Low Demand Elasticity Research Articles

Liquidity Effects, Monetary Policy, and the Business Cycle

This paper presents new empirical evidence to support the hypothesis that positive money supply shocks drive short-term interest rates down. We then present a quantitative, general equilibrium model which is consistent with the hypothesis. The two key features of our model are that (i) money shocks have a heterogeneous impact on agents and (ii) ex post inflexibilities in production give rise to a very low short-run interest elasticity of money demand. Together, these imply that, in our model, a positive money supply shock generates a large drop in the interest rate comparable in magnitude to what we find in the data. In sharp contrast to sticky nominal wage models, our model implies that positive money supply shocks lead to increases in the real wage. We report evidence that this is consistent with the U.S. data. Finally, we show that our model can rationalize a version of the Real Bills Doctrine in which the monetary authority accommodates technology shocks, thereby smoothing interest rates.

The pricing of water in a university town: An economic analysis of draining a cash cow

This paper analyzes some economic issues involved with the common practice of using metered water rate revenue to fund debt retirement associated with the provision of municipal water and wastewater services. We conclude that rather than simply raising the metered rate, city officials should seriously consider increasing the tax rate levied under the local property tax. There is an important trade‐off in the choice of a price policy. An increased property tax rate can result in tax savings to some home owners, which lowers their net expenditure for water. However, a corresponding decrease in the metered rate may increase water consumption, which in turn raises operating cost. In order to do what is best for home owners, it might make sense to give other customers (e.g., a university) an easy ride, even if the latter, because of its low (inelastic) price elasticity of demand for water, is viewed by the municipality as a cash cow.

Costs and Factor Substitution in the Provision of Local Fire Services

Evidence on costs and factor substitution is presented for a sample of local fire departments in New York State. The results suggest that fire service production does not fit either Leontief, Cobb-Douglas, or CES technology. In addition, exogenous socioeconomic variables are found to significantly affect public-sector costs and the estimates of factor price elasticities. The findings of relatively low factor demand and substitution elasticities suggest that local governments may have limited flexibility in adjusting their production of fire services to minimize the impact of rising factor prices. Copyright 1992 by MIT Press.

The Impact of a Gasoline Tax on Auto Exhaust Emissions

The EPA implements its policy of exhaust emission control by setting standards specified in terms of grams of pollutants per mile traveled. As a result, the tax must first restrain the vehicle miles traveled (VMT) if it is to have an impact on emission at all. EPA's choice of miles traveled as the medium through which its policy of pollution control must run is unfortunate, because travel is an activity that people resist giving up. This is reflected in a low long-run price elasticity of travel demand. Consequently, it takes substantial increases in the gasoline tax to make an impact on long-run travel demand. Simulation results show that under an alternative policy option, where EPA's standards are specified in terms of grams of pollutant per gallon of fuel burned, the same long-run reduction in exhaust emissions achievable today can be achieved (at an even higher level of confidence) with less than one-tenth of the increase in gasoline price required under the existing policy regime.

The Demand for LDC Exports of Manufactures: Estimates from Hong Kong: A Comment

In the March I 988 issue of this JOURNAL, Riedel claims that the findings of relatively low price elasticity of demand by 'the bulk of time series work' are based on the assumption of infinite price elasticity of export supply and that the demand parameters derived from a fully specified, simultaneous equation model strongly contradict the consensus view (on the basis of his results suggesting infinitely price elastic demand for exports of manufactures from Hong Kong). In this Comment, both of his claims and his results are disputed. The author's conclusion concerning infinite price elasticity of demand for exports can be objected to on at least three grounds: First, in the context of his formulation, it implies an abnormally large degree of 'money illusion' on the part of the importers of manufactures. Second, in using the inverse form of the demand function rather than the normal form he would necessarily produce a much larger estimate of price elasticity than otherwise. Using his approach, one can quite easily produce an estimate of the marginal propensity to consume in excess of unity or an implausibly large estimate of the marginal propensity to save. Third, infinite price elasticity is inferred from the statistical nonsignificance of the coefficient of export quantity in the inverse form of demand (which represents the inverse of price elasticity). However, it can be argued that the estimate of the coefficient of export quantity is not statistically significant because of the high intercorrelation (multicollinearity) between quantity and income. In view of the obvious upward bias involved in his approach to the estimation of price elasticity of export demand, it is not only possible but also most probable that the adoption of his approach will also yield very high estimates of price elasticities of demand generally. It is conceivable that one can produce a highly elastic demand for primary exports not only at individual country level but also at the world level, using his approach. If LDCs wrongly believe that demand for their primary exports is price elastic when in fact it is not, unwarranted expansion of production could cause a significant fall in their export earnings with grave consequence for their economic development. It is therefore most important to point out the weaknesses of his approach before it is widely adopted by other researchers keen to get high price elasticities of demand.

AGRICULTURAL EXPORTS OF DEVELOPING COUNTRIES: ESTIMATES OF INCOME AND PRICE ELASTICITIES OF DEMAND AND SUPPLY

This paper provides new evidence on income and price elasticities of demand and supply of agricultural exports from developing countries, on the basis of (a) a consistent and fully specified supply and demand model, and (b) statistical estimation procedures not frequently used in the estimation of agricultural export functions. Estimates of price and income elasticities of demand for aggregate agricultural exports for all developing countries taken together — as distinct from individual exporting countries — are found to be low; moreover, export price as distinguished from non‐price factors plays a relatively insignificant role in increasing export supply. Hence, an attempt by all developing countries to expand traditional agricultural exports with low price elasticity of demand may not yield rising earnings for all; but in fact may result in falling export revenues. Insofar as individual exports of all developing countries (not individual countries) are concerned, income and price elasticities of demand for such tropical commodities as tea, coffee, cocoa and bananas are also found to be low, except for new, non‐traditional exports like pineapples. This indicates the importance of diversification of agricultural exports as a vehicle for their future growth.

Explaining the growth of government in Sweden: A disequilibrium approach

Previous studies aimed at explaining the growth of government in a particular country have failed to distinguish between explanatory variables acting on the supply and demand side, respectively. Alternatively, they have tested one explanation at a time, implying explanatory equations that are misspecified. In addition, no allowance has been made for the fact that the interaction between supply and demand can hardly be assumed to be a self-equilibrating process, where the price of public goods and services adjusts to equate the two. Instead, a framework of disequilibrium seems more appropriate for the analysis of the growth of government. In this study we have identified a number of variables potentially important for the explanation of the growth of government. Each variable was either classified to pertain to the supply or demand side. In the empirical estimations we applied a disequilibrium maximum likelihood method, capable of accounting for the fact that we cannot expect the market for public goods to clear in each period. This method has the further advantage that we are not required to specify a priori whether we are in the supply or demand regime. Concerning the results, our regressions point to the importance of fiscal illusion, notably illusion resulting from an underbalanced budget, and bureaucratic pressure for a larger public sector as the two most important determinants behind the observed growth. A high demand for income redistribution is also found to be an important factor, especially behind the growth of transfers. Furthermore, Baumol's Disease in combination with a low price elasticity of demand seems to contribute strongly to the growth of government consumption. Finally, there is a tendency for coalition governments to let the public sector grow faster than does a one-party government.

The Boll Weevil Versus “King Cotton”

The boll weevil's impact on southern agriculture poses a dilemma. Micro-level evidence suggests the weevil triggered a transition out of cotton, but macro-level indicators fail to register much long-term impact. Econometric simulation of boll weevil impact—taking into account the low demand elasticity for southern cotton, differences between states in the timing and levels of infestation, and long-term supply and demand shifts independent of the weevil—shows that the two sets of evidence are not inconsistent.

On the Commodity Power of Less Developed Countries

Primary commodities dominated by LDC producers have very low demand elasticity, but the latent market power is often said to be unexploitable by cartelization (despite the success of OPEC) because cartels are vulnerable to erosion of market share. By appealing to the plainest possible model, this paper establishes that this vulnerability is grossly exaggerated when resort to a strategy of entry deterrence is overlooked. Informal considerations are then adduced to show that exogenous factors can play an important part in both the launching and continuation of a cartel. The inefficiency argument against cartelization as a means of income redistribution from DCs [developed countries] to LDCs [less developed countries] is questioned. The primary commodities of which the LDCs are the dominant producers have extremely low price elasticities of demand, typically in the range of -0.2 to -0.5. The latent market power which LDCs possess with respect to these commodities is therefore formidable, but to take advantage of it they must cartelize. Yet the conventional wisdom which emanates from numerous economists in developed countries (DCs) is that LDCs cannot gain from cartelization. OPEC is viewed as a unique exception or its gains are conceived as short-lived or (at the bizarre end of the spectrum) it is supposed not to have any influence because, despite appearances, the market rules. The main argument which underpins the conventional wisdom is that price enhancement by a cartel will activate alternative sources of sup

Markup Pricing and the Auto Industry: A Partial Explanation of Stagflation in an Oligopolistic Economy

Abstract. Price leadership firms and especially wage leadership unions frequently are not operating at points of maximization in the neoclassical sense, because contrived high level demand has brought low price consciousness or elasticity of demand for their commodities or services. Accordingly, they can get higher profits or wages anytime they choose to raise their price except during severe recession. If output falls as a consequence, goveniment and the central hank have stood ready to expand total spending. The contrived high demand has interacted with oligopolistic practices to obviate the distinction between elasticity for the firm and that of its industry, with empirical studies showing demand elasticity commonly not much above unity. The automobile industry is the focus of attention in this study. It appears that stable and high employment market capitalism no longer is possible, because at a minimum t requires generalized maximization behavior, which involves operation against constraining supply and demand parameters.

Expansio ad Absurdum

In 1977 I had the pleasure of Wolf Hafele's hospitality at IIASA while writing Soft Energy Paths. I have since been following his group's activities and looking forward to seeing what their protracted and costly energy study might produce. Already being extensively publicized as a careful, comprehensive, and objective assessment of long-term energy options, valuable for both policy makers and their constituents, the IIASA study is being given considerable credence by the credulous, and often the benefit of the doubt by those too busy, bemused, or inexpert to dig into its bulky technical details.

Subsidies and Basic Needs

SUMMARYThe paper examines the case for subsidies as a means of helping to meet basic needs, as compared with the direct support of incomes. In general, subsidies are justifiable where markets do not work well, where increased consumption provides external benefits, and where subsidies can be administered non‐selectively. This is most likely to be so with goods and services with a low income elasticity of demand among the wealthier members of the community. Food subsidies in particular, even if non‐selective, can be of help to the poor (although account must be taken of their impact on wages and employment). But where the income elasticity of demand for a good or service is high, non‐ selective subsidies will be regressive in their effect, while selective subsidies will favour only those with access to them.RESUMENSubvenciones y necesidades básicasEste artículo examina la solución de las subvenciones como medio de ayudar a satisfacer las necesidades básicas por comparación al apoyo directo de los ingresos. De manera general las subvenciones se pueden justificar allí donde los mercados no functionan bien, el consumo acrecentado ofrece beneficios externos y las subvenciones se pueden administrar de manera no selectiva. Esto suele ocurrir con las mercancías y servicios con la elasticidad de demanda de bajos ingresos entre los miembros mejor acomodados de la comunidad. Las subvenciones de alimentos en particular, aunque no sean selectivas, pueden ser gran ayuda para los pobres (si bien se deberá tener en cuenta su impacto en el sueldo y en el empleo). Pero en los casos en que la elasticidad de la demanda de los ingresos respecto a una mercancía o servicio sea elevada, las subvenciones no selectivas será regresivas en sus efectos, mientras que las subsistencias selectivas favorecerán solamente a aquellos que tengan acceso a las mismas.RESUMESubventions et besoins fondamentauxL'auteur examine le cas des subventions comme moyen d'aider à satisfaire les besoins fondamentaux, par opposition au soutien direct des revenus. En général, les subventions sont justifiables là où les marchés ne fonctionnent pas bien, où la consommation accrue fournit des bénéfices externes, et où les subventions peuvent être administrées non sélectivement. Ceci est d'autant plus probable avec des biens et services pour lesquels la demande a une élasticité de revenus basse parmi membres les plus riches de la communauté. Les subventions d'aliments en particulier, même si non‐sélectives, peuvent être une aide pour les pauvres (il faut cependant tenir compte de leur effet possible sur les salaires et l'emploi). Mais là où il y a une élasticité de revenus élevée dans la demande pour un bien ou un service, les subventions non‐sélectives auront des effets régressifs, tandis que les subventions sélectives ne favorisent que ceux qui y ont accès.

Economies of Size in Processing Manufactured Dairy Products and Implications for the Southern Dairy Industry

Fluid milk marketing is characterized by daily and seasonally fluctuating raw milk production, variable fluid processing schedules and seasonally fluctuating consumption patterns. These conditions, plus the perishable nature of the product and a relatively low short-run elasticity of demand for fluid milk, are generally considered to be factors requiring volume of Grade A milk available to an area at any given time to exceed the amount actually consumed in the fluid form—if the market is to be characterized by a reasonable degree of price stability. This excess is often referred to as the minimum or “necessary” reserve. The volume of excess milk available may be greater than this minimum, however, as a result of other factors such as classified pricing or producer prices above equilibrium levels.

Factors Affecting College Attendance

Factors Affecting College Attendance

Analysis of the Accuracy of USDA Hog Farrowings Statistics

OX AND OTHERS [4, 7] report that government statistics and price forecasts exhibited numerous shortcomings during the volatile economic conditions of 1973. Fox suggests that substantial infusions of money and effort will be required to develop a forecasting system that will perform satisfactorily under current conditions. Undoubtedly changes in government statistics and forecasts are needed. However, such changes should be carefully made, else good statistics will be discarded along with the bad. Hopefully, careful evaluation of shortcomings and strengths of each statistical series will precede any changes in the series. This paper represents an effort at such an evaluation for the USDA hog farrowings intentions report figures. This series was selected for study since the price elasticity of demand for hogs is low and errors in these statistics could cause large, unexpected, and disruptive price changes. Other series, especially those for other commodities with low demand elasticities, also might be evaluated using similar techniques. The quarterly 10-state farrowing intentions figures which were examined for accuracy in the study are released by the Statistical Reporting Service (SRS) in the Hog and Pig Report [10]. The initial report of farrowing intentions for a given quarter is issued by SRS about three months before the start of the quarter. Next, a revised report of quarterly farrowing intentions is issued early in the quarter to which it applies (referred to as first revision in study). Finally, in the next quarter SRS reports the actual number of sows that farmers did farrow during the quarter (referred to as second revision in study). In the study the accuracy of farrowing reports from September 1959, when 10-state' quarterly forecasts began on a continuous basis, to March 1973 was examined. During this period the SRS used three separate types of surveys to make forecasts: Rural Carrier Route Survey (RCRS), Probability Mail Survey (PMS), and Multiple Frame Survey (MFS). Thus, the analysis made a general evaluation of the accuracy of the farrowing reports as well as a determination of whether the changes in survey techniques resulted in increased accuracy. The Rural Carrier Route Survey (RCRS) covered the time period from September 1959 to March 1963. The survey included 10 states. The mailman was given survey cards to deliver on his route to farmers raising hogs. The farmer was asked to fill them out and return them by mail. The major survey took place every six months, June and December. In March and September a subsample of the farmers who replied in the previous survey was resampled. The Probability Mail Survey (PMS) covered 10 states during the time period from March 1963 to March 1970. The sample of farmers was drawn from the state farm census or a list from the ASCS office.

Incentive Policy and Supplies of Energy Sources

HE OCCASION for this session is the socalled energy crisis in the United States, and it is well to begin with a statement of my perception of it. As I see it, the crisis represents a present and prospective excess demand for energy, particularly for energy derived from oil and gas, which apparently cannot be eliminated without sacrifice of one or more present objectives of public policy, specifically security of fuel supply, environmental protection, and stable living costs. The crisis arises out of an increasing supply price of oil and gas from domestic sources accompanied by general and specific price regulation, oil import restrictions, and growing efforts to prevent environmental damages (e.g., from the burning of high-sulphur coal), and is complicated in the short run by very low supply and demand elasticities. If one takes seriously the objectives of security of supply and environmental protection and distinguishes between regulation of individual commodity prices and control of the general price level, as I do, then it is clear that the solution of the problem called the energy crisis involves either higher absolute and relative prices for oil and gas or the creation of artificial non-price incentives to increase the supply of or decrease the demand for these energy sources. The topic assigned to me is incentive policy on the supply side. I shall concentrate on oil and gas, discussing both price and non-price incentives. Of primary concern will be present incentive policy as it would be modified by the proposals of President Nixon in his message to the Congress of April 18, 1973 [13]. I shall try to appraise both qualitatively and quantitatively the supply effects of the President's proposals and the remaining special tax incentives affecting oil and gas production. In the message referred to, President Nixon announced three pertinent actions taken on his own authority. These were the abolition of the old quota system of limiting oil imports and the substitution of a fee-for-imports system, delay in the imposition of certain environmental protection standards that would limit the burning of high-sulphur coal, and acceleration of the rate of leasing of prospective oil and gas lands in the Federal domain on the outer continental shelf. He additionally proposed to the Congress legislation to free gas in interstate commerce from price regulation, to facilitate construction of the Alaskan pipeline, to extend the investment tax credit to expenditures on exploratory drilling for oil and gas, to facilitate the siting of deepwater ports and nuclear power plants, to encourge various measures of energy demand reduction, to initiate an oil shale leasing program on a pilot basis, and to double the rate of Federal financing of research and development in the energy field. Most of these actions or proposals affect demand, call for governmental in lieu of privat action, or merely facilitate private action induc d by existing incentives. Those that do (or would) have new incentive effects are the change i the import control system, the freeing of gas from price control, and the extension of the investment tax credit to exploratory d illing. It is the latter that I shall discuss, together with the remaining tax incentives affecting oil and gas production.

Farm Income and Labour Mobility

presented new hypotheses or elaborated earlier ones as events or arguments have demonstrated the inadequacies of previous explanations. However, while convictions on this issue abound, the basis for consensus has receded with the increasing complexity of the issues. Indeed, Professor Tweeten [10], a recent and major contributor to this cause cilbbre, expresses some agnosticism about the relative merits of the theories advanced to explain persistent low returns in agriculture, and even discusses the possibility that the problem is a figment of the imagination of agricultural economists.' In view of the significance of conclusions on this issue for hypotheses on farm income and labour mobility, and hence for the design of research programs and for the development of agricultural policies, thorough examination of the low returns problem is not merely necessary but crucial. In the first half of this paper the resource returns problem is discussed in a general context; in the second, attention is focused on the situation and prospects regarding incomes and employment in Canadian agriculture. I do not propose to discuss the naive thesis that agricultural output expands rapidly as a result of technological change, that given low demand elasticities for farm products, farm product prices and resource earnings are driven down, and that farmers respond by adopting more output increasing technology. While this thesis still has currency among laymen and with some professionals, its weaknesses have been dealt with admirably by Hathaway and by Tweeten [6, 10]. In much of my discussion I draw heavily on Tweeten's contributions. I make no apology for this since, to my mind, his article is by far the most rigorous and comprehensive examination of the low returns issue.

The Subsidy Problem in Hospital Insurance: A Proposal

Hospital insurance plans that lower the price of care to the consumer provide, in effect, a per unit subsidy.' As is well known, this results in an allocative distortion, assuming that the initial position was one of full competitive equilibrium.2 The allocative distortion induced by a subsidy will be less, the lower the price elasticity of demand is for the commodity. Since demand for hospital care is generally assumed to be price inelastic, economists have evinced relatively little concern about hospital insurance arrangements. For example, Pauly says: Insurance is more likely to be provided against those events (a) for which the quantity demanded at a zero price does not greatly exceed that demanded at a positive price.... [This] statement might be made with respect to ordinary hospitalization insurance.3 This notion of relatively low price elasticity of demand for hospital services is also reflected by different coinsurance provisions in Part A and Part B of Medicare. Part A, which insures hospital services, has no coinsurance provisions, while Part B, which insures physician services, has a 20 percent coinsurance feature. While the quantity of hospital care demanded may be relatively price inelastic (in that the individual who needs an appendectomy performed will be relatively insensitive to price in the range of one appendectomy), we suspect that the demand for quality of care may not be so inelastic. That is, many individuals, if they had to bear directly the differences in cost between treatment in an expensive major medical center and treatment in a lower-cost institution, would opt for the latter more often than they do under present insurance plans.4 We present evidence in support of this hypothesis elsewhere. The evidence is of the form * Any views expressed in this paper are those of the authors. They should not be interpreted as reflecting the view of the RAND Corporation or the official opinion or policy of any of its governmental or private research sponsors.

International Trade and Economic Development

A Recebt study by the U.N. Secretariat provides ample proof, if further proof were needed, that the problem of the economic development of the low-income countries cannot be solved without these countries becoming not only producers, but also exporters of manufactured goods, on an important scale.1 At present 86 per cent of the exports of the ‘developing countries’2 consists of primary products, and only 14 per cent of manufactured goods. But the world market for primary commodities expands only slowly, owing to the low income elasticity of demand. This is partly due to the low income elasticity of food consumption in the wealthy countries and the rapid growth of their own agricultural production, and partly to economies in the use of materials in industry and the development of synthetics. Since 1938, the volume of trade in manufactures has more than trebled, while the volume of trade in primary products has increased only by two-thirds.

Development of a New Approach to Forecasting Demand

Low income elasticity of demand for food and decreasing variations in consumption due to degrees of urbanization have depreciated the usefulness of income and urbanization for forecasting demand. This article reports some preliminary investigations and reviews earlier research pertinent to the possibility that moderately high income families may act as forerunners of changes in demand and consumption. Also, the author outlines a preliminary conceptual framework for analysis of family consumer behavior. Measurement of the interrelationships indicated by this framework may provide valuable clues for forecasting changes in the way Americans will live as they respond to a wide range of economic, technological, and social changes.