Sunday, March 05, 2017

Elasticity of Demand for sugary drinks


                                                  Comments due by March 11, 2017

Philadelphia supermarkets and distributors say beverage sales have dropped 30 percent to 50 percent after the city instituted a 1.5-cent-per-ounce tax on sugary and diet drinks. On one hand, these are the same people who want to get the tax repealed, and we don’t have hard numbers yet, so take this with a grain of salt. On the other hand, the whole point of the tax is to reduce consumption of stuff that will kill you anyway, so … good job?
To measure the responsiveness of consumers to price changes, economist use what is called the 'price elasticity of demand.' In simple terms, the price elasticity of demand tells us whether consumers react a little or a lot when the price of a good changes.  
In technical terms, the price elasticity of demand is equal to the percentage change in the quantity demanded divided by the percentage change in the price.  Because of the law of demand we know that the quantity demanded and the price will move in opposite directions, so the elasticity demand is a negative number.  To confuse everyone, we report the price elasticity of demand as a positive number (the absolute value).  
If the price elasticity of demand is greater than 1, then we say that demand is elastic and that means that consumers are pretty sensitive to price changes. 
If the price elasticity of demand in greater than one, then we say that demand in unit elastic (the percentage change in the quantity demanded is exactly equal to the percentage change in the price).
If the price elasticity of demand is less than one, then demand is price inelastic and that means that consumers are not very sensitive to price changes.  
One reason we care about the price elasticity of demand is because there is a relationship between price elasticities and revenues collected.  If demand is inelastic, an increase in the price will increase revenues.  If demand is elastic, a similar percentage increase in the price will decrease revenues.  The reverse is also true.
This is why we see goods with elastic demand (furniture, groceries, clothing) going on sale more than goods with inelastic demand (gas, liquor).
So what does this mean for the sugary drink example above?
Let's look at the numbers (and make some assumptions).  The tax imposed on sugary drinks is $0.015 per ounce.  For a 12 ounce soda (pop?) that's an increase in the price of $0.18.  To make the math easy let's say a 12 ounce soda costs $0.50 ($3.00 a six pack?) before the tax.  An $0.18 increase in the price is a 36% increase in the price.  That's pretty big.
How much does the quantity demanded react.  If grocery stores are to be believed, the quantity demanded fell between 30% and 50% in reaction to the tax increase.  That means the elasticity of demand is between 0.83 (30/36) and 1.39 (50/36).  
So it looks like demand is slightly inelastic to elastic.
Now we can ask question like:  
  • If the goal is to raise tax revenues, will an increase in the tax increase, or decrease tax revenues?
    • Tax revenues will increase if demand is inelastic and decrease if demand is elastic.
  • If the goal is to decrease sugar consumption, how effective will an increase in the sugar tax be?
    • It looks like consumers might be price sensitive, so an increase in the tax might be pretty effective at reducing sugary drink consumption

(Keep in mind that elasticity is a numerical measure of responsiveness i.e one, usually is interested in finding how responsive is A to a change in B. Ex. What is the change in the grade if one is to increase study hours?)

8 comments:

Lindsay Brewster said...

I actually learned in one of my classes earlier today that during the recession, sales of pepsi actually increased. This makes me not shocked that sugary drinks are slightly inelastic because clearly people will spend the money on them no matter how expensive it is to them. This could be because there are some American's who I think are definitely slightly addicted to sugary drinks, or even sugar in general. Its also roughly the same price to buy a bottle of soda as it is a bottle of water, and therefore most people would probably buy what taste they prefer, which for a lot of people is soda, or a sweet drink.

Marc Rinosa said...

I think that the economic theory surrounding this decision is really interesting, as it allows us to both analyze and understand the implications of a tax increase/decrease on the demand of a certain product. But what I question, and what Lindsay touches upon, is how the various externalities of beverage consumption impact the demand of a product far beyond its elasticity.

The pricing structure surrounding the demand of unhealthy products should also be taking into consideration government policy proposals. When Bloomberg for example banned extremely large drink cups, consumers have the option of shifting to the next big thing.

We could also argue that soda is an inferior good, and that they are responsive to price changes for the simple fact that with a greater increase an income, consumption decreases. But we could also argue that soda can be insensitive to pricing changes because of how highly consumed they are. Data suggests that because of the drive toward healthier choices, demand for soda has been decreasing -- this has led to the creation of different products within company portfolios, such as Coke's creation of alternatively-sweetened Coke product called Coca-Cola Life.

Brielle Manzolillo said...

Taxation is often used as an incentive. In this case, the incentive of the tax is to get people to not buy unhealthy drinks. This is probably due to the fact that the United States has an issue with obesity. A similar incentive tax I have heard about is a tax on meat products in Sweden in an effort to be more environmentally friendly. I do not think that taxation incentives are necessarily a bad thing since they often have a positive goal. However, the question is if these taxation incentives will work. This completely depends on if the demand for soda is inelastic or elastic. If people are not sensitive to a price change in soda and will continue to buy the product regardless, then this taxation will not accomplish the goal of limiting sugar intake. This same issue happens with cigarettes. As price rises on cigarettes, one would think people would limit the amount they smoke. However, since people are addicting, they will pay any price for cigarettes. This benefits the cigarette companies but hurts the health of the public. So if people are addicted enough to these sugary drinks, the health of the public will suffer but the soda companies will prosper.

-Brielle Manzolillo

Austin Provancher said...

I think the price elasticity theory is a ideal notion that correlates with products and how the demand changes when prices change. Also, it creates an model that categorizes products into two separate demand pools.

It is fascinating to think that with inelastic goods such as gas and liquor can have increased revenues when prices change. These goods cannot go without being needed. On the other spectrum: furniture, groceries, and clothing are seen as elastic goods. A small change is price will change quantity demanded.

I currently read the dairy demand has become more elastic. This article was very interesting and explains that substitutes are now on the market that are more beneficial to ones body.
http://www.agweb.com/article/why-dairy-demand-has-become-more-elastic-naa-catherine-merlo/

Tasfin Hossain said...

When studying economics in my old high school, one of the first topics we covered was the price elasticity. And so its quite fitting that I am studying price elasticity in my senior year in college. I feel like the elasticity of products like soda depends on the individual consumer. For instance, I have not had soda in a long time, so for me soda is price elastic. But for someone who drinks soda for every meal, his or her soda is price inelastic. And so in my opinion, instead of just putting a tax on sodas, the government could also provide incentives to the soda companies if they promote their healthier options.

Tasfin Hossain

Anonymous said...

In my opinion a tax on sugary drinks is good because as a nation we should be looking out for our health and big soft drink companies should be looking out for their consumer's health as well.
I'd like to believe that the price elasticity-demand theory truly depends on whether the consumer needs the product, or if they could do without it. When in the case of something like sugary drinks, I think the average consumer would be able to do without this product if it means paying a higher price then willing.
If a product like Insulin for example were to go up, the quantity demanded would remain relatively the same because this product is a necessity in order to sustain people's lives. Thus meaning that the demand is inelastic. Other products, ones that consumers are addicted to, alcohol and cigarettes for example; also tend to have an inelastic demand.
When you take goods that are elastic into the spectrum, when the price goes up, the quantity demanded goes down. Therefore, products like sugary drinks, clothing, etc. revenues will decrease when prices increase.

Nick Arciszewski

Katherine Murphy said...

On the health side of this topic, I believe that it is great putting a specific tax on sugary drinks. This incentive, gets people to buy less sugary drinks, which will increase health conditions. But the problem remains, that some people do not seem to mind the tax, and go out and buy these sugary drinks anyway, causing inelasticity. It all depends on if the consumer is willing to spend for this taxation or not. Things that tend to have an elastic demand, are things people do not need but are dependent on. Like sugary drinks, fatty foods, alcohol, cigarettes and the list goes on. When prices increase, these revenue price will decrease. When situations like this begin, companies begin to work around the problem of sales going down.

Janelle Gonzalez said...

The above article exhibits how products do during times of economic hardship. The article shows how the sales of a product, such as soda, performed during a recession. We can see that the sales remained constant, even as prices went up. The inelasticity of the soda was shocking to me, as it isn't really a necessity. We then see that because of this, government has established taxes to act as an encouragement to make healthier choices. Some see this taxation on more sugary beverages as a step in the right direction, as others see it as too much regulation.