The Law of Diminishing Return

The article “The Diminishing Returns to Tobacco Legislation” by Pierre Lemieux ( The Laissez Faire City Times , March 19, 2001) discusses the law of diminishing returns in relation to the consumption of tobacco products by government intervention in the cigarette industry.

The article makes some interesting and valid observations. Government intervention is required to reduce consumption of tobacco products. From 1985 to 1995, the consumption of cigarettes is reduced by 18 percent by raising taxes to 52 percent. From 1995 to 1999, prices jumped by 48 percent but consumption was reduced by 11 percent. The taxation on the tobacco industry has reduced the use of cigarettes. The government also decided to use a different strategy to reduce consumption. The Canadian federal government passed regulation to put large panic pictures of diseased lungs, hearts, gums etc. on cigarette boxes. By making people aware of the health risks associated with smoking, the government tried to persuade those smokers who were not persuaded by the tax increases.

Lemieux also points out that government intervention becomes less effective and resistance will develop. People who can be easily persuaded have already quit with initial intervention. It will take a lot more effort to persuade the remaining consumers and some may not be persuaded at all. The author also states that too much information may also kill information. With information saturation, people will start to ignore the warning messages. Consumers are aware of the health risks of smoking from independent sources which are highlighted by the images on cigarette packs.

The law of diminishing returns does not seem to have been reached.  The tax increase of 5.2 percent per year has reduced consumption by 1.8 percent per year over 10 years.  The tax increase of 4.8 percent per year has reduced consumption by 2.75 percent over a period of four years. As the law of diminishing returns has not yet been reached yet, the government has decided to use panic pictures on the cigarette packs.

Governments discovered a long time ago that tobacco products have inelastic demand. Although raising taxes, called Sin Taxes, will increase tax revenue due to inelastic demand, people will still buy nearly the same amount of cigarettes. Governments will neither make tobacco illegal nor create a public utility as proposed by David Kessler, former head of the U.S, Food and Drug Administration (Lemieux). By making tobacco sales illegal, governments will lose the tax revenue from tobacco sales and will face the task of controlling a black market of tobacco products.

Source: 

Lemieux, Pierre. “The Diminishing Returns to Tobacco Legislation.”  

Retrieved on Oct 10, 2012 from

http://www.pierrelemieux.org/artdiminish.html

Income and Cross Elasticity

Chart 1

Canada has the second largest crude oil reserve, most of it in Alberta. It is also the third largest producer of gas in the world. As the economy grows, the demand for energy resources, such as oil and gas, increases. The oil and gas industry has the largest share i.e. 54% of the economy in Alberta as chart 1 illustrates.

The state of the industry is improving, even though there is lot of noise about the environmental impact. More money is invested in development and production as long as the price of oil stays reasonably high and the projects remains feasible.

The measurable elasticity of oil and gas demand is inelastic in the short run but elastic in the long run. In the short run, oil and gas become necessities of life and not many substitutes are available. But in the long run, the other technologies like propane, electric and hybrid cars need to be developed to reduce the reliance on oil. Gas-powered power stations needs to be powered with other energy resources or should be converted to wind power or hydro-electric if possible.

Sources:

 “Demand for Canadian heavy crude is soaring”

                Retrieved on Oct 06, 2012 from

http://www.albertaoilmagazine.com/2011/11/demand-for-canadian-heavy-crude-is-soaring

 “ Importance of Oil and Gas Investment in Alberta”

                Retrieved on Oct 06, 2012 from

http://www.finance.alberta.ca/aboutalberta/spotlights/2011-0708-importance-of-oil-and-gas-investment-in-Alberta.pdf

Elasticity and Revenue

The advent of 3D TV is showing the same trends as HD-TV in terms of demand and pricing patterns. The price range of 3D-TVs is between $1300 and $6000+ depending on the size of screen and other features associated with it. Analysts are predicting the revenue growth of 3D-TVs from US $13.2 billion to US $67 billion worldwide and shipments of 3D-TV’s set to rise from 50.8 million to 226 million by 2019.



The price elasticity of demand is used to see how consumer demand is sensitive to price change assuming ceteris paribus (other things being equal). Consumer demand is extremely sensitive to higher price elasticity, whereas lower price elasticity results in a consumer demand with low sensitivity. The price elasticity of demand is the ratio of percentage change in consumer demand to the percentage change in price. The average value of price and quantity is used to calculate the change in percentage instead of lower or higher value. High price elasticity results in consumers buying less. Consumers buy more when price elasticity is at a low level. 

If we assume, the determinants of demand are ceteris paribus then the consumer demand for 3D-TVs will be sensitive to price changes. In a recent article, Mike Wheatley states that “auto-stereoscopic 3D, which is widely used on games consoles such as the Nintendo 3DS and does not require glasses, is some years away from becoming a reality in televisions due to the technology’s limitations in larger display sizes”. With the advancement of production techniques and advances in technology, the price of 3D-TVs will come down. Consequently, more people will buy 3d-TVs and sales will increase. In conclusion, the price elasticity of demand is elastic at higher price points and becomes inelastic at lower price ranges. The trends in graphs 1 and 2 make it evident that when prices are elastic, total revenue rises. When prices are inelastic, total revenue falls.

The following data illustrates the relationship between price elasticity of demand and total revenue.



The modified data is selected to show the points of elastic, unitary, and inelastic demand, although the data may not be as smooth as in the real world.



Graph 1



Graph 2

Source:

“3D TV Predicted To Spur 3-D Revenue Growth”

Retrieved on Oct 11, 2012 from

http://www.hdtvtest.co.uk/news/3d-tv-revenue-growth-201210012242.htm

 

Determinants of demand

Demand is how much someone is willing and able to buy and hinges upon number of different factors. People will consider the price of an item and their income when deciding how much to buy. Real world situations are not as simple. There are other determinants which effect demand.

In many situations, price is the most fundamental determinant of demand. If all other things are equal then the law of demand prevails for most of goods and services. When people decide to buy goods or services, two questions come to their mind: What is the price? How much should they buy?

People also look at their income when deciding on purchases and ask themselves two important questions: What do we need? How much we can afford? Then the choice is made between normal goods and inferior goods. When income goes up the demand for normal goods goes up. When the income decreases, the demand for inferior goods goes up. For example, choosing between a taxi ride (superior product) and a transit ride (inferior product).

The change in a taste and preference of a product changes the demand for it. For example, if a celebrity recommends a product (e.g. The Oprah show) then the demand for recommended products goes up. On the other hand, public scares decrease demand, such as the decline in demand for beef products during the Mad Cow Disease crisis in 1996.

When people decide to buy, they tend to take into consideration the prices of substitute goods. For example if the price of butter goes up then people tend to buy margarine. For complimentary goods, the change in price of one good will cause the change in the complimentary good or vice versa. For example, the decrease in the price of video games will increase the demand for video consoles.

The number of buyers may not be a determinant for individual demand, but it is an important determinant for the whole market. An increase in the number of buyers leads to an increase in demand, whereas a decrease in the number of buyers leads to a decrease in the demand.

Today’s demand is also based on the future expectations of price, income, and prices of related goods. Consumers will demand more of a product today if they expect the price to go up in the near future. People will also consume more if their income is going to go up in the future and their jobs are secure.

The Diner City Game

The Diner City Game makes us aware of real economic principles. It is a perfect example of competition, which is one of the four C’s of the economic system. The premise of the game is that the restaurants compete against another restaurant.  In the real world, many businesses compete against each other. The game also shows us what the other restaurant is doing i.e. number of employees working or seats available. To manage the business, you must be aware of what your competitors are doing so that you can make correct decisions and remain competitive.

The Game shows the cost of opportunity, deciding between putting extra seats (Capital Assets) or hiring an employee (Factors of Production) or raising the revenue per customer (Revenue).The player has to give up something to gain another alternative. Also, the choices must be made between resources to maximize the revenue.

Production Possibilities Curve

The Production Possibilities Curve (PPC) shows the

graphical relationship of production between two products i.e. capital and consumer goods using limited resources. It shows the opportunity cost of a given product up against another product to illustrate the best product selection with the most benefits. The opportunity cost increases as we choose to produce more of a particular product.

In the PPC diagram Point G, inside the PPC, shows that resources are under-utilized and not efficiently used whereas Point H, beyond the curve, can be sustained only for short period of time. Advancements in technology push the PPC outward to PPC (A)  which shows that we can produce more products with same amount of resources such as combination Point B or D or any other possible point on Curve A. Technological improvements for both products shift the entire curve outwards.

Family income is a limited resource. Families try to allocate resources to fulfill their essential, everyday needs. They have to buy the basic necessities of life such as groceries and pay utility bills. Products such as HDTVs, computers, cars, cell phones and holidays as these all extend beyond the most basic needs. A decision process is often behind these purchases. For example: Do we need a holiday this year or can it be postponed till next year? Should we buy a car instead of using public transport? The choice is between two weeks of fun and relaxation or spending more than a couple of hours in transit every day. Ultimately, families must decide which expenditure is most beneficial to their lifestyle and needs.

For me personally, returning to higher education involved major decisions. The significant opportunity benefit to enrolling at SAIT is to further my career and job prospects in accounting. The opportunity costs to me are the tuition fees and time spent studying. Reduction in money and free time has resulted in sacrifices; this year I was unable to take a vacation. Ultimately, I think this was a great opportunity for me to go to college and study accounting, fulfilling a long-standing ambition.

Diagram source: Prentice Hall