In perfectly competitive markets we have productive efficiency as output is produced at the lowest cost in the long run. This is because the demand curve (also the average and marginal revenue curve) for the firm is perfectly horizontal and is tangential to the minimum point of the average cost curve. There is zero economic profit at this point.
Perfectly competitive markets are also efficient in allocating resources. This is because price that people are willing to pay (represented by the demand curve) is equal to marginal cost of production. If MC > P then it is better if resources are shifted away from the current use to producing goods where the price that people are willing to pay (relecting their value for the product) is equal to the marginal cost of producing it. In perfectly competitive markets MC=P and hence there is allocative efficiency. Allocative efficiency , unlike productive efficiency , can occur in the short run as well.
Sunday, August 15, 2010
Monday, August 2, 2010
Pricing strategies and elasticity of demand
In 1931 Pepsi-cola was facing bankruptcy. Pepsi and coca cola were both selling 6 ounce bottles at five cents each. In order to save costs Pepsi began to use 12 ounce bottles and sold it for ten cents each. This did not help much . Later they began to sell the same for 6 cents - undercutting Coca cola. Coca cola had a dominant market share and did not respond to Pepsi's price cut. The unwillingness of Coca cola to match the price cuts had implications for Pepsi's demand elasticity and ensured it success.
Politicians and sunk cost behaviour
Acting on the basis of sunk cost is irrational. Behaviour based on sunk cost is like crying over spilt milk. Decisions based on sunk cost lead to faulty or suboptimal outcomes. Yet human beings are not free of such bahaviour. Politicians are the more visible category of people who are prey to such behaviour.
Take for instance a prominent politician's recent outburst against the common wealth games. He poured scorn over the governments efforts to host the commonwealth games and hoped the same would be a failure.He is of the opinion that the money could have been spent in a better manner. He could be right in questioning the primacy of games expenditure over other priorities such as poverty alleviation etc. Economic planning is all about allocating resources in a manner in which welfare is maximised.Hopefully spending on the games figures in this optimal allocation.
But now that we have ventured into these games and are at an advanced stage of completion his hopes for a failure seems to be a classic sunk cost behaviour. Hoping for a failure based on an unrecoverable cost is like hoping for the worse. The benefits of successfully hosting the games may be few or many but are certainly positive. But the consequences of a failure are certainly negative.
Take for instance a prominent politician's recent outburst against the common wealth games. He poured scorn over the governments efforts to host the commonwealth games and hoped the same would be a failure.He is of the opinion that the money could have been spent in a better manner. He could be right in questioning the primacy of games expenditure over other priorities such as poverty alleviation etc. Economic planning is all about allocating resources in a manner in which welfare is maximised.Hopefully spending on the games figures in this optimal allocation.
But now that we have ventured into these games and are at an advanced stage of completion his hopes for a failure seems to be a classic sunk cost behaviour. Hoping for a failure based on an unrecoverable cost is like hoping for the worse. The benefits of successfully hosting the games may be few or many but are certainly positive. But the consequences of a failure are certainly negative.
Monday, July 27, 2009
Regulation of consumer behaviour
About two years back the Indian Ministry for Health and Family Welfare decided to have 'junk food' such as colas , carbonated drinks, pizza's, burgers/hot dogs, chips/fries etc from school and college canteens. It was pointed out that the consumption of such products led to diet related non-communicable diseases among the youth. The consumption and availability of tobacco products, on campuses , was also banned. Many consumer organizations are also for banning junk food advertisements that are targeted at children.
The basis for such a paternalistic type of regulation seems to be that children of school going age and also of colleges are not rational. Their consumption habits are based on a short term perspective and does not consider the long term implications such as obesity and other diseases which can possibly affect the quality of life and also the longevity of life. The consumption of junk food could also be addictive making it difficult for the child to break the habit. hence the government rationalizes that it is best to ban such products in places where children and college going youth frequent - the canteen.
Two issues need to be discussed at this stage. Firstly the assumption that the targeted consumers are not rational. It is well established that children are easily influenced by emotional advertisements. They are also not well placed to understand the implications of their consumption habits. Hence there is the necessity for regulation. Since parental regulation is not working you need the government to step in. But are parents not supposed to know the ills of such consumption habits? From discussions in the Indian media ,parents are faulted for using junk food as a 'hassle free' way of getting their children to eat! Working parents often find it easy to use packaged food which appeals to the taste buds of the young ones. This seems like a rational choice for parents!! They make a choice and since they are adults they should know better than their children about the possible dangers of junk food. Are parents trading off rationally or do they too suffer from ignorance and advertisement impact? Whichever way you read it, parents need some regulating and educating too!! In one case it is irrational behavior and in the other it is rational behavior that needs to be regulated.
But banning junk food from canteens may not prevent parents from sending it from home. Hence the need to alter parents behavior by educating them. Schools appear to be one step ahead - some have banned children from consuming junk food in school premises. This further constrains the choices for parents.
How do such bans work ? Are they effective enough in controlling consumption choices. A simple ban might serve to alter only the shape of the budget line but an awareness program and labeling of food products might alter even the indifference curve. Such alterations would determine the effectiveness of the government policy.
The next issue is whether only western junk food qualifies for banning. Are our local variants such as fried bondas or pakoras, chaats , samosas etc also junk food? Such food is also available in canteens and might just lead to a substitution effect.
What about college going youth? Are they also assumed to behave irrationally? Or is their choice a trade -off?The short term preferences for taste and economising on time might just prevail over the long term cost of poor health and drop in longevity. Would a ban have a similar impact on the budget line? Probably not as large as in the case of school going children who do not have too many options for purchasing. A college youth might just shift his purchase to a nearby outlet.
This option was available for tobacco consumption too. Probably realising that strong addictive behaviour needed stronger action tobacco sale was banned for 100 yards around educational institutions for youth below 18 years. See link http://www.hinduonnet.com/2009/06/30/stories/2009063060040400.htm
This has a catch - it depends on the effectiveness of enforcement. Given our stretched police force it is unlikely that they would spend too much time enforcing such laws. Their own rational behaviour would lead them to devote their scarce time for issues which have a higher marginal benefit (social or private ?). So , the effectiveness of such a ban might be weak. Here too a policy which alters preferences and not just costs through taxes and inconvenience effect may be important.
But, since the idea is to impact the budget line for junk food why not just have a higher tax? This again depends on demand elasticities. It is tough to implement a tax policy on the informal sector which provides 'desi - junk'.
The basis for such a paternalistic type of regulation seems to be that children of school going age and also of colleges are not rational. Their consumption habits are based on a short term perspective and does not consider the long term implications such as obesity and other diseases which can possibly affect the quality of life and also the longevity of life. The consumption of junk food could also be addictive making it difficult for the child to break the habit. hence the government rationalizes that it is best to ban such products in places where children and college going youth frequent - the canteen.
Two issues need to be discussed at this stage. Firstly the assumption that the targeted consumers are not rational. It is well established that children are easily influenced by emotional advertisements. They are also not well placed to understand the implications of their consumption habits. Hence there is the necessity for regulation. Since parental regulation is not working you need the government to step in. But are parents not supposed to know the ills of such consumption habits? From discussions in the Indian media ,parents are faulted for using junk food as a 'hassle free' way of getting their children to eat! Working parents often find it easy to use packaged food which appeals to the taste buds of the young ones. This seems like a rational choice for parents!! They make a choice and since they are adults they should know better than their children about the possible dangers of junk food. Are parents trading off rationally or do they too suffer from ignorance and advertisement impact? Whichever way you read it, parents need some regulating and educating too!! In one case it is irrational behavior and in the other it is rational behavior that needs to be regulated.
But banning junk food from canteens may not prevent parents from sending it from home. Hence the need to alter parents behavior by educating them. Schools appear to be one step ahead - some have banned children from consuming junk food in school premises. This further constrains the choices for parents.
How do such bans work ? Are they effective enough in controlling consumption choices. A simple ban might serve to alter only the shape of the budget line but an awareness program and labeling of food products might alter even the indifference curve. Such alterations would determine the effectiveness of the government policy.
The next issue is whether only western junk food qualifies for banning. Are our local variants such as fried bondas or pakoras, chaats , samosas etc also junk food? Such food is also available in canteens and might just lead to a substitution effect.
What about college going youth? Are they also assumed to behave irrationally? Or is their choice a trade -off?The short term preferences for taste and economising on time might just prevail over the long term cost of poor health and drop in longevity. Would a ban have a similar impact on the budget line? Probably not as large as in the case of school going children who do not have too many options for purchasing. A college youth might just shift his purchase to a nearby outlet.
This option was available for tobacco consumption too. Probably realising that strong addictive behaviour needed stronger action tobacco sale was banned for 100 yards around educational institutions for youth below 18 years. See link http://www.hinduonnet.com/2009/06/30/stories/2009063060040400.htm
This has a catch - it depends on the effectiveness of enforcement. Given our stretched police force it is unlikely that they would spend too much time enforcing such laws. Their own rational behaviour would lead them to devote their scarce time for issues which have a higher marginal benefit (social or private ?). So , the effectiveness of such a ban might be weak. Here too a policy which alters preferences and not just costs through taxes and inconvenience effect may be important.
But, since the idea is to impact the budget line for junk food why not just have a higher tax? This again depends on demand elasticities. It is tough to implement a tax policy on the informal sector which provides 'desi - junk'.
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