Essays

Up to this point we have assumed that the point on the graph representing what we observed consumers actually doing was also on the spending curve. This may not be actually true. Now that we know what a demand curve actually looks like (in principle), we have to admit that the point we observed MUST be on this demand curve but may not actually be on the spending curve. What we observed was what consumers actually spent, not the maximum that they were actually capable of spending.

The simple truth is that over time we may be able to plot several combinations of price and quantity that consumers actually experienced but those points represent points along the demand curve, not the spending curve. In the real world we cannot actually know what consumers are willing or able to spend because they have too many conflicting priorities among items. In many cases the items interact with each other: the price of cream may increase but people buy more anyway because the price of strawberries declined more than enough to offset the overall price of strawberries and cream which is the item consumers are actually seeking.

The spending curve is what we call a "construct," meaning it is an abstract concept that we know exists even though we also know we can't really detect it. We simply know that at any particular time, consumers do have some quantity of money they are willing or able to spend even if we have no way of determining what it is.

Having said that, we can then go on to see just how we actually do discover the spending curve and use it in economic calculations. Understand that the spending curve we calculate is necessarily an extension of our demand curve calculation. We have to make some assumptions about our demand curve because generally prices do not vary sufficiently to give us precise figures from past experience. However, we do have access to statistical data about consumer behavior from which we can estimate some demand curve that represents a prediction of future behavior based on past behavior in similar circumstances.

The key is to recognize that our demand curve must be less curved than our spending curve which means that no matter what our demand curve actually looks like, there exists some spending curve that will necessarily just touch the demand curve at a single point. Given any demand curve that is a straight line or a curve, there is only one spending curve that can possibly be "tangent" (touching at only one point) to this demand curve. Therefore for every demand curve there exists only ONE spending curve that corresponds to the maximum amount of money consumers are willing or able to spend.

This point of tangency has to be the point of maximum revenue because every other point on the spending curve represents the same amount of money while every other point on the demand curve lies to the left of the spending curve and therefore represents less money. We can therefore see, without knowing about any particular demand curve, or any particular spending curve, and without specifying what the actual shape of the demand curve is nor the actual amount of the spending curve: every demand curve will have a single point of maximum revenue. This MUST be true IF we believe that people change their spending behavior as prices change.

Now, this also means that consumers necessarily enter a market with some amount of money they are willing and able to spend, but that there is only one combination of price and quantity that will equal that total amount. Remember, the existence of the demand curve is derived from observing consumers and basing future behavior on past behavior. The demand curve therefore represents what we have observed consumers are actually willing and able to spend. This observation of consumer behavior, however, leads to the inescapable conclusion that somewhere on this demand curve there is only one combination of price and quantity that will lead consumers to ACTUALLY spend the maximum amount of money they are willing and able to spend. That combination of price and quantity is the single instance where sellers can price their items to receive the maximum revenue consumers will spend.

It is relatively easy to show, however, that sellers will almost never do this. You will soon see that no matter what amount of money consumers have available to spend, and despite the fact they may be perfectly willing to spend it, no matter what the product or market, no matter what, the suppliers to this market will not take all of their money. As a consequence, consumer saving is forced by the simple fact that sellers will almost never sell at a price that takes all of the money consumers are willing and able to spend. And the reason is simple: profits.

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