Plain Sense Economics

In another post we talk about the concept of price elasticity – which measures how responsive consumer demand is to a change in price. The general elasticity approach can apply to supply (reaction of suppliers to a change in market price) and income (change in demand as a reaction to a change in consumer income).

Another application of elasticity is cross elasticity – or more properly the cross price elasticity of demand. In this case we look at a change in price for one product and measure the change in demand for another product. Let’s consider the markets for coffee and tea. Perhaps there is a significant crop failure in coffee, which significantly raises the retail price of coffee. We might wonder, then, if the demand for tea might change, as people switch to an alternative drink.

What would you expect? A significant increase in tea consumption when coffee prices rise? Or are coffee drinkers a stubborn lot and less prone to switch? A high value for cross elasticity means the coffee drinkers are switching to tea in significant numbers.

The current round of high gas prices is triggering changes in demand for smaller, cheaper cars, for public transportation, and for Amtrak and bus service. Greg Mankiw is keeping count. Here is his latest entry.