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I just have to laugh every time I read an article (usually from some proponent of big government) about “raising the minimum wage,” “lowering prices,” “raising tax revenues,” “controlling excess profits,” etc. None of these things can be made so (sustainably) by law, rule or regulation. Market incentives cannot be overcome simply by saying so (Sorry Captain Picard, telling your crew to “Make It So” does not work in economics).
As Frédéric Bastiat pointed out almost two centuries ago:
“In the economic sphere, an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.”
The attraction of “making it so” to big government meddlers is that of the immediate effects; while the rest of us are left to deal with the secondary and lasting effects of such interventions—what are known as unintended consequences.
In Economics, “elasticity” measures the change in one thing (variable) in relation to the change in another. In relation to free markets, supply, demand, prices, output, etc., it’s important to know how much one thing is likely to change when something else does. Remember, these measurements like others, are difficult to predict; however, they can be observed. One further complication is that while a change in one variable can be observed at the same time another variable is changing, it’s difficult to be sure if the first variable actually caused all of the change in the second one (other variables could be involved as well). While measurements of “elasticity” are not perfect, they can still help us determine how future changes are likely to affect markets.
“Price elasticity of demand” is the change in demand of a good or service in the presence of a change in its price. As I have pointed out before in Economic Concept: Supply and Demand, as price rises, demand decreases; so “price elasticity of demand” is usually a negative number, it just depends how large a number.
Here is what I mean: Suppose the price of gasoline increases by 20%. It may be observed that consumers buy 20% less gas when the price goes up that much. So the elasticity in this case would be –1 (% demand change to % price change is -1 to 1). In other words, the change in demand matched the change in price. Now suppose if gas goes up 20% in price, but then demand decreases by 40%, the elasticity in this case would be –2 (the dependent variable changes twice as much as the independent variable).
“Price elasticity of supply” is the change in supply of a good or service in the presence of a change in price. Since the supply curve is upward sloping (producers supply more when prices rise) this is usually a positive number (it’s just a matter of degree).
Raising wages artificially (beyond the marginal utility or marginal value added by that labor) will simply reduce the demand for such labor (lost jobs). Lowering prices artificially (below the marginal cost of production) will simply create shortages and rationing of that good or service. Read Economic Concept: Marginality – When to say enough is enough. Raising tax revenues by increasing tax rates usually reduces tax revenues as a result of a reduction in the taxed activity (income, capital gains/investment, corporate profits, etc.). In other words, when taxes are increased, people will do fewer of things that are taxable, often leading to a drop in tax revenues to the treasury. Controlling “excess profits” (which by the way, do not exist in a free market, read Economic Concept: Competition – How failure leads to success, simply reduces business investment, risk-taking, and production of goods and services.
Elasticity helps to measure and indicate the degree of damage to be expected from secondary effects of the price intervention activities of Central Planners (governments). However, it does NOT change the direction of the effect, as that is usually in the opposite direction of the meddler’s intended outcome.
So it is not a “stretch” that understanding “elasticity” is important to The Future of Your Wealth.