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.

D is for Demand: Sources of Success of 3-D Movies

According to the Wall Street Journal, 2009 was the first year since 2002 where sales at the U.S. box office beat those of DVD releases by passing the $10 billion mark. The success of Avatar has certainly ramped up the industry with its worldwide revenue of more than $2.7 billion; such an amount is comparable to the GDP of a small but affluent country like Barbados! Also interesting is the recent trend in increasing ticket prices: Prices of domestic movie tickets, according to the Los Angeles Times, have increased by more than 10% in the first few months of 2010. Specifically, not only is a 3-D movie ticket sold with an average surcharge of $4 over the 2-D ticket prices, 2-D tickets are also up by roughly 4%. Similar to books and cars, the market for movies is monopolistically competitive. Every movie is a separate product that faces competition from a multitude of similar but not identical products, namely, other movies. Entry of new products normally puts a downward pressure on the prices of existing products and the average market price overall. So, the question is: Why, despite the increased competition, have prices gone up for both formats? Why are people willing to pay significantly more to go to the movies?

Just as in the case of many other goods, the demand for movies is sensitive to the changes in ticket prices. The extent of sensitivity, which economists term price elasticity of demand, can be different for different movies because it is determined by a number of factors such as availability and prices of similar goods (substitutes), the number of consumers, and tastes and habits. The demand for goods that have many close substitutes is typically more elastic than for goods with fewer substitutes. The reason for this is that when the price increases, consumers have the option to buy other similar and potentially less expensive products. For example, when the ticket price of a traditional movie increases, more viewers are likely to decide to watch the film on DVD. This is especially true as improvements in technology have made such substitutes as DVDs, Blu-Ray Discs, On Demand products, and streaming Netflix accounts easily available. Thus, generally increasing prices of movie tickets might not boost revenues, as the decrease in sales (quantity demanded) may wipe out any gains that would arise from the price increase. But if this is the case, then how can we explain the fact that movie theaters are receiving record-breaking revenues while ticket prices are increasing?

For a long time, 3-D films have not made any noticeable impact on the industry, but James Cameron’s inventive cinematography created a new product, a dramatically different viewing experience, which shook the entire market for entertainment. Movie theater technology was updated to accommodate mass screenings, and other directors and studios followed suit. Since Avatar’s release, 3-D movies have generated more than one-third of all domestic movie revenue. At least some of the factors responsible for the price elasticity of demand for movies have changed. It is hard and relatively expensive to replicate a 3-D experience outside of the movie theater. Thus, the 3-D format has fewer close substitutes, as home theaters with 3-D capabilities are still rare and quite expensive to install, which lures more viewers out to 3-D screenings despite more expensive tickets. The demand for 3-D movies is, therefore, less elastic, which creates the opportunity for the producers and movie theaters who deliver these products to the consumers to charge higher prices.

At the same time, the 2-D and 3-D markets are intertwined as the number of movie theaters and seats is limited, at least in the short-run. Thus, the story would not be complete without taking into account theater operators’ decisions about prices and allocation of seats. The necessary reduction in the number of rooms where 2-D movies are shown shifts the supply of 2-D to the left, which drives the price of that traditional format up despite the reduction in its demand. So, ultimately, rising prices of both formats have different (although related) explanations. If the industry experiences more consumer interest in its new products, like we see with Avatar, the result is growing revenues along with higher average prices.

While it is possible that the spectacular success of Avatar was a sort of surprise attack on the consumer followed by a box office record, the systemic changes it brought to the movie industry suggest that the effects will be longer-lived. Due to the advent of the 3-D movie format that can show in regular theaters, more movies are money-makers now than before. This situation is likely to persist for some time until affordable home theaters catch up in quality and increase the competitive pressure on the movie theaters.

Discussion Questions:


1. Similar to how Napster was used as an illegal medium to download music, online services are emerging for downloading movies in theaters not yet released for home viewing. How might this affect the price elasticity of demand for movie ticket sales? How might 3-D movies be protected from this type of piracy?

2. The “second law of demand” implies that price elasticity of demand is greater in the long run. How and why might moviegoers’ behavior change in the long-run? What would this mean for theater owners?

3. The explanation offered here is based on the assumption that 2-D and 3-D movies co-exist in the market for entertainment. Do you agree or disagree? What would be an alternative approach to explain the rising average prices of movie tickets?