Law of Diminishing Returns

During what economists call a short run, not all inputs can be increased at the same time with regards to the production  process. At least one input in the production process is fixed. Let's say in this type of situation you decide to add more of the variable input to the process. At first, you would see a bigger jump in the total product produced as a result of this. However, as more of this input was added, eventually you would see a decline in the marginal product.

This is illustrated in Pierre Lemiuex's article on tobacco legislation (2001). Lemieux discusses the "diminishing returns to government intervention" (2001). Some points that the article makes that have merit is that the there have been strides made in tobacco legislation. At the time of this article, there had been an increase in the number of public places that no longer allowed smoking. Lemieux also mentions that most "smokers who were the most easily persuaded have already quit" (2001).

However, this last point, while proving his point that these campaigns had been working, also lessened the debate for me. Increasing the cost and tax on cigarettes had already deterred smokers who could no longer afford to spend so much on them, or at least could no longer validate spending more on them at the higher prices. The government warning labels had worked as well. The assumption, then, is that the people who remain smoking are not deterred by either of these factors. Increasing the price even more, or adding even more government warning labels still will not deter the people "who value smoking more" (2001). Therefore, would it not be a waste of government money and time to continue in this vein?

Lemieux indicates that banning smoking in public places "should not be discounted" (2001) in being successful while lessening their diminishing returns. If smokers continue  to quit smoking, the demand for cigarettes would decrease, causing a surplus. Since the tobacco companies would not be able to lower the price, due to the price floor set in place by the government, they would be forced instead to slow production, which would also decrease supply.

If "sin taxes" were raised on cigarettes, this would also decrease the demand, since fewer people would be buying them at the higher price. Government tax revenue would rise because the demand on cigarettes is inelastic.

While it's good to see that these government actions have had some effect and there has been a decline in smokers, in my opinion at there are some people who will always smoke, regardless of the price or the warning labels. Lemieux briefly mentions prohibition as well, which would just result in cigarettes being smuggled in and the government losing out on the sin taxes. As long as the government gains more in sin taxes than it spends on anti-smoking campaigns, there is no harm in continuing.

Lemieux, P. (2001, Mar 19). The Diminishing Returns to Tobacco Legislation. The Laissez Faire City Times. Retrieved on July 30, 2012 from:
http://www.pierrelemieux.org/artdiminish.html

Price Elasticity and Revenue

When the quantity that is demanded of a particular product changes as a result of a change in price, that is price elasticity. Typically this can be seen in luxury items, or items where there are plenty of substitues readily available. I found a great example of this in the June 2011 article about the new Fiat being sold at extremely affordable pricing. McNaughton (2011) talks about how the Fiat is being sold to a wide variety of people, in large part due to how affordable it is. Sales are high as a result of the low price, the assumption being that if the price were to be raised, sales would drop.

I have drawn up a graph based on fictional numbers to illustrate this theory.

McNaughton, D. (2011, Jun 3). Drivers get droptop at bargain; Open-air model brings back memories of original 500c. Times - Colonist, p E.7. Retrieved on July 25, 2012, from:
http://search.proquest.com.libresources1.sait.ab.ca/canadiannews/docview/871134979/1383B49AF151A305DD7/11?accountid=13652

Graphing Changes to Demand

So many different factors can affect the demand of a product over time. Sometimes this can occur simply due to a change in taste - we will not always continue to like the same products indefinitely. We try different brands or styles of a product and may switch to buying something different. For most normal products, income may play into the decision of what we purchase. Some brands are more expensive than others, so when we are making more money, we often will opt to buy the more expensive brand. If our income decreases, we switch to a brand that is less expensive to save money and buy those inferior products.

Prices can affect these decisions as well. As the price of a product rises, we may switch to a substitute product that is less expensive. Another determinant of demand is complementary products, which are products that are purchased because they complement another purchase. For example, when I purchased my iPad, I then bought the screen protector, the case, and some other accessories which complemented that first purchase. Our expectations of the future also plays a role at times. For example, if I hear that the price of fuel is expected to rise, I will gas up my car, even if I wasn't planning to or "needing" to for a few days more.

These demand changes can be illustrated on a graph. Please see the below example that I found on this website (2006).

Experimental Economics Centrer.  (2006). Using a Graph. Retreived July 18, 2012, from: http://www.econport.org/content/handbook/Demand/Graph.html

Games About the Economy and Marketplace

We've been assigned to play an online game to illustrate demand and supply. I chose to play Diner City. In this game, the player selects a business to run. Each day, the player is given options on what to purchase or upgrade with the revenue earned from the previous day in order to bring in more business and increase revenue. I felt that this tied in with my earlier post on production possibilities in that there is a scarcity of resources. If I spent money on more staff, I gave up the opportunity to spend that money on changing the menu or bringing in entertainment for the patrons. I had to gage how well my restaurant was doing as compared to the competition, and observe what they were doing differently, in order to make an informed decision about my next expenditure. It also showed me that when I upgraded my restaurant, I also increased demand in that more customers were coming through, so I then had to increase the number of seats, as well as the number of staff. Staff became more expensive, as did the cost of cleaning. It was a great example of how costs go up as revnue increases. Bonus - the game is fun to play!

Production Possibilities and Scarcity

The choices that we make have costs - this is true on both a large scale when we are looking at society's choices that affect many people, and also on an individual level. Since a country does not have unlimited resources available, society is faced with making decisions about what should be produced that will have the best impact on the economy. These choices have an opportunity cost, meaning that we have to examine not only the actual cost of the goods or services that we have decided to produce, but also the value of the alternatives that have been given up to produce these.

Scarcity can be illustrated on a production possibilities graph. This type of graph assists in showing two possibilities for production in a specific time period. It will depict that when more is produced of one item, less can be produced of the other.

This type of scarcity can also be seen on an individual level. For example, in order to make the decision to return to school, I had to assess the costs that would affect other areas of my life. Because I work full-time, I only have a certain amount of time available for other areas of my life. I have to a lot a certain amount of time to housework, gardening, errands, etc. Returning to school means that I have less time to accomplish those things, as well as less time for hobbies. I had to weigh the costs to determine what was most important to me in order to make the decision to return to school. We are all faced with these decisions, in some form or another. By analysing production possibilities and scarcity, we are able to make educated choices.