Archive for the 'Competitive Markets, Demand and Supply' Category

Jan 17 2011

Market Failure and Bullets

Should hunters switch to ‘green’ bullets? – CNN.com

Chis Rock once said,

“We don’t need gun control, we need bullet control. I think a bullet should cost $5,000, cause if a bullet cost $5,000 there would be no more innocent bystanders.”

Chris Rock may not have had market failure in mind when he wrote this joke, but he unknowingly demonstrated a perfect example of a case in which the over-consumption of a particular good results in spillover costs on third parties not involved in the original transaction (the “innocent bystanders”). In economics, this is known as a negative externality of consumption, and is considered a market failure because without some kind of government intervention, too much of the harmful good will be produced and consumed: in this case, too many bullets are consumed causing harm to society.

I always thought Chris Rock’s idea of taxing bullets was a good idea, but never thought I’d find a real example of such a solution to market failure, until now. Although the bullets in the article below are those used by hunters, whereas Chris Rock’s bullets are probably those used by gangsters, the economic concepts underlying the market failures are similar.

Three years ago, Phillip Loughlin made a choice he knew would brand him as an outsider with many of his fellow hunters:

He decided to shoot “green” bullets.

“It made sense,” Loughlin said of his switch to more environmentally friendly ammo, which doesn’t contain lead. “I believe that we need to do a little bit to take care of the rest of the habitat and the environment — not just what we want to shoot out of it.”

Lead, a toxic metal that can lower the IQs of children, is the essential element in most ammunition on the market today.

But greener alternatives are gaining visibility — and stirring controversy — as some hunters, scientists, environmentalists and public health officials worry about lead ammunition’s threat to the environment and public health.

Hunting groups oppose limits on lead ammunition, saying there’s no risk and alternatives are too expensive…

Lead bullets cause harm to the environment and possibly to human health. The private consumption of these bullets exceeds what is socially optimal, while “green” bullets, on the other hand, are under-consumed by private individuals. There are two market failures occurring here, and they can be illustrated as follows:
When markets fail, government action is sometimes necessary to achieve a more socially optimal allocation of resources. The bullet market represents a market failure because too many harmful lead bullets are being consumed while not enough environmentally friendly “green” bullets are being consumed.

The graphs above show the impact of corrective taxes and subsidies in resolving these market failures. Whether or not governments will pursue such corrective policies has yet to be seen. A couple of states, however, appear to already understand that market failures require government intervention.

Last year, California banned lead bullets in the chunk of the state that makes up the endangered California condor’s habitat. The large birds are known to feed on scraps of meat left behind by hunters. Those scraps sometimes contain pieces of lead bullets, and lead poisoning is thought to be a contributor to condor deaths.

Arizona, another condor state, gives out coupons so hunters can buy green ammunition. Utah may soon follow suit.

Discussion Questions:

  1. Why don’t all states simply ban the use of lead bullets by hunters? Is this solution socially optimal?
  2. Besides corrective taxes and subsidies, how could government reduce the demand for lead bullets and increase demand for “green” bullets?
  3. How will Arizona’s use of coupons demonstrate a market-based approach to externality reduction?
  4. And this one is from the authors of the Environmental Economics blog: “Do you think the deer care which kind of bullets the hunters use?”

18 responses so far

Nov 15 2010

Diminishing returns and the short-run costs of production – “Econ Concepts in 60 Seconds”

YouTube – Econ Concepts in 60 Seconds: The Law of Diminishing Marginal Returns

Mr. Clifford, an AP Economics teacher from San Diego, demonstrates the law of diminishing returns by deriving a total product and marginal product curve using production data from a student’s lawn mowing business.

Econ Concepts in 60 Seconds: The Law of Diminishing Marginal Returns The video above is most useful to Econ students because it enforces the Law of Diminishing Returns. The more important application of this basic economic concept, however, is the short-run per-unit cost curve, Marginal Cost, Average Variable Cost and Average Total Cost. Mr. Clifford offers his quick explanation of the relationships between a firm’s short-run costs in the following video.

Econ Concepts in 60 Seconds: Per Unit Costs Curves

Discussion Questions:

  1. Mr. Clifford derives a Marginal Product Curve in the first video and a Marginal Cost Curve in the second video. What is the relationship between the marginal product of a firm’s variable resource and the firm’s marginal cost of production? How are the shapes of both these curves determined by the law of diminishing marginal returns?
  2. Why does a firm care about its costs of production? Which of the four per-unit cost curves in the second video would a firm be most concerned with when determining whether or not it is earning profits or losses?
  3. What can cause a firm’s cost curves to shift up or down? How would a shift of the cost curves affect a firm’s profits?
  4. What is the primary economic goal of firms, and how can understanding their short-run costs of production help them achieve this goal?

21 responses so far

Sep 23 2010

Is bicycle transportation an “inferior good”?

This article was originally published on May 12, 2008. It is being re-published since it relates to our current units in AP and IB Economics.

The Associated Press: Gas prices knock bicycle sales, repairs into higher gear

Greg Mankiw has an ongoing series of posts linking to articles illustrating the impact that rising gas prices have had on demand in markets other than that of the automobile.

One of the determinants of demand for goods and services is the price of related goods and services. As gas prices rise, drivers tend to switch from automobiles to alternative forms of transportation. A few days ago I blogged about the switch from tractors to camels in India, one illustration of the relationship between the price of one good and demand for its substitutes. Mankiw has so far linked to articles about the impact of high gas prices on demand for bicycles, small cars and mass transit.

These three “goods” are all substitutes for the most common form of transport among Americans, the private automobile (often times a gas-guzzler in “the bigger the better” America). When the price of a good like personal vehicular transport increases (in this case due to the price of an input required in private cars, gasoline), the demand for a substitute good will increase.

In the case of bicycles, evidence indicates that just such a change in demand is already underway in America today:

Bicycle shops across the country are reporting strong sales so far this year, and more people are bringing in bikes that have been idled for years, he said.

“People are riding bicycles a lot more often, and it’s due to a mixture of things but escalating gas prices is one of them,” said Bill Nesper, spokesman for the Washington. D.C.-based League of American Bicyclists.

“We’re seeing a spike in the number of calls we’re getting from people wanting tips on bicycle commuting,” he said.

Interestingly, the increase in demand for bicycle travel in response to high gas prices might be even more pronounced due to America’s sluggish growth, 4% inflation and rising unemployment. Real wages have seen little gain in the last couple of years as growth has fallen close to zero while prices have continued to rise. It may be possible that a fall in real incomes in America has spurred new demand for bicycle transportation, which could be considered an inferior good, meaning that as household incomes fall, consumers demand more bicycles for transportation.

Since bicycles represent such a drastically cheaper method of transportation, high gas and food prices, a weak dollar, and falling real wages accompanying the economic slowdown have had a negative income effect on American consumers, leading to increases in demand for inferior goods such as bicycle transportation

That said, having worked in a bike shop myself for two years in college, I can say that most consumers looking at new bicycles are not doing so because of falling incomes. Quite the opposite, in fact, indicating that new bicycles are normal goods (those for which as income rises, demand rises). However, the article states that in addition to increases in new sales, “more people are bringing in bikes that have been idled for years”.

It may be that while new bicycles themselves are normal goods, bicycle transportation as a whole is an inferior good. The increase in demand for new bicycles could be explained by the substitution effect (as the price of motor vehicle transportation rises, its substitute, bicycle transport, becomes more attractive to consumers) and at the same time explained by the income effect too (as real incomes have fallen, demand for the bicycle transport has risen).

This phenomenon is an excellent illustration of how the income and substitution effects work in conjunction to explain the inverse relationship between price and quantity demanded for automobiles (the law of demand), as well as the concept of cross-price elasticity of demand between two substitute goods.

Discussion Questions:

  1. Both the price of substitute goods and income affect demand for a particular product. How have both the prices of substitutes for bikes and the income of bike consumers influenced the demand for bicycles in different ways?
  2. What is the definition of an “inferior good” in economics?Do you believe bicycle transportation is an “inferior good”?
  3. Are all bikes the same? Do you think demand for some bicycles responds differently to changes in income than demand for other bicycles?

97 responses so far

Sep 23 2010

The magical recession proof bunny

Chocolate Sales: A Sweet Spot in the Recession – TIME

Living in Switzerland, I find an article featuring a local business from the town my school is in irresistible, particularly when it appear in TIME magazine. Lindt chocolate, the company featured in this article, manufactures its delicate treats right down the hill from the ZIS campus, which means that when the wind is just right, you can just catch the scent of fresh, creamy chocolate wafting up the hillside while walking to campus.

Lindt, as well as its global competitors in the chocolate business, is enjoying surge in demand even while countless other industries are forced to cut back production, lay off workers, and close their factory doors. From TIME:

While the credit crisis has slowed down sales of everything from cars to organic groceries, people seem happy to keep shelling out for chocolate. Last year, as the global recession was gaining ground, Swiss chocolate makers bucked the trend with record sales — nearly 185,000 tons, an increase of 2% over 2007, sold domestically and in 140 export markets…

“Switzerland’s image sells well abroad, and nothing says ‘Switzerland’ more than chocolate,” says Stephane Garelli, director of the World Competitiveness Center at the Institute of Management Development (IMD) in Lausanne, predicting that this comfort food will continue to sweeten the sour economy for months to come…

“Now that people don’t have a new television or a new car,” he noted, “they eat a bit more chocolate.”

“Chocolate is one of the more recession-resilient food sectors,” says Dean Best, executive director of Just-Food, a U.K.-based news and information website for the global food industry. “With consumers eating out less and eating at home more, there is evidence that they are still allowing themselves the occasional indulgence — and chocolate is a relatively inexpensive indulgence.”

But the question of why there is no meltdown in the chocolate business may be more a matter of psychology than economics. “There is well-documented evidence going back to Freud, showing that in times of anxiety and uncertainty, when people need a boost, they turn to chocolate,” says Garelli of the IMD. “That’s why when the economy is bad, chocolate is still selling well.”

Which goes to show that chocolate is more than a candy treat — it’s real food for the soul.

So does this mean chocolate is an inferior good, or one for which demand increases as incomes fall? I doubt many Swiss chocolate producers would consider their product inferior, but perhaps it does fit the definition.

On the other hand, perhaps the reason demand for chocolate increases during a recession has more to do with the substitution effect than the income effect. As people eat out less, they consume fewer expensive deserts at restaurants and instead fill their shopping baskets with more affordable dessert options for the home. I can say from experience that this is the case for myself.

Living in Switzerland, I find myself rarely going out to eat at restaurants, an activity reserved for special occasions in this country where a steak can set you back 75 dollars. Instead, I eat at home almost every night, and nothing is more appealing to me, especially during hard economic times, than a bar of delicious chocolate after a home cooked meal. Demand for chocolate may rise during recessions simply because the demand for one of its substitutes (restaurant desserts) falls.

Discussion questions:

  1. Do you think chocolate is an inferior good or a normal good? What’s the difference? What types of goods do YOU consome more of when you find yourself faced with a tighter budget?
  2. Does economics have a good explanation for the above situation? The article mentions Freud, a pioneer in  the field of psychology; do humans’ economic behavior always appear rational?
  3. If chocolate were an inferior good, what would happen to chocolate sales when the global economy finally turns around and incomes start increasing? What do you think will happen to chocolate sales when the economy starts imrpoving? Explain.

31 responses so far

Dec 02 2009

Review Lesson: Econ concepts in 60 seconds – Perfect Competition

YouTube – ACDCLeadership’s Channel

More econ review videos from my new favorite YouTube channel, Jacob Clifford’s Econ Concepts in 60 Seconds.

To review for the upcoming test, you will join a small group and watch one of the four videos on the Perfect Competition. After watching and discussing one video with your group, you will be re-assigned to another group with students who watched a different video. You will then lead a short discussion on your original video with your new group.

With your first group – 15 minutes: As your group watches its assigned video, have your notes open in front of you and draw the graphs Mr. Clifford draws along with him. Pause the video where necessary to have time to draw graphs. Take notes while watching the video so you can teach it to another group. With your group, prepare a short discussion of the video’s main points, including:

  • What rule or lesson about Perfect Competition does the video focus on?
  • What did you already know that this video reminded you of or reinforced your understanding of?
  • What did this video introduce that was new to you?
  • How were graphs used to teach the concepts?

With your second group – 20 minutes: For the second part of this assignment, there should be four new groups, each including one member of the four original groups.

  • Each group member should lead a 2-3 minute discussion of the video he or she watched in the first group.
  • Go over each of the discussion points from above.
  • Answer any questions your new group members have about video you watched.

Group 1 – The Profit Maximization Rule – MR=MC:

[youtube]http://www.youtube.com/watch?v=qaQRM6WIxpA[/youtube]

Group 2 – Perfect Competition in the short-run:

[youtube]http://www.youtube.com/watch?v=yY8f571AUxk[/youtube]

Group 3 – Perfect Competition in the long-run:

[youtube]http://www.youtube.com/watch?v=SjZmnOAPKUM[/youtube]

Group 4 – The Shut-Down Rule in Perfect Competition:

[youtube]http://www.youtube.com/watch?v=VFY2aJwpdNM[/youtube]h

11 responses so far

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