Incentives always have unintended consequences.
Economics is about how humans respond to incentives. Not all responses, however, are intended or even anticipated. Unintended responses to incentives imposed by businesses or governments often outweigh intended effects. In teaching economics, it is interesting to see which students pick up on this insight.
Students learn about “demand shifters” in any microeconomics course. These are factors, other than the price of the good in question itself, that change human willingness to buy specific quantities at specific prices. Get that?
Mad cow disease is one example. When the media report that a cow with BSE was found in the United States, the quantities of beef that consumers will buy at any specified prices drops. Or another, a prolonged heat wave makes people willing to buy more air conditioners at any given price than they would if weather was cool.
Among several common demand shifters, “the price of related products” is an important one. If the price of chicken goes up, people will buy more beef, even though beef prices have not changed. When gasoline prices went up in 1973, oil filter manufacturers sold fewer filters, even though filter prices did not change. Motorists drove fewer miles after the gas price increase and hence changed their oil and filters less often.
At this point in a lecture, I pose the question: “U.S. consumers pay substantially higher prices for sugar because our government restricts sugar imports. This costs some 300 million consumers a few billion dollars per year while benefiting only a few thousand sugar producers. How can such a small group of producers get Congress to maintain a policy that hurts so many?”
Most students are silent but often one well-informed individual will ask, “What about the corn producers, don’t they benefit, too?” Bingo! Yes, there are only a few hundred cane sugar producers and a few thousand sugar beet producers. In contrast, there are over 300,000 corn growers. They know just how much corn goes into making corn sweeteners.
High fructose corn sweetener is very competitive with sugar when prices are high but would rapidly lose market share if lower-cost sugar could be imported freely. HFCS is a “related good” to sugar. Sugar price increases “shift” demand for corn sweetener in the direction of higher sales. The sugar lobby is a smaller factor in keeping out world sugar than the corn lobby.
Another example: Many European and Latin American countries limit firms’ ability to lay off workers once they have been employed for specified period of time, typically 24 or 36 months. This is an attempt to help working people by decreasing the power of employers relative to employees.
Employers are extremely reluctant to hire new workers, even when orders are red hot, and hire only workers who are willing to work “informally” via some under-the-table agreement. Workers who have “formal sector” jobs may benefit, but it is not clear that employees as a whole are better off.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.