Where We Get Our Curves
This is intended as a super-basic introduction to one of the first steps in understanding basic economics: learning how we use curves to model market interactions. This piece only discusses from where supply and demand curves are derived, in super-simple terms. I’d really appreciate editorial comments on its clarity and accuracy; I have also written a commentary to accompany this, which deals with a common misunderstanding about economics.The most basic curves are supply and demand curves. For simplicity’s sake, we’ll look at demand curves first and explain later how supply curves work the same way.
What a demand curve tells us is how much of a product consumers are willing to buy at a given price. The product can be anything, from burritos to houses to giant sumo robots to zebras. Imagine that, in a town with eight people in it, a burrito restaurant (staffed by giant sumo robots) opens. Everyone is delighted, because burritos are really tasty, and this restaurant serves huge burritos, so big that a single one would make anyone full.
Now imagine that this is happening in nine parallel universes, all identical except for one thing: in each universe, the burritos cost different amounts. In the first universe, burritos cost one dollar each. In the second universe, they cost two dollars each, and so on until in the ninth universe, in which they cost nine dollars each. As universe-hopping economists, we hide in the bushes and watch to see what happens in each universe. What we discover is fascinating: some people are willing to pay more for burritos than others, and as a result, more burritos are sold in some universes than others. This calls for further investigation, and probably a graph.
The graph above comes from what we see in the nine different universes. We see that Antonio (in red) is willing to pay up to $8 for a burrito– we know this because in each universe he bought a burrito, except for the one in which the burritos cost nine dollars. Antonio is really wealthy, and also a burrito lover, so this is no surprise. Barbara, who is less wealthy but also a major burrito lover, buys burritos in the universes in which burritos cost six dollars or less. Albert, Shauna, and Friedrich, who don’t love burritos as much as they should, only buy burritos in the universe in which the burritos cost only a dollar.
So due to the different preferences and wealth of these eight people, different numbers of burritos are sold when burritos cost different amounts. The resulting demand curve follows the outside edge of the graph we made, like so:
In this case, that red line has a stair-stepped shape, because we’re only dealing with a group of eight people. If we had a much larger sample size, we’d find that the curve would have a much smoother shape. It might be steeper in some parts than others, which matters for certain types of analysis, but in general, we know that we’ll have a fairly smooth curve of some shape– and more importantly, we know that demand curves for almost all real-world goods will be downward sloping– that is to say, as prices rise, people will buy less of the item. The exceptions are two kinds of goods– Veblen goods and Giffen goods– that are rare, and it’s actually questionable whether Giffen goods even exist in the real world, so we’ll note that they exist and discuss them later.
If we’re not concerned about the shape of the curve, and instead just want to illustrate general principles, our demand curve ends up looking like this:
Note that it’s smooth now, it’s downward sloping, and “Number of People Buying Burritos” has been replaced by “Quantity”. It’s really quantity that matters, after all, not the number of consumers. There might, of course, be some people out there who can somehow eat more than one huge burrito, and maybe higher prices will convince them to eat only one instead of two or three– decreases in consumption can come both from fewer people buying something and from individual consumers buying less.
Now we can use the same reasoning to construct a supply curve. Instead of going through all the steps, though, we can just look at what it will tend to look like:
We can see that the supply curve is upward-sloping. It slopes upwards because we assume that as prices rise, more people are willing to sell more of whatever the item is. Imagine if burritos sold for $100 each– would you sell burritos? Again, it can be either more people supplying, or it can be individuals supplying more– it matters in some cases but it doesn’t change the general principles behind markets.
So there you have it: curves are just ways of describing one aspect of how people behave: how they respond to changes in prices. Fundamentally, curves come from people.