Got Lobster?

It’s a good thing I don’t have to watch my cholesterol, because after moving to the Maine seacoast last July, I simply cannot get enough lobster. Though I haven’t had to worry about the health cost of consuming lobster, I have been paying attention to changes in the dollar cost over the course of the season. Monitoring prices doesn’t get any easier for this lobster-loving Mainer because every day on the way to my son’s school, I drive by a sign advertising the current price.

The start of the lobster season coincides with an increase in the demand for lobster as summer vacationers head to the Maine beaches. In York, Maine, alone, the population triples during peak season then drops back down again once the school year begins. An increase in demand means upward pressure on price, while an increase in supply means downward pressure on price.

As lobster season came to a close in the summer of 2012, however, word on the street was that there was a surplus of lobsters. With quantity supplied larger than quantity demanded, downward pressure dropped lobster prices to an astonishingly low $2.99/pound for chix (lobsters weighing between 1 and 1.24 pounds), making lobster in southern Maine cheaper than a good steak at the time.

As lobster season ended and the bitter winter set in, the per-pound price of lobster started to tick upward. This is consistent with the basic model of supply and demand—once lobster season was over, supply decreased which put upward pressure on prices and demand decreased which put downward pressure on prices . Over the last year, it appears that supply changes have been more drastic than demand ones, thus the same good that had cost roughly $3 per pound in the summer cost nearly $10 per pound by March 2013 simply because of changes in supply and demand.

Between summer and winter, supply changes outweighed demand effects in the market for Maine lobsters (as evident in the large increase in price), so I am hopeful that lobster prices will drop in the coming months as supply increases so that I can enjoy my favorite butter conduit once more!

Discussion Questions

1. Using a supply and demand diagram, illustrate the shifts in demand and supply after the lobster season ends. Be sure to pay attention to the magnitudes of your shifts so that the equilibrium price rises as described in the article.

2. If  lobster fishermen have a bad catch this summer, what would you expect to happen to the price of lobster in Maine in July?

3. How do fluctuations in the market price for lobster affect other markets for food products such as steak and chicken?

Assumption Corruption

A famous economics joke says it best: A physicist, a chemist and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, "Let’s smash the can open with a rock." The chemist says, "Let’s build a fire and heat the can first." The economist says, "Let’s assume that we have a can-opener..."

Though the above example is meant to be extreme, all economic models are based on underlying assumptions. They may pertain to variety of things such as the market structure, pricing mechanism, location, time lags, frictions, mathematical properties, etc., and they are used to simplify economic relationships.  An important assumption that drives many popular economic models is that of perfect information. In particular, models rely on the assumption that the prices of all goods and services are known.

As I was recently perusing the latest status updates of my Facebook friends, I noticed the following post: “How much do you pay a 14-year-old high school freshman as a mother’s helper a few days a week?”

As an economist, one might be inclined to quickly answer “whatever the market price is for that service!” However, it is clear from this post that that information is not actually known to the buyer.

While the internet has clearly helped to alleviate this information gap, it can still take time to gather all the relevant information necessary to make an informed decision. Sometimes, the cost of obtaining this information becomes so high that consumers decide not to research at all. For example, if you want to buy a hair dryer, a quick internet search may result in the same model offered at different stores for different prices, so you still wouldn’t know the relevant price for your needs without more digging.  

Even though the famous supply and demand model does not completely reflect the real world (since it assumes, among other things, that prices are known), this is not meant to imply that economic models are worthless. It would be impossible to model every detail of the “real world”; rather, it's important to make sure the assumptions are appropriate for what you are trying to analyze. For example, if you’re trying to model the effects of an increase in fuel price on consumers’ demand for SUVs, assuming perfect information for prices does not invalidate the results that it will decrease the demand for this good; it merely simplifies the model into something tractable. But in general, you’ll want to ask yourself the following questions when you examine an economic model: Are the assumptions of this model reasonable? Would changing the assumptions affect the result in a drastic way?

In short, be careful not to become a victim of assumption corruption, but don’t let fear of assumptions keep you away from using models at all either!

Discussion Questions

1. Another popular assumption is that agents act rationally and are utility-maximizers. How can this assumption still be valid in the presence of people volunteering their time or donating money?

2. Consider some other assumptions for the supply and demand model, such as price-taking behavior or the competitive hypothesis. How would relaxing those assumptions change the results of the model, if at all?

3. Why do we study economic models that don’t perfectly match our experience in the real world?

4. What are some other markets where the assumption of perfect information does not hold true in the real world?

Low Carbs, High Fat…High Prices?

"One box will cost you $740, but if you don’t like it, you could try your luck with the Russian smuggler down the street." There are plenty of goods that might be sold based on discussions like that, but would you ever expect to hear that said about butter? Residents in Norway are currently facing a market like that, according to recent reports.

A recent diet craze emphasizing high fat and low carbs has caused a change in Norwegian consumer preferences. Fads and trends will change the equilibrium price and quantity observed in a market by shifting the demand curve. In this case, the popular new diet increased the demand for butter (shifting the demand curve to the right), while leaving the supply curve unchanged. The standard supply and demand model says a rightward shift of the demand curve leads to an increase in the equilibrium price and quantity consumed. Both of those were observed in real life, as well.

Nonetheless, changes in tastes rarely result in price fluctuations of this magnitude, so how do economists explain why the cost of butter went so high? We see increases (and decreases) in demand every day, but prices rarely swing so wildly. A closer look at the details sheds some light on the source: the government is preventing the free market from doing its work. As the Swedish Dairy Association (Svensk Mjölk) noted, Norway has “very restrictive trading policies, borderline protectionist.” That means that the Norwegian government’s policies make it very difficult (or even impossible) for foreign goods to enter the domestic market.

Though the government does this in an effort to protect Norwegian producers, protective policies like those block markets from working efficiently. When a “shock” to supply or demand occurs (in this case, an increase in demand), protectionist policies prevent foreign producers from entering the market to capture new profits. Because the trend hit quickly, and the production time for agricultural goods isn’t exactly short (you can’t just go out and rent an extra 200 cows overnight), the Norwegian market for butter appears to be relatively inelastic in the short run (that is, even a small percentage change in the quantity supplied is associated with a large percentage change in price). If this trend in preferences continues, prices will remain high until producers have time to react by expanding their farms to accommodate more livestock, hire more workers, and install more processing equipment.

Does that mean that Norwegian consumers are going to continue facing these brutal prices for the coming months? Only time will tell, but if prices persist, it would be a testament to a population stubborn enough (or wealthy enough) to stick to the latest trendy diet, and a government dedicated to hard-line international policies, even at the cost of its own citizens’ welfare.

DISCUSSION QUESTIONS:

1) A change in preferences isn’t the only way that the demand for a good can change. What are some other factors that could cause the demand for butter to increase?

2) Rather than demand returning to where it was (the end of interest in the fad diet), the equilibrium price of butter could also decrease if supply shifts. Which direction would the supply curve need to shift for that to happen? What would happen to the equilibrium quantity? What are some ways that the supply could shift in that direction?

3) Suppose the Norwegian government feels pressure to help lower butter prices. Propose a policy that would help lower prices in the market. Is there a policy that the government could use to generate revenue for itself while lowering the price of butter?

The Demand for Natural Light

I once participated in a blind taste test involving eight light beers. Faced with eight un-marked cups, I was certain I’d prefer the priciest, and presumably classiest, light beer in the field. Alas, I chose Natural Light. For me, the cheap and down-market “Natty Light” is the choicest light beer on offer. But people who have (or think they have) a more refined palate gladly pay for a more expensive option like Heineken or Bud Light.

With the economic downturn, however, cash-strapped beer drinkers appear to be switching to cheaper beers like Busch, Natural Light, and Keystone. As average incomes declined in the United States, sales of these cheaper options have increased substantially. Meanwhile, sales of ‘premium’ brands like Budweiser and Heineken were reportedly down 18% and 14% respectively from a year ago in July 2008.

Discussion Questions

1. If, other things being equal, a reduction in average income leads to an increase in the demand for Natural Light, what type of good is “Natty Light”? If, during the same period, the demand for Bud Light declines, what type of good is Bud Light?

2. What additional information would be useful if you were trying to use changes in average income and beer sales to determine whether a particular brand of beer was a normal or inferior good?

3. What strategy might a large beer company adopt to protect itself from an economic downturn?

4. Information Resources, Inc. reports that sales of Bud Light were down about 7% from a year ago in July 2008. Let’s assume that the price of Bud Light is fixed, so that the percentage decrease in sales is the same as the percentage decrease in the quantity of Bud Light demanded. Assume that personal income per capita in the United States declined by about 3.4% over the same period. Keeping in mind that factors other than income probably affected Bud Light sales over this period, use these numbers to come up with a rough estimate of the income elasticity for Bud Light. Is the income elasticity of demand for Bud Light elastic or inelastic? Would you characterize Bud Light as a luxury or a necessity?