Microeconomics: Supply, Elasticity, and Estate Tax Analysis

Supply Shocks and Lettuce Price Fluctuations

Supply has an undeniable impact upon price: when supply goes down, price goes up. In this instance, a rapid decrease in supply has led to an increase in the price of lettuce. Unlike producers of other goods and services, farmers cannot always fine-tune their supply according to market demand, because weather directly affects their ability to produce. Farmers had already planted less lettuce, presumably based upon demand patterns from the prior year. Yet demand levels for agricultural products are difficult to predict from year to year. For example, when the weather is warmer, people tend to eat more lettuce, even in winter. Conversely, a safety scare involving a particular type of produce — such as spinach — can cause a rapid downturn in demand.

To make up for the decrease in supply caused by a harsh cold snap and still ensure that their input costs are covered, farmers must raise prices. Consumers who eat lettuce may initially be willing to pay more for the product, given that people who regularly purchase fresh fruits and vegetables tend to be more affluent than those who do not. However, there are also many substitute goods for lettuce in the form of other fresh vegetables — such as spinach — that consumers can purchase instead.

Substitute Goods, Consumer Behavior, and Market Equilibrium

While short-term consumption patterns may lead consumers to accept higher prices, over the long term consumers are often willing to shift their purchasing habits toward lower-cost items with similar applications and benefits. It is relatively easy to substitute other goods for lettuce. This is in marked contrast to something such as gasoline for a car, which has no immediate, obvious substitutes in many parts of the country. Although it is possible to buy a smaller, hybrid vehicle to replace an SUV if gasoline prices grow prohibitively high, replacing a car requires a much greater effort on the part of the consumer than simply buying a different vegetable.

Regarding food consumption patterns specifically, most consumers have a subjective sense of the maximum they are willing to pay for a specific food item — even if they have the income to afford it — unless they are convinced it offers substantial taste or health benefits. Americans are accustomed to spending a relatively small percentage of their income on food.

The rapid replanting of the crop and an improvement in weather conditions suggest that within a month or so, the lettuce supply will recover. As supply increases to meet demand, the price farmers can command for their crop will fall, and a new equilibrium of price and demand will be reached. Lettuce prices will likely be lower than they are at present. Additionally, as the weather grows warmer, more sources for lettuce and other substitute goods — such as local farmers' markets and home gardens — will become available. However, this outcome remains difficult to predict, given that food fads and consumption trends can be extremely volatile. A new diet trend may sustain lettuce consumption at elevated levels, or the price of a substitute produce may shift and, in turn, influence the price of lettuce.

Income Elasticity of Alcohol Demand During Recessions

Price elasticity of demand is a measurement of the change in quantity demanded divided by the change in price. Given the data in question, it would be necessary to first determine the extent to which demand changed relative to the price of alcohol. However, what is really being analyzed here is income elasticity of demand relative to price. Income elasticity measures the demand for a good relative to a change in income among the persons demanding that item. It is calculated as the percentage change in quantity of goods demanded divided by the percentage change in income. During a recession, the percentage change in income is presumably negative — that is, incomes are falling. The incomes of the persons being studied at both the state and federal levels would need to be calculated and compared against the decrease in consumption.

A further methodological question concerns which base income figure to use: the mean or the median income, at the federal or state level. These numbers can differ substantially because very low or very high incomes — particularly at the federal level — can skew the average relative to the typical person who may have lost a job as a result of the recession. High-wage earners' incomes are less dependent upon employment and more dependent upon assets, while low-wage earners often had little room in their budgets for anything beyond necessities even before the downturn.

Alcohol consumption is also affected by many factors beyond income. Individuals who are addicted to alcohol regard it as a necessity, and one of the hallmarks of addiction is prioritizing alcohol consumption over food. Individuals with a predisposition to alcohol abuse who lose their jobs during a recession may shift to cheaper alcohol, but they are unlikely to cease consumption entirely. Moreover, a higher percentage of alcoholics may already be unemployed, meaning that a recession will not significantly affect their consumption patterns.

The marginal utility perceived by the average non-addicted consumer from drinking more alcohol is finite. A significant increase in income will not lead to a significant increase in alcohol consumption, although it may lead to increased spending on higher-quality alcohol. Given that alcohol is not a necessity, it is likely that during recessions — particularly prolonged ones — most consumers will forego purchasing alcohol before cutting expenditures on gasoline and other essential items. Demand for alcohol is therefore likely to be fairly elastic relative to income, except among certain problem drinkers.