2/15/2015

The perpetual motion of supply and demand

From an educational standpoint, it is understandable that supply and demand is taught in a such a way that the increase or decrease in the supply of product A increases or decreases the demand of product B without any further advancement of the topic. It may seem more complicated due to multiple variables, but I believe that people would get a better understanding of supply and demand if they are shown how one individual product can have a seemingly endless effect on a multitude of other products.

Starting with a simple example, this article shows that the increase in the cost of one product decreases its demand and directly affects the supply of another product. The increase in the price of corn has decreased the demand of corn from beef producers. Beef producers have decided that it is not worth the investment in corn, for feed, so they have decreased the number of cows that they raise leading to a decrease in the supply of beef.

The decrease in the supply of beef has led to an increase in beef prices which has steered consumers towards other products, like chicken. This increase in the price of beef has led to an increase in chicken consumption showing that chicken is an inferior good. Meaning that if the price of chicken and beef were the same, based on weight, consumers would prefer beef. The price of corn has begun to stabilize, even decreasing a little, and it will be interesting to see how quickly consumers will see an increase in the supply of beef which will lead to a decrease in the cost of beef. Have consumers gotten comfortable with chicken or will they switch back to beef in droves? This will really tell us whether chicken is an inferior good.

7 comments:

Dave Tufte said...

Bruce: 100/100

:) There's a book called "Economics In One Lesson" by Henry Hazlitt. It's widely criticized by people who don't like its implications. Even so, the big picture idea that it's trying to present is that people don't think through those secondary and tertiary connections of economics actions. So, you're in good company.

I can see what you're trying to say about chicken, but that doesn't make it an inferior good — at least by the economics definition.

I do think that your logic is correct: eventually the market for chicken is affected by shift variables coming from the other markets. The thing is, chicken is probably more seriously affected because it is a substitute for beef, rather than because the increase in beef prices make people feel poorer so they buy more chicken.

The text we're using is unusual for an MBA one in that it's put that stuff about substitution and income effects in early and heavily in Chapter 4 (some books wouldn't even include those topics at all). The reason that formal breakdown exists is because it isn't that easy to tell from a narrative approach like this whether or not chicken is in an inferior good. It really does require the extra math, and this text at least points you in the right direction to figure this out.

Andy Dufresne said...

As a poor little pork farmer, I feel left out of this conversation entirely. And I disagree with your contention that this is a simple example of supply and demand.
There seem to be many more variables that you are ignoring in this situation than we can cover in this blog (inputs such as prices of feed, cost to get food to market, climate change), and that is before we even start to contemplate the substitution effects between beef, pork, and chicken. It’s easy to think that since beef, pork, and chicken are competitors for the shopper’s food dollar, then we should observe clearly positive cross price elasticities between them. But this has not always been the case, since there have been negative elasticities observed in the past between both beef and chicken, and beef and pork (http://ageconsearch.umn.edu/bitstream/32518/1/10010116.pdf). If this controversial research is correct, then this would suggest a possible complementarity between these meats.
This seemingly clear supply and demand relationship may be nothing more than just a function of expenditure. And expenditure “elasticity” might be a better explanation for what behavior we see at the grocery counter. Perhaps consumers just look at the prices of all three meats and make a spontaneous decision on what to purchase with the money they have on hand based on behavioral economics? This may be biased even further in our state since many people have an additional substitute: venison. It gets tricky when we try to explain these relationships but I guess as economists we have to start somewhere.

Dave Tufte said...

Andy Dufresne: 50/50

My contention, or the one in Bruce's post?

I like the article you found, and don't find it controversial at all. I don't usually like to call research dated, but I do wonder about this one given all the conflicting dietary advice Americans have gotten over the last 40 years.

I also think you're right that there are way more variables involved than we're prepared to discuss here. Probably more than in the article you referenced too. You're also right that you have to start somewhere.

Even so, elasticity measurements are supposed to correct for as many of those effects as we can gather data on.

I probably sound like a cad who's backtracking on this, but I've always tried to teach that elasticity isn't something you assume, but rather a measurement that you incorporate into your theory. So in this case I'd defer to what your article says.

I am not sure that the behavioral economics point has much relevance here. I have no doubt that this explanation is relevant for individual decisions, but I think it may tend to even out when aggregated across many individuals. And that's the data on which elasticity estimates are based.

FYI: There's one problem with word usage. Economists usually don't use "complementarity" to describe the relationships between different goods bought, since the word is used in a different context in understanding firm's pricing decisions.

P.S. Do you really raise pigs?

Sebastian said...

I love the chain reaction characteristic of this post. In our assignments, we are able to calculate the cross-price elasticity between two goods. While this is a great tool, I think it is interesting to broaden our view to span various industries as you have with this article. With summer approaching, I'm itching to get back out on the lake with my wave runners. The gas prices last summer prevented my wife and I from taking them out as much as we would have liked. We often stay in a hotel close to the lake; I spoke with the owner and he reported an uncharacteristic decrease in patronage during the peak tourist season, citing a month-long spike in gas prices as the culprit. The low oil prices we have recently enjoyed result in lower gas prices, allowing vacationers to afford more frequent trips, leading to increased revenue for tourism-related businesses. The dip in oil prices spans multiple industries, moving from oil refineries to gas stations to hotel owners. This story illustrates the connectivity between seemingly unrelated industries. I, along with many hospitality firms, am hoping that these favorable prices continue through the summer, allowing for more fun in the sun.

Cam said...

It is hard for me to see chicken as an inferior good. To some it may be, but I think that for the most part it is personal preference. I know people who have decided to avoid red meat, making chicken and pork their preference. Since I think of beef as beef and chicken as chicken rather than substitutes for each other, I’ll draw another item up for question.
Beef has many uses. One of which is ground beef for hamburger and casseroles. A product people will use instead of ground beef is ground turkey. My initial thought was that turkey is the clear inferior product. My behavior is to use turkey when I can’t afford beef. My lower income increases the sales of ground turkey. Also, in my experience serving at a food pantry, ground turkey was handed out because it was cheaper. Food pantries act as though they have little income so they can spread what they have farther. I am unaware of health benefits of turkey over beef, but I am sure some prefer turkey.
Since I don’t eat chicken steak or beef fingers, I figured this may be a more apples to apples approach.

Dave Tufte said...

Sebastian: 50/50

You are right that elasticity, while interesting, is not technique that readily extends itself to the network of connections often seen in the real world.

Of course, it's like a mission in life for economists to get others thinking about the secondary and tertiary impacts of their choices, so we put up with the headaches.

There are two avenues we use to get around this problem. What you're recognizing is that a lot of what we do, both in class and out, is partial equilibrium economics. This means we assume everything else sits still while changes take place in the market of interest. But this isn't usually the case.

The old school way of dealing with this is with something called an input-output model. You still see these in regional science software from time to time.

The newer way is to do general equilibrium analysis. Basically, you build a bunch of markets with supply and demand and then connect them together so that when one changes they all do.

Both of these are way beyond what anyone does in MBA programs, but there are Ph.D.'s working for big firms and government that use them all the time.

Dave Tufte said...

Cam: 50/50.

Part of what you're supposed to gather at the MBA level is that we don't "decide" whether something is an inferior good. Instead, it's a result of a statistical measurement from a widely used technique. So I think we should believe the numbers (although the ones cited in this article are from before the boom in chicken consumption in the last quarter of the 20th century).