Real World Economics: Elasticities help explain tariffs’ impact
Edward Lotterman Donald Trump keeps flipping and flopping on tariffs Multiple are scheduled to kick in on Aug but who knows Nevertheless U S households and businesses need to gird their loins for the biggest and fastest economic adjustments since the Japanese attack on Pearl Harbor brought us into World War II As things play out we will make adjustments to what we buy what we can sell where we will work and now we will spend our free time How much will consumers cut their consumption of taxed imported goods How much will we shift to substitutes or spend our money on unrelated alternatives How fast will domestic production of items hit with import taxes grow as Trump suggests And what about production ramping up in countries facing U S tariffs when the historic dominant exporter faces rates by the U S Economics offers us a tool to understand these issues ones that will be critical over the next decade It s called elasticities and it s one of the fundamental concepts in economic analysis Elasticities explains and measures the degree to which changes in one variable affect another variable Applied broadly they facilitate comparisons between different products different eras different countries and different currencies The key is that they use objective percentage changes rather than subjective changes in quantity and value Start with an example of Mexican avocados facing high U S tariffs Guacamole lovers like me wonder how much and how hurriedly U S production might increase Not considering elasticities ag economists might analyze historical statistics and conclude When avocado prices go up by cents a pound U S production increases by crates per year How does that compare to say Spain When the price there goes up by half a euro per kilo output increases by metric tons OK what about fresh sweet corn Well for every -cent increase per dozen ears U S production goes up by bushels See the challenge How a great number of avocados per crate or pounds of avocados How plenty of ears of corn per bushel Using this approach one must examine a multitude of years of figures to get statistically valid conclusions But doing that we then would also have to consider that the overall buying power of a U S dollar has fallen by half since and that Europe now uses euros rather than francs guilders and marks The resolution is to ignore price and quantity units Applying elasticities we can pose all the changes in percentage terms When the price of avocados rises U S consumption falls by You can apply that comparison to Spain or sweet corn or asparagus without getting into pounds kilos cases bushels dollars euros or any other unit You can analyze changes in price-quantity relationships in the s when we ate a half pound of avocados per person annually and could get fresh sweet corn over a -day season Now we eat nine pounds per person per year and can buy corn over at least days Forget quantity units Ignore price changes The percentage relationships alone give analytic power These elasticities can be used in all sorts of economic relationships The common element is that we look at the percentage change in one variable relative to the percentage change in a related one Consider common examples By what percentage does U S consumption of avocados fall when their price increases by That is an elasticity of demand specifically their own-price elasticity By what percentage does U S consumption of corn chips fall when avocado prices increase by That is an elasticity of demand but a cross-price one where we look at the relationship between the price of one good and the consumption of a related good By what percentage do consumer purchases of chunky tomato salsa rise when the price of avocadoes drops by That is also a cross-price elasticity but one for products that are substitutes for each other The prior example of chips and a key guacamole ingredient involve complements or things that are consumed together For consumers salsa and guac compete with each other Then look at the producer side By what percentage does U S production of avocados rise when import prices increase by That s an elasticity of supply The idea of related goods that are complements or substitutes similarly applies to supply and production as well as consumption If the price of gasoline falls what happens to production of paving asphalt It increases because asphalt is a complement in production of refining crude oil into fuels With lower prices more gasoline is sold more crude oil refined and more asphalt produced even if the price of asphalt stays the same The common term for complement here would be by-product When we had a great number of integrated steel mills higher steel output increased percentage production of Portland cement made from blast furnace slag even if cement prices had not changed a dime In Minnesota despite predominance of corn and soybeans oats and barley remain viable and are competing crops using near-identical inputs They are substitutes in production Oats is ideal for horses When Canterbury Downs and hundreds of associated horses came in the local price of oats rose compared to barley Planted acres of oats increased slightly and barley fell In Manitoba barley and canola are substitutes for farmers Bad crops of corn and soy in the U S corn belt may reduce output of corn and soy oil increasing prices This may reduce next year s sowing of barley in Manitoba Farmers may plant more canola in the hopes of catching at least the tail end of the vegetable oil price increase Applications of elatsticies are almost endless and can be used to understand virtually all cause-and-effect relationships Poisoning By what percentage would China s emissions of carbon drop if the price of its coal increased Tuition By what percentage do completed family sizes for Rwandan women fall for every increase in the numbers of them who complete secondary school Improvement By what percentage does conversion of Brazil s campos cerrados dry forests to farmland increase for every increase in Chinese household incomes and thus of pork consumption Now let s apply this to how the U S economic activity adjusts to Trump s enormous tariff shock regardless of whether it even shows up in actual price and quantity evidence The June Consumer Price Index established an increase in the price of toys Over time how multiple fewer toys will parents buy Will kids only have to play with them longer Will people buy more durable toys Will trips to waterparks or minigolf outings make up for less lavish birthday bonanzas Furniture prices also went up Will prices of used items at yard sales spike Will skilled restorers have long waiting lists With selected women s clothing also showing increases will skilled tailors who can restyle and spiff up used dresses tops and pants be able to raise rates without losing customers Will charity shops see more buyers Fewer donations Both Will someone seeking a master s degree in consumer econ get funding from Goodwill for a thesis forecasting how used clothing donations and sales will respond to higher U S import tariffs Understand that nearly all elasticities vary with the length of time available for both producers and consumers to make adjustments In the short run it is hard for a coffee shop to change either menu or suppliers Given more time it can Building a new brass foundry might take two years In the meantime industrial brass casting users will have to pay more for imports eating several of the costs and passing chosen along So don t believe assertions that tariffs will be a one-time price shock Intertwined economic relationships are highly complex Predicting details of how everything will fall out is nigh impossible Related Articles Real World Economics Trump s chaos hurts his own cause and all the rest of us Real World Economics Looming farm problem by the numbers Real World Economics Fed up Delusions about the central bank continue Real World Economics Storm clouds gathering for a new farm emergency Real World Economics Bonds Part How this affects us St Paul economist and writer Edward Lotterman can be reached at stpaul edlotterman com
