Saturday, August 05, 2006

A Buying Power Externality?

Peter Coy has a great article in BusinessWeek on inelastic demand for gas. Coy's article is particularly smart because he looks at how the trend affects different income groups:

The healthier the finances, the smaller the reaction to costly gasoline. Leonard Mintz . . . who made his money in the plastics machinery business, just finished an 800-mile trip through the Northeast in his . . . bus-size . . . recreational vehicle [with] granite floors. Miles per gallon: 6. Concern: zilch. . . . Low- and middle-income families seem to be doing most of the conserving, by necessity.

The "granite floor" RV put the following hypo in my mind. Imagine two situations:


A) A luxury vehicle leaves in its wake tiny, sticky particles that make all standard vehicles have to "work" much harder to travel (say the particles require as much effort to get past as, say, a 10% uphill grade in the road). The average driver of the cheaper vehicles has to buy twice as much gas in order to travel the same distance.
B) A luxury vehicle consumes five times as much gas as standard vehicles. The price of gas doubles due to the popularity of such vehicles.
I think economists would have no problem identifying the particles in A) as an externality. But why not the extraordinary demand in B)? In both cases the drivers of standard vehicles are paying twice as much for gas because of the actions of the luxury car drivers.

I suppose the classical response would be: the extra demand just shifts the demand curve out, and eventually suppliers will respond by bringing more fuel to market. But in the short and medium term, supply is pretty fixed. If their buying power is very high, the luxury car drivers will not be sensitive to the "signals to conserve" the market is sending via high prices, and may instead lead those signals to become ever "louder" to those lacking their buying power. (This differential signalling process always struck me as a fundamental flaw in Hayek's essay The Use of Knowledge in Society...but that's another post!)

This hypo might seem fanciful, but I think it brings together some interesting insights on the costs of inequality and creeping positionality in consumption. Don Herzog has suggested (in "Externalities and other Parasites") that the externality concept can be a valuable entry point for a more holistic approach to economics. Given that the increase in U.S. gas consumption from 1995 to 2005 is about two-thirds of China's entire current consumption, it's something to think about.

2 Comments:

Blogger J.B. Ruhl said...

This post poses a number of important questions. While I agree that those huge RVs one sees tooling down the road raise a fuel consumption eyebrow, and that the US rate of energy consumption is disproportionate to anywhere else in the world, I wonder how, precisely, we are to respond. So I am going to play devil's advocate. Let us assume a world in which across the board improvement in fuel consumption efficiency (e.g., through a new technology) is not on the table, meaning that we have to reduce fuel consumption in specific sectors by way of regulation, incentives, education, etc. So, this post raises two questions for me:

1. I have a neighbor, an ortho surgeon, who owns a huge, luxurious, gas guzzling RV. He spends a month a year on the road in it. But he also spends a month a year in Central America volunteering his surgical services in rural communities. I wonder what would happen if we told him he couldn't have his RV, meaning he can't take his road trip. Might he decide that his volunteer trip is no longer what he wants to do either? In other words, can we use regulation to surgicaly remove what we consider to be "bad" behavior without also affecting the amount of what we consider to be "good" behavior?

2. Let's say, in the absence of any direct intervention, the increase in US energy use in the next ten years would be equal to one third of China's total energy consumption. OK, so which specific BTUs do we dispense with? The RVs? My use of electricity at midnight typing into this blog? If the demand elasticity for energy use by very wealthy people is relatively inelastic, maybe we should target energy use by less wealthy people. Or, maybe if China increased its energy use to catch up with us, it would become a font of many beneficial medical and scientific advancements, as is the US. Of course, these are not serious policy suggestions, but stats like those thrown on the table by this post don't tell us much in isolation. The US uses more energy per capita than any other nation, and some US population segments use more per capita than others. So what? I need to know what we are getting in return before I can say whether the "costs of inequality" are, when all is taken into account, actually costs or benefits, and I need to know the effects of regulating some particular manifestation of the inequality before I know whether it produces a net gain or loss.

It's nice to think about what the effect of a new rule would be with "all other things being equal," but in fact all other things are never equal.

8/08/2006 11:56 PM  
Blogger Frank said...

Thanks for the comment. I respect the points you raise here, and certainly any respectable energy policy would have to address them.

But my post was designed as a commentary on inequality policy...the energy focus was just illustrative. I wanted to work outward from an area where we all recognize externalities, to a point where they are more highly contested.

What I really want to get at are the phenomena described in this piece by Robert Frank, about positional externalities:

http://www.brookings.edu/gs/events/externalities.pdf

particularly on p. 10 or so, where he discusses "Rising Income Inequality and Expenditure Cascades." Frank describes "a variety of ways in which increased income and wealth inequality
have made it more costly for middle-income families to achieve important goals in everyday life."

Here is the most relevant quote:

"Higher incomes at the top have induced top earners to buy cars that are faster, more luxuriously
appointed, and heavier than those purchased by their counterparts two decades earlier. But the same changes have occurred even for automobiles marketed directly to middle-income consumers whose incomes have risen little. Today’s entry level Honda Civic, for
example, is at 2500 pounds about the same size as 1985’s Honda Accord, whose current model weighs 3200 pounds. For about the same real price, an Accord buyer in 1985
could buy today’s Civic and in the process do better on virtually every absolute performance dimension. The new Civic is faster and more reliable than the old Accord. It has nicer upholstery and a better sound system. And it even gets better gas mileage.

But people who buy a 2500-pound Civic today will incur a significant risk that
they wouldn’t have incurred in their 1985 Accords, because they must now share the
roads with 6,000-pound Lincoln Navigators and 7,500-pound Ford Excursions. The odds
of being killed in a collision rise roughly five-fold if your car is struck by one of these
large vehicles. To explain why many families might decide against today’s Honda Civic,
we need not assume that they are driven by envy or other psychological frailties."

What I am trying to say in the post is that gas consumption is a lot like "safety consumption" in this hypothetical--there's a zero-sum game going on here, at least a) in the short run and b) until everyone can afford the advantaged, heavy cars.

8/14/2006 12:15 PM  

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