Learning to think like an economist can be a daunting task for beginners. Introductory economics courses often begin with a jargon-loaded discussion of opportunity costs and marginal benefits versus marginal costs—in other words, what is the benefit of continuing to read the rest of this post, and what else could you be doing with your time? In this case, the benefit is pretty high (and given that this blog is a mere 635 words long, the cost is low), because one of the most vital skills in all of economics (to say nothing of the GMAT) is learning to appropriately, and efficiently, read and interpret graphs.
For example, one of the most basic economic concepts is related to the principles of supply and demand. Take the market for any good – let’s say running sneakers. We generally plot the price of sneakers on the vertical axis (y-axis) and the quantity of sneakers on the horizontal axis (x-axis). The law of demand states that there exists a negative relationship between price and quantity on the purchasing/consumption side: at higher prices, people demand fewer sneakers, and at lower prices, people demand more sneakers. To illustrate this, we draw a downward sloping demand curve (blue) relating price to the quantity of sneakers demanded. The law of supply states that there exists a positive relationship between price and quantity on the production side: at higher prices, firms want to produce and sell more sneakers, and at lower prices, firms want to produce and sell fewer sneakers.
Traditionally, in mathematics, we assume that the variable on the x-axis is the independent variable, which means that changes in the x-variable cause changes in the y-variable, the dependent variable. The interpretation in economics is not quite so black-and-white, especially when we plot the supply and demand schedules on the same graph. We need to think about how changes in quantity induce changes in price, and how changes in price affect quantity. With practice, it will become easy to recognize what story the graph is telling. Here are a few steps to follow when learning how to read graphs in economics:
- What is the overall economic story being portrayed in the graph?
- What assumptions must be made?
- Are there other things (i.e. prices of other goods, labor available for production, etc.) that are assumed to be unchanged?
- What information is being described on the x-axis and the y-axis? What are the units of each?
- Is there a causal relationship between the variables? If so, in which direction does the relationship flow?
- Does a change in x necessarily cause a change in y?
- Are these two variables related or is this simply a spurious correlation?
- Did you know that the per capita consumption of margarine the U.S. is 99% correlated with the divorce rate in Maine?! (Check out http://www.correlated.org/ )
- Do both variables affect each other? (i.e. x affects y and y affects x)
- How do we differentiate between a shift in the curves or a movement along a curve?
- Shifts generally preserve the direction of the relationship and simply move us to a different part of the graph space (i.e. the same prices may now correspond to higher quantities).
- Movements along the curve dictate the relationship between the variable on the x-axis and the y-axis (i.e. on the demand curve, higher prices correspond to lower quantities and lower prices correspond to higher quantities).
Now, take a look back at the graphs presented in class, or from your textbook, and see if you can determine the overall story. If you're still struggling, consider spending a few sessions with an economics tutor. Once you have this down, you should be able to open up the Financial Times or the Wall Street Journal and recognize some of these important economic principles at work!