During the last two days I have been attending some lectures on price theory (or “microeconomics”) at the 29th Annual LEC Economics Institute for Law Professors. I teach torts and constitutional law, and my areas of research are the evolution of conflict and cooperation, so I am fascinated by economic theory, especially the idea called the “Coase theorem,” or the principle that voluntary negotiations are a better way of resolving disputes than the legal process is. I will say more about the Coase theorem in future blogs, but for now, I just want to pose a question that popped into my head today after my 7th or 8th lecture on price theory: do economists really “test” their models when they are engaged in the study of economics? Put another way, is it possible, in principle, to “test” the law of demand or the elasticity of supply?
Consider, for example, iTunes. Why would anyone pay $1.00 or $1.50 to download a song from iTunes when you can easily download the exact same song for free off the internet? This behavior refutes the law of demand, since some fraction of consumers are willing to pay for a good that is available for free. Perhaps the reason for this (irrational?) behavior has to do with the legality of both options. Since music piracy is illegal, the true cost of an illegal download must consider the probability of being caught and punished. But if, as I imagine, this probability is really low, then why doesn’t the iTunes example refute the law of demand? Is music a Giffen good? Is there another ad hoc explanation? Are core economic concepts like the law of demand really testable?