The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop University
In Search of the Perfect Christmas Tree
Can’t we just buy this one and go home?
…..shopping-wearied husband to wife
My former hometown of Indiana, Pennsylvania sat smack in the middle of the self-proclaimed Christmas Tree Capital of the World. Pine, fir and spruce varieties thrive in the soil above played-out coal mines, and local growers export millions of perfectly-trimmed specimens all over Eastern U.S. and Canada each holiday season.
When my sons were young, I made an annual and obligatory trek to a "cut your own" Christmas tree farm. What a great experience. Biting December winds would make my eyes water and freeze the tears to my cheeks. Ground snow would work its way around my boots, drip down my ankles and wrap my toes in icy molds. After about ten minutes and/or one hundred yards of arctic chill, the boys would plead to cut down the closest conifer and return to the cozy comfort of the car.
Regrettably, children have short memories. Each year, forgetting red noses of the past, they begged to repeat the ritual. So we did. Each year I returned to the farms with a saw in one hand and a child on the other, looking for the perfect tree.
And that was the problem. The perfect tree was hard to find. Christmas trees were everywhere, but most were too short or too tall, too scrawny or too full, with bulges or holes in all the wrong places. You could not just walk into the field and cut the first available tree. You had to hunt...and hunt...and hunt. And get colder...and colder...and colder. By time fathers like me hit the fields, the best trees were gone. The best trees had already been harvested and trucked off to distant cities. Shipped out.
At least I knew why. Armen Alchian and Robert Allen nailed it many years ago with their "Shipping the Good Apples Out" theory.1 Alchian and Allen correctly noted that demand patterns are determined by relative prices, not absolute prices. Changes in relative prices cause consumers to substitute among goods and services. When the relative price of a good rises, consumers shift purchases to other substitute goods and vice versa. As a result, Alchian and Allen reasoned that high transportation costs cause consumers to substitute toward higher-valued goods. Why? I am glad that you asked.
The price of apples
Imagine that an orchard stand outside Kalamazoo, Michigan charges $1 for a bag of "standard" apples and $2 for a bag of "premium" apples. The premium apples are twice as expensive. In economic terms, the opportunity cost of a premium apple is two standard apples. However, consumers in Phoenix must pay to transport the apples to their local stores. If transportation costs are $3 per bag, those same Michigan apples will be costlier. The standard apples will cost $4 per bag and the premium apples will cost $5 per bag.
Are you catching on? Transportation costs raised the absolute price of premium apples in Phoenix, but lowered their relative price. The premium apples were twice the cost of standard apples in Kalamazoo [$2 versus $1], but are only 25 percent more expensive in Phoenix [$5 versus $4]. A premium apple cost two standard apples in Kalamazoo, but only 1.25 standard apples in Phoenix. Premium apples are relatively cheaper in Phoenix than in Kalamazoo! Similarly, standard apples are relatively cheaper in Kalamazoo. The standard apple costs only 1/2 of a premium apple in Kalamazoo [$1 versus $2], but cost 4/5 of a premium apple in Phoenix [$4 versus $5].
Aha! If premium apples are relatively cheaper in Phoenix, the relative demand for premium apples in Phoenix should be greater. The profit-maximizing orchard will ship the premium apples out to Phoenix and stock their local stands with standard apples. Kalamazoo will ship the good apples out, Boise will ship the good potatoes out, and Indiana will ship the good Christmas trees out.
Does the same principle hold in other countries? Yes. To limit traffic congestion the Singapore government imposed extensive taxes on automobiles in the early 1990s. These complex levies had the effect of driving up the prices of low-cost vehicles proportionately more than the price of more expensive cars. In fact, as a result of the charges, a Mercedes Model E was only twice as expensive as a humble Honda Civic. The result was exactly what Armian and Alchian would have predicted; the Mercedes became the best-selling new model in Singapore.2
As another international example, I recently heard a public radio commentator lament his inability to find a good cup of coffee while traveling in the country of Colombia.
Shipping the buyers
The theory also works when consumers travel to the product. It should not matter if the goods are shipped to the buyer or the buyer is "shipped" to the goods. Those of you with young children -- after contracting to pay $20 for a babysitter, do you head to McDonald's? Probably not. Hiring the babysitter lowers the relative price of an outing to a more elegant eatery. A $40 meal in a nicer restaurant would normally be four times the expense of a $10 McDonald's outing. But, after tacking on the $20 babysitter fee, a trip to the more expensive eatery costs $60; only twice the McDonald's cost of $30. Couples hiring babysitters, all else equal, are more apt to dine in style.
As another example, suppose that a choice seat at a college football game costs $40 while a standard seat costs $20. To a local fan, the choice seat is twice as expensive, but to the fan who spends $80 to travel 300 miles to see the game, a package with the choice seat is only 20 percent more expensive than one with a standard seat [$120 versus $100]. If the relative price of the choice seat package is lower, the relative demand should be higher. Indeed, economists at Clemson University found that fans who travel the farthest to Clemson Tiger games buy the best seats.3
Football itself offers a final example.4 Teams with strong-armed quarterbacks and fleet receivers will opt to throw the ball while those with 250-pound tailbacks who can run the 40-yard dash in 4.0 seconds will rely on a ground game. If the Pittsburgh Steelers average five yards per running play and four yards per passing play, the team will clearly choose to run more often than it passes. Runs, on average, are 25 percent more productive than passes. But, what if it rains? During a downpour, running backs lose their footing and fumble. However, quarterbacks and receivers find it more difficult to hold onto the ball. Should the Steelers run more? Should they run less?
Suppose the rain cuts average yardage for both running and passing plays by two yards. The average running gain per Steelers play is now three yards and the average passing gain is now two yards. Although running still has the same one-yard-per play absolute advantage [three yards versus two yards per play] it had in dry weather, its relative advantage has increased. Running is now 50 percent more productive [three is 50 percent larger than two], rather than only 25 percent more productive. The result? The Steelers should run even more. Do you believe it? Check out those game summaries and see for yourself.
1. Alchain, Armen, and Allen, William, University Economics, Belmont, CA, Wadsworth Publishing, 1964.
2. Toh, Rex S. and Phang, Sock-Yang, "Cubing Urban Traffic congestion in Singapore," Transportation Journal, Winter 1997, volume 37, number 2.
3. Bertonazzi, Eric P., Maloney, Michael T., and McCormick, Robert E., "Some Evidence on the Alchain and Allen Theorem: The Third Law of Demand," Economic Inquiry, volume 31, number 3, July 1993, pp. 383-393.
4. This example is adapted from McCormick, Robert E., Managerial Economics, Englewood Cliffs, Prentice Hall, 1993, p. 165.
To test your understanding of the concepts in this reading, try answering the following:
1. Explain why premium apples are relatively more expensive than standard apples in Michigan than in Arizona.
2. According to the article, "couples hiring babysitters, all else equal, are more apt to dine in style." Explain why.
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