You’re in a real-life elasticity experiment

Partisans see what they want to in price signals, but economists are less sure

Everyone knows that when the price of something goes up, people tend to buy less of it.

The tougher question is how much less. Getting the answer right has always been important for retailers. High prices can result in an empty shop. Low prices can be equally painful as you read the red numbers on your profit and loss statement.

It’s increasingly important for government officials to get it right too. Governments are using price signals more than ever to steer citizen behaviour in the direction government wants.

For decades, governments discouraged tobacco and alcohol by whacking these products with taxes that dramatically increased their price. But nowadays it goes far beyond smokes and booze. Ontario has different prices for prime-time electricity compared to the middle of the night. London discourages downtown traffic with special tolls.

Canadian governments, including those in the Yukon, are currently grappling with several thorny price-setting problems. Should the carbon tax be high or low? How much higher should taxes boost marijuana prices to restrain consumption and generate revenue? And should the minimum price for labour — also known as the minimum wage — be boosted significantly, as many have recently recommended?

The concept of higher prices reducing demand is simple, but economists have done their best to complicate it by calling it “elasticity.” A good is said to be elastic if a price hike reduces the quantity bought significantly.

Take furniture. If, for example, a global particle board crisis caused furniture prices to double, people would buy a lot less of it.

Cigarettes, on the other hand, are inelastic. As governments have learned, they can raise the price of an addictive product quite high and people will still buy lots of it.

For now, the elasticity is unclear for carbon taxes, marijuana and labour. This may seem strange since they are such well known items.

However, carbon taxes are relatively new with just a few years of experience in places like British Columbia. Economists couldn’t test marijuana demand at different price levels very easily since selling it is still illegal and drug dealers don’t seem to like sharing their sales and price data. There have been more studies of the price elasticity of labour — the fancy way of referring to boosting the minimum wage — but even these have not been particularly conclusive since few jurisdictions make large and sudden changes for economists to track. Furthermore, there are so many other factors going on such as recessions, exchange rates, tax changes and new technologies that it is hard to tell what the exact impact of raising a minimum wage was.

Into this data void comes speculation, with commentators often predicting elasticities that suit their political beliefs.

Chambers of commerce say higher minimum wages will cause employers to cut jobs, i.e., that labour is elastic. Anti-poverty activists say it is inelastic and a higher minimum wage will result in just as many people working while getting paid more.

Some people seem to hold different views for different commodities. For some on the right, higher prices for labour will cause dramatic reductions in jobs, while higher fuel prices caused by carbon taxes are just a tax grab and won’t really reduce usage.

Sometimes the left seems to argue that the minimum wage induced price signal won’t affect jobs, but will be very effective at reducing use of fossil fuels.

So what do the studies say? The studies remain frustratingly unhelpful. But we have a few hints.

For example, Ontario’s experiment with time-of-day electricity pricing suggested energy usage may be relatively inelastic. This is even though the peak electricity price is 13.2 cents/kWh, double the off-peak rate of 6.5 cents/kWh. The Ontario auditor general found that 65 per cent of households did not change their consumption during peak periods, and another government report estimated the program had only reduced peak demand by a meagre 0.7 per cent.

B.C.’s carbon tax experience suggests fossil fuel demand may be slightly more elastic than electricity, but still not very responsive to price. The province’s carbon tax, which currently works out to about 6.7 cents per litre of gasoline, was introduced in 2008. In the five years following, per capita consumption of fuels subject to the carbon tax fell about 16 per cent. This is good, although some of the effect was probably caused by the major slowdown in the forestry industry around the same time. This shows some positive response to the price signal, but also suggests a much higher carbon tax may be needed to get us to achieve the major shift to renewable energy that climate scientists say is necessary.

On minimum wages, there have been many inclusive studies over the years. Quite a few have indicated that modest increases had little effect on hiring. However, a recent Seattle study suggested that significant increases in minimum wages can result in major losses of hours or jobs for low-income workers. Seattle raised the minimum wage significantly from US$9.47 per hour in 2014 to US$13 per hour in 2016 (and has announced plans to go to US$15 per hour). The study found that hours worked by affected workers fell nine per cent, more than offsetting the positive impact of higher wages.

However, as soon as this study was published, other economists pointed out methodological issues with the study. So the topic remains murky.

One thing to do is put yourself in the shoes of the decision maker and think about their alternatives. In this view, fossil-fuel usage is likely to be relatively inelastic. Yukoners don’t have convenient subways to take to work. Our houses are spread out and were often designed and insulated years ago. Electricity, the main alternative, keeps going up in price. A hike in gas or heating oil in the range of B.C.’s carbon tax, which is 6.7 cents per litre, seems unlikely to change behaviour dramatically.

It may take a long time, or a much higher carbon tax, to steer us to buy electric cars, walk to work or switch to electric heat.

Marijuana taxes may have to be low for the first few years. Demand for the product is probably relatively inelastic like tobacco, but buyers have access to a well-established black market that limits the effectiveness of a tax on legal marijuana.

Labour demand may be more elastic than the products above, at least for businesses with tight margins and where labour is a big part of the cost base. I’ve seen such businesses reduce staff levels or opening hours. In the longer run they may change their business models. If you buy groceries in Juneau, you’ll know that warehouse grocery stores don’t pay anyone to line up the cans nicely on the shelf. Gas stations and grocery stores in Whitehorse have already started replacing humans with electronic point-of-sale machines. At one local coffee shop, you press a button on a machine for your coffee. Big fast food chains outside are encouraging people to order by smart phone or at kiosks in the restaurant rather than from a human.

So what should government officials do? They want to send you price signals but don’t have full information on what the consequences will be. They’ll have to make decisions based on partial information.

In a way, we’ll all be participating in a giant elasticity experiment.

Next time you think about buying a gasoline-fuelled vehicle, a legal joint (maybe next year) or hiring someone, try to imagine if your decision would be different with or without the government’s price signal to you.

Keith Halliday is a Yukon economist and author of the MacBride Museum’s Aurore of the Yukon series of historical children’s adventure novels. He is a Ma Murray award-winner for best columnist.

economics

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