Every semester I write something like this on the chalk board (it's not really a chalk board anymore, it's a computer, but I don't really know what to call it ... the computer projector screen?):
A hurricane hits Florida and damages the
hurricaneorange crop. The decrease in the supply of oranges causes orange prices to rise. As prices rise the demand for oranges falls which leads to a decrease in the price of oranges. The final price of organges may be either higher or lower than before.
And I ask them, True or False?
The answer, of course, if you've taken microeconomics is False. The statement should read:
A hurricane hits Florida and damages the hurricane crop. The decrease in the supply of oranges causes orange prices to rise. As prices rise the quantity demanded for oranges falls
which leads to a decrease in the price of oranges. The final price of organges may be either higher or lower than before.
The problem is that most people never take micro so the above statement sounds perfectly reasonable. Confusing quantity demanded with demand will inevitably lead to serious mistakes in the most simple of economic analysis. Here is a textbook treatment of the issue.
That's why it bugs me so much when I read stuff like this (from the WSJ Morning Report):
While "it is premature to claim that the type of record prices seen earlier this summer will not ultimately lead to demand destruction at a global level," CERA wrote last month, "at an aggregate level there is little evidence that high prices have had more than a moderating impact on global demand growth so far." CERA predicted that "resilient" growth in demand -- especially demand for gasoline and other transportation fuels in North America -- will combine with lagging additions to global refining capacity to keep the downstream market tight through next year.
Where to start? High gas prices cause the quantity demanded to fall. This is a movement along (up, actually) a demand curve. If record prices destroyed demand we might expect prices to fall, if we confuse quantity demanded with demand.
And "little evidence that high prices have had more than a moderating impact on global demand growth so far" means that demand elasticity is low. Higher gas prices on quantity demanded don't have a big effect on quantity demanded. The only things that affects oil demand for consumers are income, prices of related goods (substitutes, complements) and tastes/preferences. Business firms increase oil demand as the price of the products that they produce rise and as labor productivity rises. The price of oil does not change demand.
And I've said all this before: deja vu (September 28, 2005; May 4, 2006, May 16, 2006). The short story is that I've suggested that the media use "consumption" instead of, incorrectly, demand.
