No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Three: Demand 75 gas goes up, we simply pay it—since we have little alternative. Over the longer term, there are options to reduce gasoline usage such as buying more efficient cars. The blue demand curve is more elastic, and the quantity demanded is greatly affected by the price. A product that might fit this type of demand curve could be fountain drinks at 7-eleven. There is not a great deal of difference between a fountain drink at 7-eleven and a fountain drink at any other convenience store (although their marketing department may want you to think so!). If 7-eleven raises their prices while others keep their prices the same, many of their customers will switch (especially those just dropping in for a fountain drink). As a memory trick, it may be helpful to note that an inelastic curve is more vertical like an “I”, whereas an elastic curve is more horizontal like the horizontal parts of an “E.” So what determines whether a product is more elastic or inelastic? I’ve already mentioned a couple of factors, but let’s go a bit more in-depth. First, demand curves tend to be more inelastic in the short term. People are creatures of habit and continue in their shopping patterns for a period of time even with prices hike. In some cases, they may not have many short run options, such as our gasoline example. But in the long run, they can change their behavior. Another example is blood pressure medicine. If the price is hiked, there are not a lot of short-term alternatives; but in the longer term it might make sense to exercise more and eat better so one doesn’t need medicine. Of course, it makes sense independent of the price hike, but perhaps this will influence the behavior. Remember, incentives matter! Another factor is the closeness of substitutes. Sometimes this is related to the first issue of time; consumers may not be as aware of other alternatives when the price is lower, but as the price rises, they begin to look for and consider other options. My wife, for instance, doesn’t believe there are any substitutes for Heinz brand ketchup. But if the price rises high enough, she may very well consider alternatives. Of course, given how little we spend on ketchup, it might take a very dramatic price rise for her to consider substitutes. This is our third factor influencing elasticity, or how much of our budget we spend on a good. Goods that consume a larger portion of our budget tend to be more elastic; we’ll look for opportunities to save money when a large budget item’s price goes up. Because it takes a large part of the budget, the opportunity cost of an increase in price is relatively large, so we have an incentive to “shop around.” Goods that consume less of our budget will tend to be more inelastic, since even if the price rises there is little opportunity cost. We tend to not to see any impact on our overall budget and thus don’t change our behavior.