Previously I blogged about the decline in demand for natural gas and the resulting decrease in quantity supplied by gas producers:

Welker’s Wikinomics Blog  ’Disequilibrium in the market for natural gas

Professor John Whitehead over at Environmental Economics Blog took the liberty of calculating the price elasticity of supply (PES: a measure of the responsiveness of producers to a change in a product’s price) of natural gas. In this case, since the price of natural gas went down, producers decreased the quantity of gas supplied. Professor Whitehead simply found the price of natural gas, and the rest was easy, given the date from the original article:

“Amid an abundance of natural-gas supplies and soft prices, gas producers are starting to pull the plug. Chesapeake Energy Corp. said it will cut 6% of its gas production in September in response to low natural-gas prices.”

And the professor’s calculation of PES:

PES = (change in Q/Q)/(change in P/P)And the percentage change in quantity is 6% (“Chesapeake Energy Corp. said it will cut 6% of its gas production …”).

…natural gas is about $5.75. During the period Feb-July ’07 price was pretty stable at about $7.50.

So, change in P/P = (7.5-5.75)/5.75 = .30 or 30%

Therefore: PES = 6/30 = .2

Update: While going over this blog post with my AP Econ students today, we noticed that the calculations from professor Whitehead’s blog are actually incorrect. The PES for natural gas is NOT 0.2, as Whitehead showed. Here’s why:

The original price of NG was $7.50, and when the price fell to $5.75 the quantity produced by Chesapeake Energy fell by 6%. Whitehead’s calculations of the percent change in price are wrong because he divides the change in price by the new price, when he should have divided it by the original price. The numerator in the PES formula should be (5.75-7.5)/7.5, which comes out to -2.33.

The PES is therefore -6%/-23.3%, or  0.26

While supply is still inelastic, it’s not QUITE as inelastic as professor Whitehead’s blog indicated.

Discussion Questions:

1. With a price elasticity of supply of 0.26, how would you describe the responsiveness of gas producers to changes in price?
2. Do you think the PES for natural gas would remain 0.26 over time if the prices were to remain low? Why or why not?
3. What is the primary determinants of PES?

A Silver Lining? The connections between gasoline prices and obesity – by Charles Courtemanche

Here’s the abstract from a new study about relationship between gasoline prices and obesity (I know, weird, right?)

A causal relationship between gasoline prices and obesity is possible through mechanisms of increased exercise and decreased eating in restaurants. I use a fixed effects model to explore whether this theory has empirical support, finding that an additional $1 in real gasoline prices would reduce obesity in the U.S. by 15% after five years, and that 13% of the rise in obesity between 1979 and 2004 can be attributed to falling real gas prices during this period. I also provide evidence that the effect occurs both by increasing exercise and by lowering the frequency with which people eat at restaurants.

Given these numbers, you, my students, should be able to calculate the cross-price elasticity of demand between gasoline obesity. Crunch the numbers, what do you see? Is this research plausible or did this guys simply see the relationships he wanted to see to support his thesis?

Hat tip to Professor Greg Mankiw.

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Econ professor and blogger Tim Haab has posted a great story on market failure, efficiency and corrective taxes at his blog, Environmental Economics: I love when someone else does my work for me.

With appreciation, I re-post his blog here in its entirety. Tim’s “Questions to consider” are perfect for IB and AP Econ students to answer in their Market Failure unit. Read and answer Tim’s discussion questions in the comments:

Today’s Econ 101 topic–actually AED Economics 200 but same diff–the deadweight loss from taxes in otherwise well-functioning markets. In my neverending–futile?–attempt to stay current, I plan to use this example from today’s Wall Street Journal:

Senate leaders are considering new federal taxes on soda and other sugary drinks to help pay for an overhaul of the nation’s health-care system.

The taxes would pay for only a fraction of the cost to expand health-insurance coverage to all Americans and would face strong opposition from the beverage industry. They also could spark a backlash from consumers who would have to pay several cents more for a soft drink.

The Center for Science in the Public Interest, a Washington-based watchdog group that pressures food companies to make healthier products, plans to propose a federal excise tax on soda, certain fruit drinks, energy drinks, sports drinks and ready-to-drink teas. It would not include most diet beverages. Excise taxes are levied on goods and manufacturers typically pass them on to consumers.

…

The Congressional Budget Office, which is providing lawmakers with cost estimates for each potential change in the health overhaul, included the option in a broad report on health-system financing in December. The office estimated that adding a tax of three cents per 12-ounce serving to these types of sweetened drinks would generate $24 billion over the next four years. So far, lawmakers have not indicated how big a tax they are considering.

Proponents of the tax cite research showing that consuming sugar-sweetened drinks can lead to obesity, diabetes and other ailments. They say the tax would lower consumption, reduce health problems and save medical costs. At least a dozen states already have some type of taxes on sugary beverages, said Michael Jacobson, executive director of the Center for Science in the Public Interest.

Questions to consider:

1. How do you reconcile the seemingly conflicting goals of reducing soda consumption and raising revenues to pay for health care?
2. Which effect do you expect to dominate: reduction in quantity demanded due to higher prices or increased revenue from higher prices?
3. Assuming the market for sodas (pop around here) is currently working efficiently, what effect do you expect a new tax to have on consumer well-being, producer well-being, government revenue and total social welfare?
4. What role do the elasticity of demand and elasticity of supply play in your answers to 1,2 and 3?

Kite Powered Ship Sets Sail for Greener Futhre – Guardian.co.uk

A German engineer has given an old technology new life to help make trans-oceanic shipping greener and least costly.

A cargo ship pulled by a giant, parachute-shaped kite will leave Germany on Tuesday on a voyage that could herald a new “green” age of commercial sailing on the high seas.

The owners of the MS Beluga, a 462ft cargo vessel, will try to prove that modern steel ships can harness wind power and reduce their reliance on diesel engines.

During the journey from Bremen to Venezuela, the crew will deploy a SkySail, a 160 square metre kite which will fly more than 600ft above the vessel, where winds are stronger and more consistent than at sea level.

Its inventor, Stephan Wrage, a 34-year-old German engineer, claims the kite will significantly reduce carbon emissions, cutting diesel consumption by up to 20 per cent and saving £800 a day in fuel costs. He believes an even bigger kite, up to 5,000 square metres, could result in fuel savings of up to 35 per cent.

Here’s a thought… reduced fuel costs to trans-oceanic shipping companies should shift the supply of such services out, as the marginal cost of shipping falls. Greater supply will mean lower prices to customers demanding such services, moving downward along the demand curve, increasing the equilibrium quantity of trans-oceanic cargo journeys.

Question: Assume all cargo ships in the world eventually incorporate the sail technology, increasing the supply and reducing the price of shipping by an average of 20% and reducing the emission of greenhouse gases of vessels by an average of 20%. What would have to be true about the price elasticity of demand for trans-oceanic shipping in order for a 20% reduction in price to result in an overall reduction of greenhouse gas emissions by cargo ships? Depending on the answer to this question, this “green” technology could actually result in greater emissions of greenhouse gases by cargo ships.

Explain…

As Clinton Seeks Gas Tax Break for Summer, Obama Says No – New York Times

Times are tough for American consumers. Rising food and fuel prices have increased the proportion of household incomes that must be allocated towards these two necessities, both for which demand is highly inelastic, meaning that as their prices rise, the quantity demanded by consumers remains relatively high.

In response to the pinching of Americans’ pocketbooks, two presidential candidates are advocating action at the federal level.

Senator Hillary Rodham Clinton lined up with Senator John McCain, the presumptive Republican nominee for president, in endorsing a plan to suspend the federal excise tax on gasoline, 18.4 cents a gallon, for the summer travel season.

Sounds like a good idea, right? If Americans are finding it burdensome to pay more at the pump, and the government can do something to relieve that burden, why shouldn’t they do it?

Let’s do a little calculation here: At 18.4 cents per gallon, how much per fill-up will Americans save?

I drive a ’94 Toyota pick-up, has a 15 gallon tank and gets notoriously poor mileage. I’ll save $2.76 per tank of gas I buy. I usually fill up my truck about once a week during the summer, meaning I’ll save that much each week. McCain wants to suspend the gas tax from Memorial Day until Labor Day, or for a total of about 12 weeks. If Clinton and McCain get their way, I could very well save as much as $33.12 this year! ASTOUNDING!! What a deal for Americans!

Clearly, repealing the gas tax will have only a minor impact on disposable incomes in America. Obama seems to understand this better than the other candidates:

Senator Barack Obama, Mrs. Clinton’s Democratic rival, spoke out firmly against the proposal, saying it would save consumers little and do nothing to curtail oil consumption and imports…

Mr. Obama derided the McCain-Clinton idea of a federal tax holiday as a “short-term, quick-fix” proposal that would do more harm than good, and said the money, which is earmarked for the federal highway trust fund, is badly needed to maintain the nation’s roads and bridges.

The decision to suspend or not suspend federal gas taxes is essentially a cost-benefit decision. The benefit? Well, apparently around $30 per driver, or about half a tank of gas, compliments of the US government. The cost? Read on…

The highway trust fund that the gas tax finances provides money to states and local governments to pay for road and bridge construction, repair and maintenance. Mr. McCain and Mrs. Clinton propose to suspend the tax from Memorial Day to Labor Day, the peak driving season, which would lower tax receipts by roughly $9 billion and potentially cost 300,000 highway construction jobs, according to state highway officials.

There you have it; $9 billion dollars and hundreds of thousands of jobs that won’t be created in order to put half a tank of gas in each American’s car, which if you think about it, will only lead to Americans driving more this summer. Repealing the gas tax may actually induce Americans who weren’t planning road trips to go ahead and take one, increasing the overall demand for gas and driving the price up to the level it would have been with the tax.

And what about the much needed government revenue the tax creates? Hillary has another plan for recouping that loss:

Mrs. Clinton would replace that money with the new tax on oil company profits, an idea that has been kicking around Congress for several years but has not been enacted into law. Mr. McCain would divert tax revenue from other sources to make the highway trust fund whole.

Clearly, Mrs. Clinton needs a refresher course in basic microeconomics. If she had paid attention in AP Economics (did she even take AP Econ?), Clinton would know that a tax on producers of a highly inelastic good such as oil can be passed almost entirely onto the consumers. In this case, the oil companies, when faced with additional federal taxes on profits, will respond by restricting output, which reduces overall supply in oil market, raising the price of the main input for gasoline. Higher input costs for gasoline refineries will reduce overall supply of gasoline, increasing the price paid by consumers at the pump, negating any price-reduction induced by the suspension of the gas tax.

Ultimately, all taxes are borne by the consumers of an inelastic product: gasoline in this case. Whether the tax is levied on drivers directly, or the oil companies “upstream” in the production process, the outcome is the same: supply is restricted and price is higher.

The suspension of a gas tax that only costs Americans $30 over 3 months appears to impose a much greater cost to society than benefit. At least Obama seems to understand the basic economic reasoning behind this fact.

Obama on State Gas Tax Suspension

Carbon tax bill in the mail – Canada.com

…then we’d be spared the naive statements that appear in our media and out of the mouths of our citizens when a basic economic principle plays itself out in the market place.

In Quebec, the provincial government levied a carbon tax on energy producers:

When the provincial government imposed the country’s first carbon tax last fall, it wanted producers to pay.

But just as oil refiners have already done, Gaz Métro started passing on the cost of the carbon tax (to consumers) this month.

Big surprise, right? Only in a market in which demand is perfectly elastic would the entire burden of a tax be born by producers, since raising prices at all would mean loosing all their customers. Clearly, electricity is not such a market, and given the inelasticity of demand for a necessity such as electric power, chances are a big chunk of the “0.67 cents per cubic metre of natural gas” tax placed on utilities is being passed onto consumers.

In market economies, tax incidence is shared between producers and consumers. This of course, is the way it should be. If the price stays low and output remains high, no externality has been corrected and just as much greenhouse gas will be emitted as before the tax. In order to decrease output to a more socially optimal level, the tax should be passed on to consumers, but also born by producers in the form of lower profits. Despite this economic reality, consumers still aren’t happy about it:

“I don’t care how much it is, even if it’s just half a penny,” said Leonard, a Laval resident who called to complain about his gas bill. He spoke on condition that his last name not be used.

“They said consumers would not pay for this – and now here we are, paying for it.”

Poor old Leonard… never got to take an economics class in school! If only everyone had taken AP Econ in high school, naivety like this could be avoided! Ask ol’ Leonard if he’s stopped using electricity due to the higher price, and I bet you can guess his answer. Why? Inelastic demand.

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by Annie Sung and Kristie Chung

Which do you prefer, the Wii? the XBox 360? the PS3? How about other video game consoles? Can you even think of any other video games consoles? Hmm… let’s see… how about the Sega? Wait, no, haven’t seen any of those in a while… what about the Atari? Oh, shoot, nope! Oh yeah, don’t forget the Caleco Vision (for the record, Mr. Welker’s earliest video game memory was of playing Smurfs on a Caleco Vision).

The fact is, today, the market for video game consoles has shrunk to three dominant firms: Nintendo, Microsoft and Sony. This podcast will investigate the video game console market, examine its characteristics, including the elasticity of demand for the different consoles, and conclude whether it exhibits the features of an oligopoly.

by Caleb Liao and Drew Venkatramen

Just how important is the caramel frappuchino to Starbucks? This podcast will explore the demand for a particular product from the ubiquitous coffee chain, a new branch of which has recently been opened across the street from Shanghai American School.

SAS students overwhelmingly favor the sweet, caramel goodness of the beloved Frappuchino, but how much would they really be willing to pay for already the steeply-priced beverage. At its market price of 32 kuai, customers seem to arrive in droves from the SAS campus; but could Starbucks do better by charging a higher price? What if they lowered the price, would it make a difference in their revenues? This podcast explores the market for the crowd’s favorite coffee beverage, the caramel frappuchino, and tries to learn something about demand, elasticity, and firm behavior in the process!

SAS Economists Podcast #5: What does the Caramel Frappuchino mean to Starbucks? [ 0:01 ] Play Now | Play in Popup | Download (8)

By Nicole Wong and Katherine Yang

Podcast number 3 investigates the competitive market among groups selling baked goods here at Shanghai American School. The annual Relay for Life requires teams to raise 5,000 RMB (equal to about $650) in order to enter in the Relay. The most popular method of raising this entry fee is through bakes sales. This means that the month or so before Relay for Life SAS enters its “bake sale season” when countless teams try and push their products on teachers and students alike.

This podcast will explore the nature of the market for baked goods at SAS, determine the elasticity of demand for baked goods, and explore the prospects for increasing profits among teams hoping to make an easy kuai in the month leading up to the Relay for Life.

If the image is off, right click on the viewer and click “zoom” and “full screen”

Competition in the Baked Goods Market at SAS [ 0:01 ] Play Now | Play in Popup | Download (13)

BBC.co.uk – News – Science/Nature – “Brits ‘adicted’ to cheap flights”

As we continue to learn economics, you’ll begin to realize more and more how important this field is to truly understanding how things in our everyday lives work. For example, how will people respond to the increase in a product’s price when the government places a new tax on the product?

Chapter 18 of our text discusses the implications of price elasticity of demand on governments’ decisions of what types of goods to place excise taxes on. Given an understanding of PED, we as economists understand that taxes will earn the most revenue for a government when placed on goods for which the PED coefficient is less than 1. In other words, revenue seeking governments should tax products for which demand is highly price inelastic, and avoid taxing products for which demand is highly price elastic. This just makes sense: when the price of an inelastic good goes up, consumers will respond very little, while an increase in the price of an elastic good will scare away a relatively large number of consumers, meaning a decrease in total revenue (tax revenue in this case).

In addition to elastic and inelastic price elasticity of demand, we also discussed today the theoretical existence of products for which PED is perfectly inelastic. In the article linked above, geographers from the University of Exeter in the UK share findings from a study that seem to indicate that PED for air travel in the UK is perfectly inelastic:

“The government raised air passenger duty in February, and the European Union is set to include aviation in its Emissions Trading Scheme (ETS), which could increase costs further.

But the Exeter research suggests price hikes would have a minimal impact.

‘We found that flying is quite embedded in peoples’ lifestyle choices,’ said Stewart Barr from the university’s Department of Geography.

‘And it’s not people on lower incomes taking these flights, it’s middle class people taking more flights to go on city breaks, and they can afford to pay higher prices.’”

According to the Exeter geographers, because “flying is quite embedded in peoples’ livestyle(s)…” the increase in price resulting from the new taxes should have “minimal” impact on air travel. When most people say “minimal”, what they are implying is “none”… in which case we as economists can translate the geographers’ statements as thus: “the price elasticity of demand for air travel in the UK is zero (or darn close to it!)”

Could this be true? Do you think air travel has a PED of zero? If so, what are the implications for airlines? What are the implications for travelers? Could the geographers be wrong? What about air travel makes demand for it so price inelastic? Discuss!!

Hat tip to Professor John Palmer at EclectEcon for the link to this article.

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