Welcome to week two of the Power of Markets course. Delighted to be taking this journey with you. Hope that by now you've had a chance to take the quiz for week one, and test your understanding. The first session this week will cover what happens to market equilibrium, when there's a change in demand and supply. So we'll make prediction, what'll happen, when a determine of demand, like preferences, or taxes, or government subsidies, or income changes. Or when a determine of supply, like technology or input prices and then we'll also see how the subply command model can be used in reverse to explain what has happened in a market. This is a very powerful tool, and you'll see why. First though, I thought I'd cover just some brief examples from our discussions last week, to test your understanding of the various concepts that we covered. One of the first things that we did was compare real versus nominal prices. And just some additional examples let's say we looked at Abraham Lincoln when he was president, he made 25,000 a year. Was he underpaid relative to President Obama, that nowadays gets paid 400,000 a year as president? When you adjust, first, the CPI for the changes in the value of money over time, the general price level, it turns out Lincoln, in today's terms, would, would be making $625,000. So he's actually making more than President Obama. When you look at somebody, for example, like John-D Rockefeller in the 1910's that had a wealth of 1.2 billion dollars, was he a light weight relative to a Larry Elsanor or Bill Gates nowadays? Whose fortunes span into the 40, 50, 60 billion. It turns out when you adjust for inflation the changing value of money, JD Rockefeller, the oil tycoon from the 1910s, stacks right up there with nowadays titans like Bill Gates and Warren Buffett. But when you look at stock market values, the overall price level, we also have to make similar adjustments. So we just can't compare the stock market being 14,000 versus 30 years ago it might be at 2,000. We have to make that adjustment. Or how much a movie grosses, we also have to make that adjustment for changes in the general price level. So this should help you drive home the importance of always looking at real prices, not nominal prices. We also covered the concept of opportunity cost. That whenever you have choices you give up something, either directly or indirectly, when your pursue an alternative. Posted on the site, you'll see an article looking at the decision to pursue an MBA, and why the research says it's better to go earlier rather than later. If you have the time, would encourage you to take a look at this brief article. And then another article done by an alum of the school, Ron Yaple, that looks even more systematically at this question and comes to the same conclusion. Ron, by the way, is the architect of the Forbes survey that measure the ROI, the return on investment of pursuing an MBA degree. Then, other examples of opportunity. Oh, one other tip, by the way. If you're going to pursue an MBA down the road, it's always better to take the GMAT earlier as opposed to later. most schools like the Simon School, will count your best score. And scores decline over time. It's just the way our brain are wired. So five to six years down the road, on average, somebody will score 100 points lower on the GMAD, than when they're fresh out of college. Just an aside, if you're in that point in your career where you think a graduate business degree might be in your future, earlier is better than later. We also ended up looking at [UNKNOWN] cost, the costs that are common to all alternatives. A recent examples involve the firm Research in Motion from Canada, that sunk several billions of dollars into their next model of Blackberry. It, it turned out not to work as well with consumers. And so not withstanding the fact that they'd, sunk all these billions into the new model, they ended up deciding to abandon the consumer segment, and just focus on business services. The billions that they'd spent on the new model for personal users, was correctly viewed as being sunk. It was still painful but, like the old saying goes, you don't want good money to follow bad. The bad money is sunk and common to all alternatives. Motorola, a few decades ago, faced a similar choice when they designed an iridium phone that you could call from anywhere in the globe. It's pretty bulky, consumers didn't take to it because of the bulkiness and cost. They also had to chalk it up to a sub-cost. And then last, we talked about price and non-price effects, non-price determinance on quantity demand and quantity supplied. And just to drive home your understanding of this, think about cigarette smoking. And let me just share some stats from 1900 to the present day. The average american adult in 1900 smoked 54 cigarettes, by 1965 it had grown to 4,260. Nowadays we're back down to 1,700. What drove those changes over time? And what it was, was both price and non price determents. In that first stretch when cigarette consumption was growing, from 1900 to 1965, advertising helped build awareness for smoking. substitute sorry, complements such as safety matches were invented. Lighters that helped people make it easier to smoke. But then price also played a key role. mass production came on line and allowed companies to produce cigarettes at much lower cost, drive down the price that faced consumers. That had a significant effect on cigarette consumption. What changed post '65 to produce that decline in cigarette consumption, both price and non price factors? Non price factors, such as scientific studies, saying there's a link between smoking and cancer. That changed consumer's preferences, shifted the demand curve for cigarette consumption leftward. But there are also important price determinants that effected [UNKNOWN] demanded. The law of demand also applied over this time period, when governments started raising the taxes, on cigarette consumers, on sales of cigarettes. And that increase in price led to a decrease in demand. So both price and non-price factors played a role in shaping that pattern of rises in cigarette consumption through '65, and then declines since then. Last two concepts we reviewed last week and this one that plays off of that there sometimes can be an interplay between priced and non-priced determinants. This is an area that behavioral economics has been addressing as of late. And let me just mention one example, it comes from an Israeli day care center. Where the people that ran the daycare center were upset that so many families were showing up late to pick up their kids. So they had the thought, let's impose a fine. If you show up late, we'll charge you x shekels the Israeli currency, for showing up an hour late, or two hours late. So in a sense, they raise the price of being late. Instead of seeing the decrease in the amount of tardies though, they saw an increase in the amount of tardies. Why? Because there was this inner play, when the price part is to be applied to being late, it also had a subtle but important effect on people's preferences, the guilt they felt, from being late. It was no longer a big deal, so long as you had the means to pay for the lateness, to show up late. And so it wasn't a contradiction of the law of demand, but the increase in price from being late also had an indirect and important affect on people's preferences for being late. And so behavioral economics deals with those important interplays. If you delve more into microeconomics and behavioral economics in particular, you'll be able to start teasing out some of those important impacts. An analogy may be when we raise kids, we generally don't want to pay them for getting good grade, or for writing thank you notes. We want to inculcate those preferences in them, and not use law of demand in changing the prices, to induce the behavior we want to see out of them. And then last we covered is how to we get to market equilibrium? There is a lot of evidence from a variety of sources, that as we saw a price ends up being where quantity supplied equals quantity demanded. That if they're is an imbalance between quality supplied and quality demanded, they'll be upward or downward pressure on price to head to equilibrium, where quantity supply equals quantity demand. The internet is speeding up the process along the way, moving us from disequlibria to equilibria. we're even seeing now the advent of parking meters that adjust prices based on the time of day and the amount of congestion in a city. Or machines that adjust the price of a soft drink depending on how hot it is outside. So, more and more evidence being brought to bear. And I'll just share a personal story. in the 80s I lived in LA, and took a niece of mine to Disneyland and we had to wait for Space Mountain a long time. Huge line, huge quantity demand relative to quantity supplied. And this will give you a sense how economists think. Most people stuck in that line would say, would be real annoyed or pissed off that you had to wait an hour or an hour and a half to get to the ride. To an economist, the first thing that occurs, is, the price is too low. Quantity demand is less, is greater than quantity supplied. And so, what Disneyland needs to do is start thinking about raising prices. And it's interesting to note that, that Michael Eisner, who was the CEO, then, of Disney, that was one of his chief strategies. To look at their theme parks, and start raising prices to deal with the fact that quantity demand exceeded quantity supplied. So those are some helpful reviews from what we covered last week. Let's now turn to see how equilibrium changes the eqilibria, the equilibrium in a market changes, when we have changes in demand or supply.
