supply and demand

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Demand for shopping bags is “extremely elastic” says Kellogg’s Marty Lariviere, commenting on the success of the District of Columbia’s recently imposed $.05 per shopping bag tax (on paper or plastic) to pay for cleaning the river. Already there’s been an average of 60 percent reduction in the number of bags handed out across retailers. Maybe the program is a failure then since it was designed to be a revenue generator and it’s not hitting its targets.

The river clean up fund had been anticipating raising over $3 million dollars this but has collected only $1.1 so far.

Lariviere chalks up the drop in bags to “social pressure”–presumably by environmentalists–as well as the low-cost of avoiding the $.05 tax (bring a bag!), but does this explain the huge drop in shopping bags taken. Bringing a bag was never an onerous task and $.05 per bag is still a drop in the bucket on a typical grocery bill. What seems at work here is a reference price of $0.00. Bags were always part of the grocery shopping experience and came to be part of the value a customer expected. With the new tax, customers couldn’t make proper comparisons to the cost of their old “free” bags because it wasn’t clear what those costs were. Lariviere notes that for some nice shopping bags the costs are well above $.05., so retailers are happy not to hand them out. But without making the price connection, customers felt nickel and dimed. And, as he argues, they could easily act on their outrage because the cost of avoidance is low.

Back to the first statement, though. Is shopping bag demand highly elastic? Here’s a thought experiment. Lots of stores sell shopping bags these days. Some of them, like card shops, even sell relatively plain bags with handles similar to what you would find at some grocery stores (like a Whole Foods). If the price of those bags went up $.05, do you think the demand would fall 60 percent? Another way to reinterpret Lariviere’s point is to say Yes, with the following caveat. Any once free good has a high elasticity when no longer free – even if the absolute price increase is tiny.

Writing the Journal of Marketing, Gadi Fibich, Arieh Gavious, Oded Lowengart devise a theory for this reference-dependent elasticity. Gated here.

The effect of reference price is most noticeable immediately after a price change, before consumers have had time to adjust their reference price. As a result, immediate-term price elasticity is higher than long-term elasticity, which describes the response of demand long after a price change, when reference price effects are negligible. Furthermore, because of the differential effect of gains and losses, immediate-term price elasticity for price increases and price decreases is not equal.

Caution: This argument is just a theory. But here’s another way to put it: When you suddenly realize there’s no such thing as a free lunch, that first paid one really hurts. Let’s see where shopping bag demand in the District is a year from now.

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How far has behavioral economics come?

Prospect theory now has its own facebook page, set up by Risk Psychology last April.

How far does behavioral economics have to go?

The page has three members. Supply and demand also has its own facebook page. Not sure when it was created, but there are 127 members, who seem to post items on the wall frequently.

For more on part I, click here.

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