Why Smoking is Taxed, Not Banned

Recently, I have been published in the Hunterdon County Democrat with an article related to economic theory on smoking. This article appeared on page B-6 in the September 22 edition.
The article is below.

Compliments and Substitutes

A consumer’s buying decisions are often affected by whether the product they are buying is a compliment or substitute to an existing good. A compliment good is a good which pairs well with an existing good, while a substitute good is a good which generally serves a similar function, and is therefore replaceable with, an existing good. Compliment goods are generally bought together, while substitute goods are often in competition against each other. Example of compliment goods include: milk and cookies, DVD players and DVDs, cellphones and cellphone cases, or cars and gasoline. Examples of substitute goods include: Coca-cola and Pepsi, chinese food and pizza, or Post cereal and Kellogg’s cereal. How is a consumer’s budget factored into this? If the price of a good increases, you are less likely to buy the compliment and more likely to buy the substitute. Conversely, if the price of a good decreases, a consumer is more likely to buy the compliment and less likely the buy a substitute. For example, if the price of DVD player becomes really low overnight, you will not only buy the DVD player, but also be willing to buy more DVDS because you have allotted a certain amount of your budget to home entertainment. Similarly, with substitutes, if the price of Coca-cola doubles, you are likely to be willing to drink Pepsi instead, even if you don’t prefer it as much.

Price Elasticity of Demand

Some products are naturally highly sensitive to a slight price changes, while other products remain almost completely unaffected by a large price change. Economics refer to this property of a product’s sensitivity to price as its elasticity. An elastic product is a product for which the demand is highly affected when a price change occurs. Meanwhile, an inelastic product is a product for which demand is somewhat unaffected when a price change occurs. In terms of a mathematical sense, an elastic good is one for which demand changes by more than one percent for every one percent change in price (again, displays sensitivity). An inelastic good is one for which demand changes by less than one percent for every one percent change in price (insensitivity). Following is examples and determinants of elasticity.
Examples of relatively elastic goods:
• luxury chocolates
• vacation
• technologies such as MP3 players
Examples of relatively inelastic goods:
• medicines
• gasoline
• electricity
• water
Clearly, elastic goods are generally luxuries while inelastic goods are logically necessities.

Here are some determinants of elasticity
• How badly you need it
• Substitutes (If Hershey’s doubles it’s prices, you’d be willing to settle for Mars, right?)
• Time factor (For example, a house is a long term purchase and it’s not an immediate necessity. If the prices of houses shot up, consumers would be willing to wait)

Public Relations And Why Established Companies Advertise

There are some brands that just stand out. For soda, Coca-cola tends to be a big name. For Cereal, Kellogs is the major player, and for a laptop, Apple or Dell is the “go-to” company. A big question that can come up, then, is why do established brands bother advertising? If you go to the store, chances are you already have the brand you’re planning to buy in mind; yet some already reputable companies spend millions of dollars for a thirty-second commercial (super-bowl!)- so how is that value determined? Well, the most significant reason companies like coca-cola still advertise is to uphold the public’s feeling of attachment to the product in order to continue the rate of revenue. This is known as sustaining or improving public relations, also known as PR. Public Relations are the reputation and perceptions of a company- how consumers view the product. For example, a commercial which evokes a sentimental feeling, laughter, or the “cool” factor will tend to be glorified in the eyes of a consumer. Companies can even create consumer pride if the PR is strong enough. For example, my dad is a die-hard apple fan. He pays to have Apple’s logo on hats, and he is willing to argue (rightfully) that apple macs are better than dell PC’s when discussing technology with a friend. Generating and maintaining this sense of pride (eventually translated into consumer-generated advertisement) is a difficult task, and one that takes quite a bit of work. So, next time you catch yourself arguing about how much better the Yankees are than the Red Sox, or Visa versa, consider the power of the PR that brand has built.

How Much Does It Cost You?- Explicit vs. Implicit Costs

How much does it cost you?
Generally, a person's first instinct is to respond by answering with the price. If it's social networking, such as twitter or facebook, it's easy to say "free". If it's an hour of tutoring, you might say $20. But if these are your answers, you're just accounting for explicit costs- a direct payment transaction. But it is also necessary to consider implicit costs- costs that might not necessarily be in the form of a direct transaction, but are still equally- if not more- significant. Examples of implicit costs includes an entity's opportunity cost. For example, twitter may be free, but for that hour you are tweeting, what else could you have done with your time? Babysit for $10? Read and acquire knowledge worth $5? Take a job for $15? Whatever the best alternative of your time is (your opportunity missed), is considered your implicit cost. While implicit costs are often hard to identify in terms of a pure cash transaction (how do you value acquired knowledge in terms of money?), they are ALWAYS important to consider.
Twitter may be costing you more than you think, so you probably shouldn't consider it a free service.

Diminishing Marginal Utility and Why the Demand Curve Slopes Down

In life, it generally holds true that the more of something you have, the less you value it. This property is referred to as Diminishing Marginal Utility. Diminishing Marginal Utility is an economics term which basically states that the more of good X you consume, the less the utility you will gain out of consuming the next unit of it.
While you might value the first sip of water after exercizing a lot, the twentieth sip will have almost no value, and at a certain point, you might actually not want any more.

(in this diagram: while the consumer is willing to pay six dollars for the third unit, they are only willing to pay four dollars for the fourth. this displays diminishing marginal utility)

Diminishing Marginal Utility serves as a great explanation as to why the demand curve slopes down for a normal good. As the quantity increases, the willingness to pay for the next unit of the good decreases as well.

It's a simple concept, but very useful when it comes to understanding the demand curve.


©2011. All rights reserved.

Quantity Demand vs Demand: Explained Through Example

Economists often use the terms “quantity demand” vs “demand”, and sometimes it is easy to mix up the two, so in the following blog-post, I intend to differentiate the two through an explanation and graph. While it is hard to understand the difference between the two by definition alone, I will explain through an example. Let’s take the perfectly competitive market for oranges, and assume each type of a given orange originally costs one dollar.

Scenario one: All of a sudden, a study come out saying that if you eat an orange a week, you will add 10 healthy years to the end of your life. clearly, the demand for this product will increase. Now, for the same orange, you would expect to pay more than a dollar. Or, you would expect to get a fraction of an orange in return for the dollar. Basically, you are willing to pay more, and, as a result, the demand curve shifts to the right. This shift in demand caused a shift in the whole line. As scene in the “ health research” example, a change in demand can be caused by preferences and tastes, and it can also be caused by expectations.

GHANGE IN DEMAND:

* There's a shift in the demand point, and the demand line *
Scenario two: The manufacturing cost increases for a company, and, as a result, the price changes. The supplier can now produce less, and the supply curve shifts to the left. Consumers still demand the same amount (quantity demanded goes down).

CHANGE IN QUANTITY DEMAND:

*There's a shift in the demand point, but not the demand line*

©2011. All rights reserved.