Wednesday, June 4, 2008

Price Affects Behavior

Among the basic concepts in economics are supply, demand, and price. We spend a great deal of time trying to help our students understand that people (either as consumers or producers) respond predictably to price changes, changing the quantity of the good/service supplied or demanded, or changing the supply and demand for the good/service. The difference between these two - moving up and down the existing "curves" on the graph to indicate changes in quantity; or shifting the "curves" right or left to indicated fundamental changes in supply and demand - are often stuck in the students' minds as very theoretical. And even if we provide examples in discussion, the ideas may not crystallize, much less become part of their analytical tool box.

That's why it's always exciting when a large number of actual news events hit on the same day, allowing us to pick, choose, and present to the students as examples of real life economics. Today is such a day.

We'll start with a couple of stories in USA Today that deal with the airline industry. The first story explains why airlines are reducing flights on routes that cannot generate sufficient revenue given higher ticket prices due to rising fuel costs. (Shift the supply curve left as the number of flights/seats drops in many markets.) It includes an interactive graphic that allows you to see how various airports in each state will be impacted.

The second story actually cites another from the Chicago Tribune. The article in USA Today says that United Airlines will be grounding more of their 737 and 747 aircraft because of fuel concerns. This ties in with the first story quite well - fewer aircraft available translates to fewer seats/flights. (Might this represent another shift of the supply curve?)

The next group of stories has to do with ground transportation and gasoline prices. The first, again from USA Today, points out that drivers, faced with higher gasoline prices, are choosing cars over trucks. It combines well with a story in The Wall Street Journal about the collapse in the SUV market. The second story adds a different view because it also discusses how current owners of SUVs are finding harder to get a decent trade-in price because the second-hand market for SUVs is disappearing. They also see the value of their vehicle deteriorate because of this. And for those who still have payments on a more recent purchase; the value could be well below the amount owed. (This sounds like a housing situation we've heard about.) Anyway, for those of you using graphs, your students can shift the demand curve for new SUVs left; they can shift the supply curve right for used SUVs; and all can marvel at what happens to the corresponding prices.

Now because of the shifts in the market for SUV's and light trucks, we can follow along to another pair of stories in the news - both based on yesterday's announcements from General Motors (GM) about plant closings. Again, the first is in USA Today and states that GM plans to be less reliant on SUV's and pickups for their revenue. The second story, again from The Wall Street Journal, highlights auto plant closings, not just for GM but also for other auto-makers. It also contains an interactive graphic spotlighting plant closing and showing the vehicles produced and the number of employees at each plant. Again, the supply curve shifts left for each type of vehicle.

And finally, an opinion piece in The Wall Street Journal foresees an oil investment boom. The author speaks about how high prices are beginning to drive up the quantity supplied in some areas (move right along the supply curve). But he also talks about higher prices driving firms and nations to look for new sources of petroleum, moving the supply curve to the right.

And while you're looking at the whole oil and gasoline market for supply, demand, price linkages, I also suggest you take a look at this report (link no longer available) from the American Petroleum Institute (API). (HT to Mark Perry at Carpe Diem.) While it may be more than you care to know about the industry, and you may have concerns about the data source, the graphics and charts paint an interesting picture to use with your students.

I look forward to your comments.

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