Archive for the 'Inferior goods' Category

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?

77 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.

26 responses so far

Feb 25 2009

Starbucks instant coffee: a sign of the times?

Chicago, Seattle first markets to get instant Starbucks — chicagotribune.com

I consider myself a Seattleite. I discovered the joy of drinking coffee in the home of Starbucks, Tully’s, Seattle’s Best, and countless local coffee shops that inhabit every corner of the rainy city.http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2008/02/25/0225_starbucks_460x276.jpg To me, the experience of drinking a latte, machiato, cappuccino, or simply a “coffee of the week” encapsulates the smells, soft decor and friendly greetings from the barista at my favorite coffee shop. Living overseas, I have turned to Starbucks over and over for a taste of Seattle and a feeling of home.

There is no denying that the Starbucks experience is one that does not come cheap. Here in Switzerland, a grande latte, my drink of choice, sets the consumer back nearly $7. In an economic downturn such as that the US and the rest of the world are experiencing right now, such expenses are often the first to be reduced by cash strapped consumers. In fact, I recently began bringing a thermos of homemade coffee to work every day, rather than stopping at the Starbucks at the train station as I had done for several months not long ago.

Starbucks, which recently announced the closure of hundreds of its locations around the world, is actually expanding its product line while simultaneously closing down shops. It may not be in the way you expect, though. Soon, I’ll be able to get my $7 cup of coffee for as little as $1, it will just come in a different form:

Starbucks Corp. will launch its new instant coffee product next month in Chicago and its home turf of Seattle, with a full-scale, national offensive set for the fall.

Starbucks on Tuesday formally unveiled the new product, called Via Ready Brew. It will be available in Starbucks retail outlets in the Chicago and Seattle areas on March 3, Howard Schultz, the company’s chief executive, said in an interview with the Tribune.

Instant coffee from the king of gourmet blends? Sounds suspicious. Well, it’s all about economics, you see. Starbucks coffee is a normal good, one for which demand falls as incomes fall, as evidenced by falling sales at its coffee shops around the world. In order to maintain its customer base even as incomes fall, a company like Starbucks must expand its product line to include inferior products, or those for which demand increases even as incomes fall. Clearly, instant coffee is viewed as an inferior product, due to its significantly lower price and reputation of poor quality.

Furthermore, Starbucks’ new product is in response to increased competition from lower-end fast food chains that traditionally did not compete in the coffee market, but recently have begun offering various blends and varieties of coffee to the price-sensitive coffee consumers, further harming business at Starbucks’ higher end coffee outlets.

Via marks Starbucks second announcement this month of a cheaper menu alternative, as the famous coffee chain struggles in a weak economy. Starbucks is also now selling pairings of coffee and breakfast offerings for $3.95.

Starbucks’ troubles have occurred at the same time value-oriented fast-food chains, particularly Oak Brook-based McDonald’s Corp., have thrived. McDonald’s owes part of its success to improving the quality of its basic coffee, and expanding into new drinks like iced coffee, and, more recently, flavored specialty coffees such as lattes and cappuccinos.

Still, Schultz said McDonald’s coffee offensive hasn’t really affected Starbucks: “We have a lot of respect for McDonald’s as a company. But we have not seen any significant issues with McDonald’s share of the coffee business affecting Starbucks.”

McDonald’s offers “a different product, a different value proposition,” he said. In fact, Schultz said McDonald’s should expand the overall coffee market, thus leading some customers to “trade up” to Starbucks.

Despite the CEO’s claims that Starbucks and McDonald’s coffees are “different” products, it is clear by his firm’s decision to expand into the instant coffee market that Starbucks is concerned about the loss of customers to lower-end coffee retailers.

The theory of firm behavior as studied in AP and IB Economics teaches us that firms in oligopolistic or monopolistically competitive markets, such as that for coffee shops in the US, tend to compete using non-price methods such as product differentiation and advertising. Rather than slashing the prices of all of its coffee in the face of a recession and falling consumer incomes, Starbucks has instead diversified its product line to include lower end options for consumers whose sensitivity to price and demand for gourmet coffee have been adversely affected by the weak economy.

24 responses so far