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Monday, June 02, 2008

Elasticity of dad?

I am not talking about his waistline, although that might be a topic for another day. Rather, I refer to this National Retail Federation survey which purports to find evidence that the increase in food and gasoline prices will reduce the amount of money people spend on Father's Day this year.

In and of itself, the fact that Dad gets less props this year than before is not surprising. After all, Father's Day is a luxury good (whereas Mother's Day is a necessary good) and therefore should be sensitive to the amount of money being spent on necessities such as food and gasoline.

The survey is somewhat convoluted in its methodology. The survey asks individuals if they will purchase certain products for Father's Day, say, a greeting card or sports equipment, and if they are to purchase how much they intend to spend. The methodology then computes a weighted average of spending in each category and then sums over the number of categories. In this fashion, the NRF finds that this year the average spending on Father's Day will be $94.54, whereas in 2007 it was $98.34. I don't like the methodolgy because it makes it seem that the average household will buy gifts in multiple categories, which I think is not likely on average

Nevertheless, if the comparison is between the estimated spending this year versus last year, the reduction in spending might be a reason of concern, especially when the survey makes it pretty clear that the reason Dad gets $4 less spent on him this year is because the price of gasoline is higher. Yet if you take just a second to think about this claim, it makes you want to either chuckle at the "sky is falling" tone or pull your hair out at the fact that this is essentially a non-story (like so many other non-stories that are played up in the media).

Economists would rather not look at the absolute dollar change in spending on Dad, and definitely wouldn't want to put a lot of blame on the gasoline market without having some idea as to what has happened in the gasoline market and how that relates to spending on Dad (assuming direct causation).

Economists like to talk about elasticities: the relative change in one variable due to the relative change in another variable. Another way to think about elasticitie is the percentage change in variable A after a percentage change in variable B. If the percentage change in variable A is relatively high, economists claim that Variable A is elastic with respect to Variable B; if the percentage change is low, economists state that Variable A is inelastic to Variable B.

Thus, instead of casting aspersions on the gasoline market and the food market, an elasticity measure would indicate whether the response to spending on Dad is elastic or inelastic to the price of gasoline. If the spending on Dad is elastic in response ot the price of gasoline, then the increase in the price of gasoline might be expected to put a crimp on the revenue potential of those firms that sell items that are commonly given to Dad on "his day." On the other hand, if the elasticity measure is low, then it seems the NRF is trying to get themselves into the news cycle with a non-story.

The reduction in average spending (flawed methodology and all) is in the area of a 2.8% reduction in spending (95.54-98.34)/98.34=-0.028. The national average price of gasoline was $2.81 in April of 2007 and was at $3.52 in April 2998, an increase of approximately 25%. Therefore, the elasticity of Father's Day spending with respect to the price of gasoline is extremely small, in the area of -0.11.

One reason economists like to use elasticities is that it scrubs the data of scaling effects and allows for easier comparisons across markets. The price of gasoline and food have increased dramatically, but the nominal reduction in spending on Father's Day is trivial when put in the perspective of elasticity.

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