PRICE ELASTICITY OF DEMAND FOR CRACK

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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14 Responses to “PRICE ELASTICITY OF DEMAND FOR CRACK”

  1. j Says:

    This reminds me of the discussion I had in my high school Econ class regarding whether or not the price of gasoline was elastic. The textbook asserted that it was elastic, but my intuition told me otherwise and so I tried in earnest to convince the class that it was inelastic. The unqualified teacher relied on the omniscient textbook to prove me wrong. Ho ho, turns out I may have deserved a bit more credit.

    Your metaphor about the crackhead is all too apt. However, you fail to take the metaphor to the essential next step. The crackhead won't bitch about the price of crack; he will do ANYTHING in his power to get some. That's when armed robberies and murders happen in the ghetto; and that's when bombs start falling on Iran.

  2. mike Says:

    I think the decadent, my-god-it's-too-far-out-there-but-keep-going-man "double-album" of the uchicago 'everything can be explained by economic theory' moment is Gary Becker's "A Theory of Rational Addiction" (1988), which explains addictive behavior (drugs, smoking, overeating) using economic utility maximization models. Read a random paragraph, it's crazy fun:

    http://www.drugtext.org/library/articles/becker02.htm

    j – some argue that gas might be a giffen good – as price goes up, we'll purchase more of it, which is entirely possibly within a textbook/classical framework. (I doubt that's the case, but if you are an econ nerd, it's an interesting google search.)

    Personally, I'm worried that as people are looking to other transit possibilities, public transit is about to go bust as it is funded not really by fares, but by municipality's taxes, which are overextended anyway and going to collapse further due to the recession (not even to mention the increased $ in energy costs of providing said services). So when our local governments most need to be expanding these services, they'll be scuttling them to not go bankrupt. This is already happening.

  3. Liz Says:

    Hearsay, but I do know people who are trying to find jobs closer/ within walking distance/ on public transit from where they live (though they are not really succeeding thanks to the fact that they live in the suburbs or in towns like Bloomington or Ann Arbor), partially because of gas prices.

    Additionally (and I heard this on Marketplace, the economics equivalent of the NY Times Style Section, the journalism equivalent of making trends up based on reliable sources like These Two Dudes I Know), some towns are starting to build (or rebuild, in the case of Greensburg, KS after a tornado) using green/ sustainable/ anti-sprawl sensibilities, thanks in large part to gas prices, and similarly, people are thinking about mileage/ getting a hybrid when they purchase new cars. I agree that, in your metaphor, all of these things are like switching to ibogaine for a couple of weeks before hitting the pipe again, but there are tiny glimmers of hope.

  4. Michael Says:

    In the "tiny glimmers" category, I can see a core inelasticity built in — people are largely locked into their current jobs / neighborhoods — but changes in behavior do seem to be popping up: http://www.cnn.com/2008/US/05/26/gas.driving/index.html ("The Department of Transportation said figures from March show the steepest decrease in driving ever recorded. . . . Americans took 10.3 billion trips on public transportation in 2007, the highest level in 50 years[.]"). My sense is that there are meaningful ways to cut back on discretionary driving, or at least structure driving for maximum efficiency.

  5. J. Dryden Says:

    The metaphor breaks down, I'd argue, in that crack is an inherent evil, while oil is a economic necessity (unless you're a radical environmentalist.) As such, is it possible that government regulation–even nationalization–will be the inevitable result, as it was for trains and various aspects of the airlines?

  6. beau Says:

    j., i don't agree. for a start, introducing the notion of 'evil' into an economics discussion? whoa. but the metaphor works if you strip it back to basics. like so-

    "i'm addicted to crack, i must change this. if not for myself, then for the people around me. ah, fuck it, i'll just get some more crack."

    now replace 'crack' with 'oil'. oila.

    only difference i see is we ain't runnin' outta crack.

  7. mike Says:

    For those who are interested in urban planning and/or gentrification, I just saw a neat back-of-the-envelope calculation/argument that in the short run (and perhaps the long run) if gas increases costs a household in the suburbs $125/month (not unreasonable), they are now willing to bid up the price of housing close to transit lines or in cities to take that off their back – if they could get a house near transit for only $100 more, they'd grab it, and save the $25.

    It's crude, but it could explain how someone off a crappy stop on the CTA or Metra in Chicago (for instance), who was taking public transit and perhaps doesn't even own a car, could see his rent jump up $125/month (with this back-of-the-envelope $, make up your own!) even though he doesn't even drive. In gentrifying neighborhoods that could make a huge difference.

  8. J. Dryden Says:

    Sorry–my choice of word was poor. By "evil" I meant "inherently harmful and without compensatory benefit," not "immoral." My bad.

  9. Brian Says:

    Nice post. I guess I fall into the category that thinks the latest 'crisis' (it's not a real crisis yet) will be good in the long run. We need a wake-up call … people are talking about our dependence more and more … I hear conversations every day now. Before, we floated around blissfully unaware.

    Btw, i'm a geologist … I looked into the numbers for the recent lift-the-offshore-drilling-ban meme … it would give us about 15 years-worth of oil (and not for decades from now) … that's is. Check it here.

  10. Adam Says:

    To me, fuel costs are a nasty, twisty issue to parse out. Sure, if you look at rising fuel costs and diminishing supply from a long term view, you can see it as a net good leading to more efficient and less environmentally harmful forms of energy. But short term there's a lot of suffering going to be inflicted on the poor. The poor are always the ones to feel the full weight of any economic upheaval, and going from affordable gas to unaffordable in a few short years definitely qualifies as the mother of all upheavals. It's nice to think that everyone will be driving hydrogen cars and living in solar/wind powered homes, until you realize that many, many Americans can ill afford such technology and that although said tech exists, it doesn't exist in enough quantity to supply demand AT ALL. So guess how much a hybrid or hydrogen car is going to cost in such an environment?

    Additionally, for all you philosophizers out there, I ask this: What if in the long run the new fuels we use are worse? The next major oil supplies outside of the typical heavy crude wells scattered around the world are the oils that will be extracted from sands and other materials that were previously too inefficient (and thus too inexpensive) to mine. That's right, massive strip mines in Canada, Venezuela and wherever. What if the production of hydrogen is too friggin inefficient to power our needs? What then, nuclear power a la France?

    And all the while, as these minor niggling details are hammered out in policy meetings and think tanks, the average joe has to come up with some way to make a living so he and his family doesn't starve when fuel, power, and food become so prohibitively expensive that he can't afford any of them. When or if that ever happens currency will be unsound and the nation's power will lie solely in its military. And while this may sound like hyperbole, it's happened many times throughout history and there's absolutely no reason it couldn't happen here. We're already seeing inflation starting to take hold in every market, and the dollar suddenly seems like a bad investment to Americans and foreign buyers.

    Saying that this situation is a good thing is as overoptimistic as Bush's war on terror. This kind of thinking ignores the massive peril involved in economic change.

    But hey, maybe I'm wrong. Maybe this crisis will resolve itself in a clean, green America. But I won't hold my breath. History is not in our favor.

  11. Brian Says:

    Adam … you're absolutely right, the poor do always bear the brunt in the worst way. And they are already.

    How we power our world is THE problem of our time … it can't not be resolved … because the alternative is collapse. Maybe I'm optimistic, but I think we'll figure it out. But, that doesn't mean there won't be any hardship or suffering.

  12. grendelkhan Says:

    Demand isn't as inelastic as you think. A carpool with three people reduces total gas expenditure for commuting by two-thirds. How is that implausible? Demand may be plenty elastic, just not immediately; even if you rent, rather than own, it still takes months to relocate closer to your job, assuming you're not stuck in a lease.

    Adam: nuclear plants aren't necessarily a bad thing. Several current designs have the advantages of much higher efficiency in fuel use, no long-lived radioactive byproducts and passive safety. If the project hadn't been cancelled in 1994, we'd probably have some of them built by now.

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