Economics 101

There are some basic economic principles taught in elementary economics, among them the concept that at an equilibrium price supply and demand will be equal. In this simple model if supply contracts while demand remains the same, the price will rise until there is a new equilibrium. In real life it doesn't always work that way as changes in either supply or demand don't result in equivalent price changes. The economic principle is of price elasticity. If consumers continue to buy the same amount of a commodity at a higher price, the price is said to be inelastic. A case in point is gasoline: a price increase this year in the range of 35% appears to have reduced demand by around 3.5%, a reduction but clearly an example of price inelasticity.

Politicians seem not ever to have taken Economics 101. The Maryland legislature earlier this year faced a substantial budget deficit. So one of the measures taken to address the issue was to raise the tax on a pack of cigarettes to $2.00. Now they discover that cigarette sales in the State have fallen 25% compared to last year and that their assumption of physical sales volume remaining the same despite the sharp increase in price was, to put it mildly, flawed. If one assumed that the sales decline meant a reduction in smoking you could at least assign a health benefit to the measure. What is more likely, however, is that smokers are buying their cigarettes out of state: the neighboring Commonwealth of Virginia imposes only a 30 cent tax per pack. So now the Maryland politicians are calling for policing the border to make sure that no one has bought more than 3 packs out of state. In New York City where very high cigarette taxes were also imposed, it is estimated that 75% of the cigarettes consumed come from outside the city. High cigarette taxes in some jurisdictions within a common market, e.g. the United States, in which other members impose much lower taxes is a blatant invitation to smuggling and political jawboning won't stop the illicit flow of goods.

A similar disregard of the economic laws produced the "gray market" many of us have taken advantage of. Manufacturers, especially of pharmaceuticals and goods for personal consumption devised a strategy of differential pricing. One, high, price for the US market and other, usually lower prices, for foreign markets, like Europe. But the entrepreneurial spirit lives and selected merchants discovered the price differential for many items was large enough to allow purchase in Europe followed by shipment to and resale in the US at prices undercutting the manufacturer's list prices but still profitable. The manufacturers screamed and demanded the US government deny imports from "unauthorized" dealers. Now with online purchasing prevalent it's extremely hard to maintain differential pricing.

People in general are not "economic men" making their decisions based on carefully calculated economic principles, but governments, corporations and people discover eventually that you can ignore economics but only to a degree and for a limited time before the consequences catch up. Today there is an electric power shortage in China: electric prices are kept below economic rates by the government to keep costs low for consumers, but coal prices go up and electric power companies even in China are reluctant to buy more coal just to lose money selling electricity. Future economic growth is threatened. What's a government to do? Let electricity prices rise? Subsidize the power companies? How does misallocation of resources encourage investment in power generation?

And so it goes - populism versus the insights of all those dead economists.