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?

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.

A few summers ago, my wife and I spent three weeks travelling around the island of Bali in Indonesia. For six of those days we rented a jeep and circumnavigated the island. Our first stop was for two days of scuba diving in the northeast region of Ahmed. As we drove along the seven beaches near Ahmed, we observed there were around ten dive operators offering packages for the local dive spots (including one of Asia’s most famous dives, the WWII-era USS Liberty wreck). Based on our Lonely Planet recommendation, we settled on Eco-Dive, where we paid $60 a day for two dives and all our gear rental. We felt good about this rate and agreed that $60 was a fair and competitive price for a day of diving.

Our next stop, Pemuteran, a remote and relatively undeveloped area on the northwest coast just across the straits from Java, is also known for its great diving. On our first morning in Pemuteran, my wife and I strolled along the beach and found that there were only three dive operators to choose from! And guess what, they all charged between $95-$105 for a day of diving. That’s around 60% more than the operators in Ahmed charged! In the end, we decided to do only one day of diving in Pemuteran, and elected to spend our second day there reading by the pool.

Discussion Questions:

1. What was the difference between the scuba diving markets in Ahmed and Pemuteran? Which market was more competitive? Which of the four market structures did the two markets most resemble: perfectly competitive, monopolistically competitive, oligopolistic or monopolistic?
2. How were the dive operators in Pemuteran able to charge 60% more than the operators in Ahmed?
3. What do you think is keeping one of the three dive operators in Pemuteran from lowering their price to, say, $60 for a day of diving? How would the other two operators respond? Would this be good or bad for the dive operators of Pemuteran? Would it be good or bad for scuba divers?
4. Assuming that the cost of opening a dive operation was relatively low, and there were no government or other barriers to doing so in Pemuteran, what do you suspect will happen in the Scuba diving market as the tourism industry continues to develop in the remote town of Pemuteran? Explain.
5. Which village’s dive operators do you think were more “efficient” in their use of resources? Explain.

This article was originally published on June 9, 2008

Asia Sentinel – Malaysia cuts fuel subsidy

One of the recurring themes of this blog is the conflict between good politics and good economics. Most of the time in government, smart economic policy is sacrificed in order to achieve political favor with voters. Whether it’s price ceilings on petrol in China, Zimbabwe’s slashing of food prices, harmful import restrictions to benefit domestic producers, or the proposed suspension of gas taxes in a time when fuel conservation is really what’s needed, politicians often act in economically stupid ways to bolster or hang on to their popularity.

So when a government makes a bold move that is economically sound, it sometimes comes as a surprise, as in the case of the Malaysian government this week. The government in Kuala Lumpur has for years subsidized domestic fuel prices, which at under 2 Malaysian Ringit per liter have been the equivelant of roughly $2.40 US per gallon, far below the average price in the west. Drivers benefited from this subsidy, but were not forced to bear any of the burden of rising oil prices, nor had they any incentive to conserve or switch to more fuel efficient automobiles or alternative forms of transportation. The Malaysian government, on the other hand, has had to allocate more and more of its limited budget towards subsidizing petrol prices.

Well, as of yesterday, all price supports for petrol are cancelled, and the effect will be sweeping in the Malaysian economy:

The government announced Wednesday evening that petrol prices would rise by 78 sen (US24¢) at midnight — a 41 percent jump from RM1.92 per liter to RM2.70. That means those spending RM2,000 per month to fill the tanks of their BMWs will now be paying RM2,820. Regardless of income levels, it is likely most Malaysians will feel the pinch.

The subsidy would have cost the Malaysian government 56 billion ringit (around $17 billion) this year. With the money it will now save by ending the subsidy, the government will begin making public transport cheaper and more convenient for commuters who wish to avoid paying for the more expensive petrol to fuel their personal automobiles:

The government hopes to channel the savings into improving public transportation, as it promised many years and elections ago but with little to show. In Kuala Lumpur, despite having a light rail train service and monorail, public transportation is expensive and inconvenient. Worse, intercity travel is still being serviced by old and slow trains, and accident-prone buses.

Malaysia is not the only country taking measures to end government fuel-price supports:

Indonesia has hiked fuel prices by an average of 29 percent, saving about 34.5 trillion rupiah and kicking off a series of street demonstrations… Similarly, after slashing subsidies, Taiwan will distribute US$659 million to middle and low-income families. The latest to raise oil prices is India, whose government announced Wednesday that gasoline and diesel prices will increase by 10 percent.

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…

Op-Ed Contributor – Buy American. I Am. – NYTimes.com

So Wall Street has recently experienced its worst shocks since the great depression. Every day the Dow Jones is like a roller coaster, DOWN 800 points, then  UP 500 points, then DOWN 200 followed by another rally of 600! In just three weeks the Dow has gone from 11,500 to below 900 points. Surely, the wise thing to do is get OUT of the stock market, right? WRONG! At least, so says the richest man in the world, Warren Buffet, someone who should know a thing or two about smart investing.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Discussion Questions:

1. Why does holding cash seem like the smart thing to do during periods of volatile stock prices like the last month or so? Why does Mr. Buffet think that holding cash is NOT so smart?
2. Mr. Buffet’s advice is counter-intuitive to some. Buying more of something that is falling in value (American stocks) may appear unwise… but what is Buffet’s rationale for why buying now may in fact be the smartest thing for an investor to do?
3. Does the behavior of investors on the stock market reflect the behavior of consumers in a typical product market? In other words, do the laws of supply and demand apply to the stock market? Discuss…

FT.com / World – Air fares nosedive amid falling travel demand

Our IB and AP Econ classes here at Zurich International School have just begun our second unit of the year, where the concepts of Demand and Supply are introduced and the effect these have on prices is examined. The first assignment of the new unit was for each student to find an article discussing the demand for a particular good, service or resource, and post it to our Unit 2 wiki page.

If it’s ever unclear whether a change in demand for a good or a service can actually affect the price, the article linked here should make it perfectly clear that demand is a powerful market force. In an industry where it has seemed recently that prices only rise, a recent fall in market demand has driven prices downward, as firms have responded to consumer demand in order to sell their product, which in this case are seats on short and long-haul flights within and from Europe.

Falling demand for business and leisure travel is causing a marked decline in air fares, with UK fares to North America declining by nearly a half, according to American Express.

Air fares peaked earlier this year as a result of rising oil costs. But the slowing global economy has caused that to reverse.

The lowest economy class fares in Europe, the Middle East and Africa fell on average by 12.5 per cent in April to June compared with the first quarter, with long-haul fares down more than a quarter.

But UK fares suffered the sharpest falls, with the lowest economy fares down by an average of 20.2 per cent, including a 49 per cent fall in fares to North America and a 22 per cent decline in fares to Japan, Asia-Pacific and Australia.

Discussion questions:

1. What factors are driving demand for air travel down within, to and from Europe?
2. Why does the price of air travel fall as demand for air travel weakens?
3. Which other industries may have to lower their prices as fewer and fewer people travel between European countries and North America?

UN chief warns world must urgently increase food production – Yahoo! News

So you don’t say things that make you sound stupid to people who have studied economics, i.e. AP Econ students. Here’s UN chief Ban Ki Moon speaking at a UN conference in Ghana this week:

“One thing is certain, the world has consumed more (food) than it has produced” over the last three years, he said.

Ban blamed a host of causes for the soaring cost of food, including rising oil prices, the fall of the U.S. dollar and natural disasters.

He said he would put together a special task force to help deal with the problem and called on the international community to help…

“We need a real world and not the world of economic theories,” Ban said. “I will work on this right now with a sense of urgency.”

You know who says things like that? People who don’t understand the basic economic theories. Sadly, the theory Mr. Moon is missing here is one of our science’s most basic and simple to understand: that of supply and demand.

First of all, I’d just like to point out the absurdity of his first statement, that “the world has consumed more than it has produced.” Mr. Moon, I’d like to ask you this: If our world has not produced all the food we’ve consumed, then whose world DID produce it? Can’t we just call up the world where all the extra food we’ve consumed was grown and ask them to send us more?

Next, regarding Mr. Moon’s “task force” that he plans to form to deal with the problem, my question is this: What can a handful of bureaucrats accomplish around a table in New York that the market can’t do on its own? Rising food prices send signals to farmers who grow food; a signal that sends a very clear message: “GROW MORE FOOD!”

I’m sorry, but Mr. Moon and his “task force” can spend all the time and money they want brainstorming ways to get farmers to grow more food, but in the mean time the invisible hand of the market, guided by price signals sent from consumers to producers, will work its magic to allocate more resources towards food production and away from alternative uses of grain crops such as ethanol production, eventually shifting the supply curve of food out, stabilizing food prices.

Mr. Moon’s intentions are honorable, but his means of achieving his goal are misguided in an era of the market mechanism, which underpins most of the world’s agricultural economies today.

In recent years coffee consumers may have noticed more and more cafes are offering “fair trade” coffee as an option. Usually, for an extra 10 or 20 cents per cup, you can get a beverage made from beans that were grown by farmers earning living wages and working in safe and sustainable environments. In some cases, “fair trade” coffee is of higher standards, representing a higher quality product. The premium paid by consumers, in theory, will eventually result in better standards of living for coffee farmers and their families.

Mike Munger, chair of Duke University’s economics department, argues that “fair trade” products, while they may represent good intentions, probably don’t do much to help poor farmers. While the full podcast offers even more reasons, the clip below presents one clear explanation of why “fair trade” may actually make poor farmers worse off.

Munger on fair trade Play Now | Play in Popup | Download (117)

Another interesting point Munger goes on to make relates to one of the models of economic growth we have been studying in IB Economics: the Lewis dual-sector model of structural change. According to the model, the path towards economic growth, which should create conditions that lead to economic development, requires the transition of workers from the low-productivity agricultural sector to the capital-intensive, high productivity manufacturing sector.

China, in its own economic growth, has demonstrated the success of this model, which involved rural to urban migration, employment of surplus labor from the farming sector in the industrial sector, giving workers access to capital, increasing productivity, output, income, saving, and investment, putting an economy on a path towards growth and development.

According to Munger, “fair trade” premiums paid to poor farmers create a disincentive for a farmer to migrate to the higher productivity industrial sector that may be emerging in his country. In essence, coffee drinkers in the rich world are offering a subsidy to farmers in the poor world aimed at keeping them poor. If the path to wealth and prosperity requires the transition to a capital-intensive industrial economy, then subsidies to poor farmers are only reducing the likelihood that they’ll achieve significant increases in income and savings.

Munger’s views are compelling, if a bit hard for a socially conscious, well-intentioned coffee lover like myself to swallow. I like to think that I’m helping farmers in the developing world when I drink “fair trade” coffee. If anything, Munger has at least made me think a bit harder about the true impact of the premium I pay when I choose “fair trade” next time I walk into Starbucks.

For the full podcast, click here: Munger on Fair Trade and Free Trade – EconTalk with Russ Roberts

Well, not exactly, but that’s kind of a dramatic headline, isn’t it? The other day I blogged about the demand". Occurs when the price is below the equilibrium level, for example, when a government imposes a price ceiling in a market.');" onmouseout="tooltip.hide();">shortages experienced in the petrol market in eastern provinces, evidenced by the long queues at gas stations around Shanghai last weekend.

Petrol stations resorted to rationing their product in small doses (between 20 and 40 litres) as the price of oil hit $92 and Chinese refiners scaled back production due to rising costs that they were unable to pass on to their customers. Beijing had previously imposed a price ceiling on fuel in an attempt to keep inflation low and Chinese consumers content; the actual impact of this price control was predictable: not enough fuel to go around as the quantity demanded exceeded the quantity supplied, leading to shortages and rationing at the pump.

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