PRICE ELASTICITY OF DEMAND FOR CRACK

Posted in Rants on June 18th, 2008 by Ed

When economists talk about elasticity and demand they are addressing a very fundamental question in a free-market system: how do changes in price affect demand? Finding the ideal point is an important component of profitability and growth for retailers and manufacturers. For example, Ford sells 100,000 pickup trucks at $25,000 (total revenue: $2.5 billion). If they increase the price to $28,000 and sell 5% fewer trucks that's a good move (total revenue: $2.66 billion) even though they sell only 95,000.** However, if the price increase reduced demand by 10 or 15 percent it would not be profitable.

This is not a revelation. You probably already know this, even if you are unaware of the fancy name. So here is a question I would like you to ponder: from the perspective of a crackhead, what is the price elasticity of demand for crack?

This is not a question that fits cleanly into the model. In a standard economic example (trucks, tennis shoes, tuition, fast food) there are a number of important assumptions being made. First, the items for sale are "wants." We can walk away. We don't really need the truck or the Big Mac. There is a price at which we will say "Screw this." Second, there is choice. If the Ford gets too pricey but we remain interested in a new truck, try the Chevy. Honda. Dodge. Whatever. In other words, the manufacturer and retailer must be wary of the strategies of other competitors in the market when developing their pricing strategy.

If the price of a Big Mac goes from $2.50 to $7.00, it is very likely that demand would fall precipitously. Consumers would choose Whoppers as an alternative or simply avoid eating out. But what happens if the price of crack goes from $25 to $50 per unit? Or $25 to $100? This is irrelevant to the demand among crackheads. If crack is $25, $50, $100, or $250, crackheads need, want, and will buy crack. They will either cut other expenses from their budget or steal more things to sell for crack. "Rational economic behavior" is not a phrase that springs to mind in the decision to purchase crack.

Why? Because crackheads are addicted to crack. Duh. The crackhead can't walk away like a car shopper or make a substitution. He or she needs crack. Not weed, not booze. Crack. So until crack gets so expensive that it is literally unaffordable (i.e., $10,000 per gram) the crackhead's demand is going to show remarkably little sensitivity to price. Sure, he or she may buy a little less, sacrificing something in the margins. But overall that person is still going to be buying crack, whether it's expensive or cheap.

Ending extended metaphor…..now.

The media and public have been harping on the same story for the last two years – what is the "breaking point" with gasoline prices? At what point will Americans stop using so much gas or snap and demand some sort of political/military/whatever resolution to the problem? First it was $3/gallon. My, when those prices hit $3.00 Americans would seriously change their driving habits. Then it was $4.00. We tolerated $3.00 but there's no way we'll maintain our lifestyles and relative calm at $4.00. Now it's $6.00. If it hits $6.00, everything's gonna change.

No, it isn't. We are completely, hopelessly addicted to oil. People who already use very little (preferring public transit, walking, or biking) will cut even deeper while most other consumers will dabble a little bit in the margins (trying to drive a little less and usually not succeeding). If you live in the suburbs, 30 traffic-clogged and train-free miles from your job, you're driving. Period. $6/gallon gas isn't going to get you to quit your job or sell your house. You're going to pay $6/gallon and compensate with sacrifices in other areas of your budget (or, in classic American style, by simply charging what you can't afford).

Everything about our way of life, including every step of the food chain, is hopelessly dependent on oil. There simply is no "magic price" that will make everything different and usher in sweeping changes. Crackheads pay whatever price is quoted for crack because they're physically addicted to it and have no alternative except quitting, which is as inconceivable as it is difficult. Americans, for all the bitching and resolutions to drive less and can't-someone-do-something-about-this water cooler talk, are ultimately going to pay whatever price is demanded for gasoline unless it simply becomes unaffordable under any reasonable circumstances (i.e., $25/gallon). So the next time you hear someone hypothesizing or making vows regarding the price of gas, remind them that our national addiction is going to preclude any response more substantive than bitching.

**This is logically assuming that it costs less than $0.16 billion, the difference in revenue, to build 5,000 extra trucks. Since most manufacturing costs are fixed (overhead, salaries/benefits, equipment) I feel safe assuming that it would not cost $160 million to build an additional 5,000 trucks.

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