full price for the third ride

The seller gets this, and figures it might be better to charge Stan less for the third

ride. That's why we have deals like 'Buy two and get the third half off'. The point is

we all use marginal analysis when we make decisions.

Thanks, Thought Bubble. So that's marginal analysis. Armed with our new knowledge, let's

go back and look at the most important model in microeconomics: supply and demand, on the runway.

Let's use the market for strawberries. Remember, the price of strawberries is on the vertical

axis, and quantity is on the horizontal axis.

The demand curve for strawberries is downward sloping,showing the Law of Demand. When prices

are high, people don't wanna buy very many, and when prices are low, people want to buy a lot.

The shape of the demand curve reflects the idea of the law of diminishing marginal utility.

The first pint of strawberries you buy give you a lot of additional utility.

The second one, maybe not as much. And the third pint, even less. If you eat ten pints,

you're gonna get sick. So, as you consume more, you're willing to pay less and less.

This explains why the demand curve is downward sloping and why it's really just a marginal benefit curve.

The supply curve is upward sloping representing the Law of supply an increase in price gives

producers an incentive to produce more.

It turns out that supply curves are really just marginal cost curves. It represents the

additional amount of resources and energy that each additional pint of strawberries

costs. This graph explains why markets tend to be so efficient with ours scarce resources.

If strawberry producers produced too few strawberries, the marginal benefit of the last unit will

be greater than the marginal cost. That's the market calling out for more strawberries:

"Give us strawberries, please!"

If they produce too much, out here, then the marginal cost would be greater than the marginal

benefit, they'd be wasting resources on things that consumers don't value.

Equilibrium is efficient because the marginal benefit of the last unit consumed equals the

marginal cost of that unit. The market is making the exact amount that consumers want.

This is reminiscent of an example Adam Smith used. Why are diamond more expensive than

water? Water is absolutely crucial for keeping us alive, while diamonds do nothing except sparkle. But

the price of a bottle of life-giving water is around a buck twenty and that's when you're overpaying for water.

The average one-carat diamond is well over $3,000. This is called the Diamond Water Paradox,

and it can be explained with marginal analysis and the law of diminishing utility.

The total utility we get from water is VERY high, but since it's so plentiful for most

people, the marginal utility is really low. If you can stay hydrated, cook, take showers,

wash your clothes and occasionally use your slip 'n' slide, then the additional satisfaction

of yet another gallon of water is small. The result is a lower price.

On the other hand, diamonds are extremely scarce because they have to be extracted from

expensive, dangerous, mines. Since there are relatively few diamonds, the additional satisfaction

of another one is relatively high, so people are willing to pay a higher price.

If diamonds fell out of the sky like water, we wouldn't get that much additional satisfaction

from them, and the price would be low. It might seem irrational that society values

diamonds more than water, but using marginal analysis, it sort of makes sense.

Relative scarcity does contribute to a product's value - that's partially why Action Comics

number one, the first comic book with Superman recently sold for over for over £3m on eBay,

but just because something is limited doesn't automatically make it valuable.

There are plenty of other things that are scarce that we don't value as much as diamonds.

For example, panda boogers. They're super-rare, but we don't put them on engagement rings

or pay an outrageous price for one in mint condition.

The point is, utility is subjective, and demand depends on the tastes and preferences of consumers.

That's why there's no market for panda boogers.

Hold on, Stan tells me that, because the internet, there does seem to be a market for panda boogers.

But it's gotta be a small one. I think the example still holds up.

Anyway, the demand also depends on the number of substitutes. For example, strawberries

have plenty of substitute goods - cherries, raspberries, blueberries. When the price goes

up for strawberries, consumers buy less because they'll go buy something else instead.

This is a substitution effect and along with the law of diminishing marginal utility, it helped shape the demand curve.

Let’s see what this looks like in the real world. Have you ever wondered why gas stations

don’t have sales? It has to do with substitutes and what economists call elasticity of demand.

Elasticity shows how sensitive quantity is to a change in price, when the price of gas

goes up people don’t buy that much less gas because they need it and there are few close substitutes.

Now you can walk, or ride your bike, or get an electric car but there is nothing else

you can put in your current gas guzzler, this goes the other direction too, if gas stations

had sales, consumers wouldn’t buy that much more gas. Economists would say that the demand

for gasoline is relatively inelastic: a large percent change in price leads to a small percent

change in the quantity demanded.

This is shown on the graph by making the demand curve steeper, other products that have that

have relatively inelastic demand include electricity, healthcare and coffee, there’s no substitute

for my five cups of coffee in the morning.

And there are few products that have perfectly inelastic demand, if the price goes up people

who can afford it will always buy the same amount, an example is insulin for diabetics

because in that case they need it to live.

What about the demand for pizza? Well there are many close substitutes, I could eat a

burrito or a burger, I don’t really need pizza. So a small increase in the price could

cause the price to decrease a lot, for pizza the demand curve would be more flat, showing

the demand for pizza is relatively elastic. If a pizza place has a sale a lot of customers

would buy pizza instead of other substitutes like burgers and burritos.

Now there’s also elasticity of supply. A steep curve shows the supply is relatively

inelastic, so a large change in price, leads to a small change in quantity. Like an airplane

is difficult and time consuming to build, so even if a buyers willing to pay more for

one, they’re still going to have to wait.

Relatively elastic supply is when quantity is sensitive to a change in price because

producers can respond quickly, stuff like t-shirts and strawberries. Something like

the supply of Vincent Van Gogh paintings, well that’s perfectly inelastic because

when the price goes up, the quantity doesn’t change. It doesn’t matter if people want

more, Van Gogh is not going to be doing anymore paintings.

So that’s microeconomics in a nutshell, it doesn’t focus on GDP or on unemployment,

it analyses the details. It’s helpful to understand concepts like marginal analysis

and elasticity. You’re going to be using them to make decisions anyways so you might

as well understand what’s going on. Ideally that’ll help you make better decisions.

We hope the additional benefits of watching this video was greater than the additional

cost. I’d say it was at least 50 utils for me.

And not that it’s a util contest but I’d say 55 utils. See you next week

Crash Course Economics made by the help of all these nice people. If you’re still watching

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Course free for everyone, forever and get great rewards. Thanks for watching and I hope

you got some utils out of this.