Turkish Auto Sales Down, Theory of Price and Demand Confirmed
So, let's review. Remember this idea from Economics 101?
A. The Law of Demand
The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.
And for fun, let's remember a conversation I had once with Neil Kinnock, leader of the Labour Party during Margaret Thatcher's time in power. I'll use him as a stand-in for "the entire stupid world."
NK: Sure. Whereas, when we used to go around saying that we could get unemployment down, and it would require generating X amount of expenditure in the economy, etc., etc., etc., we’d get absolutely bloody hammered by the classicals—
CB: You’d get hammered by who?
NK: --by, you know, the classical supporters of the Conservative philosophy. .... Anyway, you know, it depends on what you think a country should be run for, and how you think it should be run. The great thing about the kind of boiled-down Friedmanism that they had is that they didn’t think the country should be run. Or certainly, the economy. They felt that it should be left to the magic of the market. She said to me, in Prime Minister’s questions, you may have heard the phrase, “You can’t buck the market.” And this is an incantation, this is … a religious conviction, almost, which is bloody ridiculous! I mean, there’s no serious economist in the world who would offer that as a kind of a chant in an economic church--
Yes, yes, of course. The people who think there might be some very regular relationship between such things as price and demand are in the grip of a religious fervor. It's just a weird dogma, they have no special reason for believing this, right?
So, suppose you're the proud owner of an emerging economy, and suppose the automative sector plays a particularly large role in your burgeoning manufacturing sector. Suppose, in fact, that it's really the star of your economy, with some 17 domestic and foreign principal producers and 4,000 sub-industry companies directly employing at least 300,000 workers. Now let's suppose you decide to tax the hell out of auto consumption.
Whoa! Who would have predicted this?
Automobile and light commercial vehicle sales in Turkey for January fell 34.2 percent compared to a year earlier, according to the Automotive Distributors Foundation (ODD).
The total number of automobiles and light commercial vehicles sold in January was 29,545, down from 44,892 in January 2011. The fall began in the third quarter of 2011. In the last quarter of 2011, the market for automobiles and light consumer vehicles dropped by 11.75 percent, reaching 34.2 percent by January 2012.
Now, in fairness, it's pretty obvious that this was the intended result; I don't think they just decided to do it on a lark. With the whole world screaming about the risk of overheating to the Turkish economy, well--that's one way to cool it, I guess. My judgment isn't a normative one; I'm not sure that it was a bad decision. I just point out that it was a decision with absolutely predictable results.
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Comments:
Dec '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Have you, or anyone else here ever suffered from an "over heated" economy?
I cannot recall a single instance in my lifetime that I suffered because the economy was too good.
Yet we hear that phrase over and over again, usually as the justification for some idiotic intervention that results in just what it resulted in here, the hobbling, blunting, or in this case nearly outright destruction of an industry.
If you all can remember a time when things were so good that they were bad, by all means, enlighten me.
'Cause from where I'm setting, that old bromide is just rhetorical cover/code for looting an industry that is doing well for itself.
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Well, of course the idea is that no one suffers from an overheated economy--but they suffer when it crashes. Let's take the idea seriously and not argue with a straw man. (I don't necessarily disagree with you, by the way, but I don't think you can just dismiss the more serious arguments about overheating as a myth. We just need to specify what we're talking about.)
Jun '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Doctors, bleeding their patient into better health didn't work very well in medicine, and it doesn't work with economies either.
Sep '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Economics 101 is a bit off the mark. If the price goes up, sales drop because someone else is selling still at the lower price - in the classical model you can sell an infinite amount at the market price and nil at a price even slightly above that. This is the price effect, and applies, say, to bars of chocolate. Separately, if the price of something that is a major part of your expenditure goes up, such as the rent you pay, you have less money to spend on other things. This is the income effect. There is no income effect from a rise in the price of chocolate bars. there may or may not be if the price of cars goes up. People may be delaying the expenditure. It depends on the elasticity of demand, which again Economics 101 doesn't mention. Is this how economics is taught Stateside?!
It's well known also that raising wages may cause people to work shorter, not longer, hours. In the mining industry shift payments were raised to persuade miners to work longer hours. They did the opposite. Another example of prices working in a more complicated way than might be expected.
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
You're right to point out the importance of considering the elasticity of demand, and also right to point out that complicated, weird things can happen when prices go up. This example is an uncomplicated, un-weird thing, however.
Oct '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
And Obama Administration economists (along with several, but not all, on CNBC) ought to learn the same "uncomplicated, un-weird" lesson.
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Hi Claire. I'm not entirely sure that these numbers are saying exactly what you say they're saying. Sure, bumping up the tax rate will push down on demand, but there are other considerations, which I think may be doing more of the causal work in relation to this slump in sales. For one thing, there are massive base effects. In the year to Jan 2011, there was a 123% increase in sales, so a reversal of 34% in the following year isn't hugely surprising. The Jan 2012 number remains 47% up on the position two years earlier, notwithstanding any tax hikes. Another factor to be borne in mind is the reduced availability (and increased cost) of credit in recent months, which is likely to have had a significant impact on demand in the automotive sector. While those credit-related changes are clearly part of a policy response to the risk of overheating, excessive reliance on "special consumption taxes" is more a reflection of structural problems in the Turkish economy. In particular, endemic tax evasion means that a disproportionate amount of revenue must be raised through indirect taxes, which are more difficult for citizens to side-step.
Jul '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
"Overheat" and "bubble" tend to be synonymous in many cases, but since they evoke different gut responses, CoolHand, you tend to see a bubble as dangerous, but overheating as not really a big deal.
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Some of the causal work, I'll agree--but more of the causal work? And the second part of your argument (the endemic tax evasion forcing reliance on indirect taxes) is why I said "I'm not sure it was the wrong decision." This is after all the real world, and they had to use the tools they really had, not the ones we'd like them to have.
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
By the way--hi! So nice to see you here!
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Yep, more of the causal work. With a surge in car sales like that recorded between Jan 2010 and Jan 2011, a period of retrenchment was very likely. Sales growth like that can't be sustained. Add in the reduced credit availability and I think we've got much of the causal work done before we start thinking about the effect of recent changes to the consumption tax rate. Also, that 123% surge in sales during 2010 came despite a big upward jump in taxes in mid-to-late 2009, when stimulus cuts to special consumption taxes lapsed. So it doesn't appear that fluctuations in the special consumption rate have been the key driver of auto sales in recent years. Which is surely another way of saying that most of the causal work is being done elsewhere?
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Claire Berlinski, Ed.
By the way--hi! So nice to see you here! · 25 minutes ago
Likewise!
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
By the way, none of what I'm saying here is an attempt to refute the law of demand. "The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good." For our purposes the key phrase there is "if all other factors remain equal". In Turkey recently, other factors haven't remained equal in this way. Credit availability has been soaring, allowing auto prices and demand to rise alongside each other. Which is maybe just to point out that the determinant price here hasn't been the price of the autos being purchased, but the price of the money being used to purchase them.
Oct '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
I imagine Eco 101 is taught by starting with simple concepts - like the law of demand aka substitution effect. Then they might introduce the income effect as the effect on a consumer's preferences arising from a change in their income. The price effect is then the sum of the substitution effect and the income effect. Discussion can then move to things like labour-leisure tradeoffs and the shape of labour supply curves.
At some later stage (in Eco 101) they will introduce theories of market-clearing price under conditions of perfect competition, a quite separate, if related, matter. A nice logical place to discuss price elasticity of demand is when discussing the decisions a firm makes about price.
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
I guess the science is settled then
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
istanbulnotes
Yep, more of the causal work. With a surge in car sales like that recorded between Jan 2010 and Jan 2011, a period of retrenchment was very likely. Sales growth like that can't be sustained. Add in the reduced credit availability and I think we've got much of the causal work done before we start thinking about the effect of recent changes to the consumption tax rate. Also, that 123% surge in sales during 2010 came despite a big upward jump in taxes in mid-to-late 2009, when stimulus cuts to special consumption taxes lapsed. So it doesn't appear that fluctuations in the special consumption rate have been the key driver of auto sales in recent years. Which is surely another way of saying that most of the causal work is being done elsewhere? · 35 minutes ago
Now hold on. That's not quite an accurate history of the application of the special consumption tax! (I can't believe I've actually generated a serious discussion of this.)
Jan '11
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
Haha! True, it's far from fully accurate. And it's drawn (perhaps "conjured" is more apt) entirely from memory. But is my account of changes to special consumption tax fundamentally wrong in a way that fatally undermines my argument here? (I'm worried you're going to ask me to provide a fully accurate history of the tax. Is it OK if I plead "insufficient will to live" on that one?!)
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
We might both lose our will to live with this one, and I'm not sure it would serve humanity well for us both to spend hours looking for the data here, but yes, I think you're remembering it wrong. Perhaps we could leave it as an exercise for Ricochet to review the history of the tax and see whether the relationship between the tax and sales looks causal or correlative. It would probably be quite persuasive to break it down into sales by engine volume, too. (I remember a 2007 paper arguing that the demand for cars in Turkey was relatively price-inelastic, but I can't remember who wrote it--for what that's worth. Helpful, I know.)
Dec '10
Re: Turkish Auto Sales Down, Theory of Price and Demand Confirmed
When in the last hundred years has the government ever sensed a bubble building an staved it off without simply causing it to burst then and there?
This is one of those instances where I think the best course of action is no action at all, regardless of what you call the "problem".