Tuesday, February 15, 2011

The illogicality of plastic ear-swabs (or why some savings decisions make more sense than others)

While perusing the aisles of Safeway the other day, I pondered the rationality of my grocery selections. I bought the Q-tips brand ear swabs instead of kind with plastic stems which would have saved me about $0.70, but reluctantly opted not to buy my favorite kind of chocolate because it was selling for $3.99 rather than the frequent sale price of $2.99 a bar. I selected the grape tomatoes at $1.99 a carton instead of my preferred cherry tomatoes at $3.99 a carton, but bought a fancy bottle of salad dressing for $4.59 in spite of a myriad of cheaper alternatives.

Why did I spend the extra money on Q-tips when I could have used it to buy chocolate instead? Why forgo the expensive tomatoes but not the pricier salad dressing? The answers lie largely in the economic concept of elasticity. Price elasticity of demand describes how much a change in the price of a good affects the quantity demanded for that good. If a good has very elastic demand, then a small change in the price will have a large effect on how much of that good is demanded. Conversely, the price of a good with inelastic demand can rise substantially without having much effect on the quantity demanded. For example, my choice to stop buying chocolate bars in response to an increase in price suggests my demand for them is relatively elastic.

Cross-price elasticity of demand refers to how much a change in the price of one good affects the demand for another good. The switch from cherry to grape reflects a positive cross-price elasticity of demand, because my demand for grape tomatoes increased when the price of cherry tomatoes rose. This illustrates one determinant of elasticity: the availability of viable alternatives or substitutability. Although I do prefer cherry tomatoes to grape, it is a slight preference, so when cherry tomatoes are not on sale, I substitute grape tomatoes for cherry and save $2.

Another determinant of a good’s price elasticity is the percentage of one’s overall budget that a good requires. I eat a lot of chocolate; therefore, only buying it when it goes on sale adds up to far more savings over time than choosing to buy the generic Q-tips, which I only buy every six months or so. Because I find off-brand Q-tips mildly frustrating (the cotton doesn’t seem to stay properly attached), choosing the off-brand to save $1.40 a year would probably be one of the least worthwhile money-saving sacrifices I could make.

A third determinant of price elasticity is necessity. While food in general is perhaps the most necessary good I buy, my actual need for chocolate is (somewhat) less pressing. Reluctantly, I postponed my chocolate purchase in hopes that next time it would be on sale.

While normal people do not consider the elasticity of their demand for various grocery items, their actions are inevitably guided to some degree by the prices of alternatives, the weight of the expenditure in their overall budget, and the necessity of the good. But why stop at the checkout line? While it might be most natural to illustrate the elements of elasticity with groceries, economists believe the same decision-making behaviors apply when people buy any good or service. So, next time you’re considering whether to sacrifice or splurge on anything from cupcakes to cell phone plans, remember that some savings make more of an impact on your budget than others.

Discussion Questions:

1. Instead of talking about one type of tomatoes versus another, how does my demand for Roma tomatoes compare to my demand for tomatoes in general? How does a narrow or broad definition of a good relate to its elasticity?

2. The income elasticity of demand refers to the change in the quantity demanded that results from a change in the buyer’s income, rather than the price of the good. Suppose I got a raise. How would a dramatic increase in my income affect my demand elasticity for an expensive treat, like steak? Would the effect be the same on all goods? What about my demand for ramen noodles?

3. If the producers of a good have conducted research that suggests demand for their good is highly elastic, how might this affect their pricing decisions?

4. Recently, there have been “sin taxes” proposed in some states on a number of goods, including artificial tanning, tattoos, and sugary sodas. Economists call these Pigouvian taxes. They are taxes placed on goods that the government believes are socially unappealing. Suppose the demand for artificial tanning is very elastic, while the demand for sugary soda is not. Compare the effects of two equal sized taxes on the equilibrium market price, the equilibrium quantity consumed, and the tax revenue raised.

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Tuesday, February 08, 2011

Technology, jobs, and creative destruction

In response to the recent approval of an all-electronic toll-collection system for the Golden Gate Bridge, many San Franciscans have voiced concern over the loss of toll workers’ jobs. The belief that new technologies are necessarily detrimental to employment, however, reflects a common misunderstanding regarding the interplay between technological advance, progress, and the economy as a whole. Though the introduction of electronic tolls will harm the toll workers in the short run by putting them out of work, they also enable the government to re-allocate the money formerly spent on toll-worker wages. These savings will either pay for other public goods and services (thereby employing workers in other sectors) or be used to reduce the deficit (thereby reducing the burden on the taxpayer).

Many balk at the notion of cutting jobs for the sake of “efficiency.” Consider, however, whether people would choose to move in the opposite direction—sacrificing efficiency for the sake of increased employment. Instead of using dishwashers and washing machines, individuals could hire others to wash their dishes and clothes by hand—that, too, would create jobs. It is tempting to separate such individual spending decisions from those made by the government, but ultimately the saving from automated tollbooths is no different from that provided by any other time- and money-saving device.

The process of old products or services dying out in the wake of new technologies, known as creative destruction, has been transforming the world for centuries. Many typewriter manufacturers went out of business with the advent of computers, yet few people would argue today that we should have repressed such technological advances for the sake of workers. Just as the computer industry gave birth to myriad of new jobs, the new tolls themselves create jobs in technology development, manufacturing, maintenance, etc. Thus, instead of widespread unemployment, the result of such technological progress is economic growth. People use technology to produce goods more efficiently, and those goods then become available for everyone’s consumption.

Does this mean new technologies never cause employment problems? Of course not. Those whose skills are made obsolete by new technologies may indeed suffer a period of unemployment, although often the money saved is even put toward job-training programs and unemployment insurance to ease the pain of transition (to quote The Economist, “Protect workers, not jobs”). While this is an unfortunate side effect of technological growth, the difficulty imposed on the unlucky individuals is typically outweighed by the widespread benefits to society that technology creates.

Discussion Questions:

1. Can you think of other industries where creative destruction is present and thus encourages the creation of improved technology on an ongoing basis?

2. Before the Golden Gate Bridge was built in the 1930s, cars had to cross between San Francisco and Marin County (the two ends of the bridge) on ferries. How is building the bridge like an improvement in technology, and how did it impact employment?

3. How does creative destruction affect the quality decision producers must make? Why is it that some goods are made with the intention of lasting decades while others are only designed to last a few years?

4. In this case, the tolls will reduce the number of workers in the toll-collecting industry, but is this always the case with new technology? What is an industry where technology acts as a complement to labor, and how is this different from technology as a supplement to labor?