One of the first things you learn as a student majoring in Economics is that the average politician could not pass the midterm in any of your freshman classes. The realization is that most of the members of Congress have almost no understanding of the basic facts about our economy is rather frightening.
Luckily, most of the members of Congress have very little to do with drafting legislation: they are far too busy fundraising and searching for the next camera. Most legislation is actually written by Iron Triangles, cooperative groups that—though they rarely make the news—are the real power in Washington.
These triangles have three parts: Congressional Committees are the members of Congress (especially subcommittees) who write laws and control agency funding. They want expertise, support, and campaign donations. Bureaucratic Agencies are the government departments (like the EPA, FDA, or Department of Defense) that implement laws. They need budgets and legislative authority to do their jobs. Special Interest Groups include corporations, lobbyists, unions, and professional associations. They want favorable policies or regulations, and they offer expertise, lobbying, political support and (most important) the campaign funds needed to keep the members of Congress from running off in search of a press conference.
Here's how it works: Interest groups draft or heavily influence legislation. Bureaucrats shape the policy in regulations or provide technical language. Congressional committees then adopt it (usually word-for-word, because that saves time and pleases donors). These triangles become self-reinforcing loops, as Interest groups support Congress, which in turn funds the agencies, who enforce the rules favoring the special interest groups.
You’ll notice that nowhere in the above have I mentioned the constituents—the people like you and me—who pay taxes and naively think our votes and opinions matter. Oh well, I’ll play along. The hot topic on the news right now is tariffs and who pays them, and it won’t surprise you when I tell you the news channels aren’t telling you the whole story. News reporters keep you interested by relying on the fallacy of a binary choice—difficult problems rarely only have two options.
However, before we can talk about tariffs, we have to talk about one more variable factor: price elasticity of demand. I promise the lecture will be painless. Mostly.
Elasticity of demand, as it refers to price, is a fancy way of asking: “How much do people freak out when prices change?” Imagine you’re shopping for chocolate. If the price doubles and you say, “No thanks!” and walk away, your demand is elastic — it stretches and changes a lot when price changes. But if it’s coffee and you must have it, no matter the cost, then your demand is inelastic — it barely budges.
Examples of inelastic demand products include insulin, cigarettes, sugar, and gasoline. No matter what the price is, people will come up with the money and pay for goods that they “have to have”.
Economists measure this using a number. If the price goes up 10% and your quantity demanded drops by more than 10%, that’s elastic. If it drops by less than 10%, it’s inelastic. A perfectly elastic demand would mean nobody buys it at all if the price rises even a little. A perfectly inelastic demand? People buy the same amount no matter what it costs.
Why does demand elasticity matter? It tells businesses how much they can raise prices without losing customers. It tells governments who really pays when they add taxes—think tariffs. And it tells you whether you can really justify that $12 latte.
Demand elasticity is how sensitive people are to a price change. If a small price increase makes you stop buying something, your demand is elastic. If you’ll keep buying no matter what (like gas or insulin), your demand is inelastic. Think of it as the “ouch” factor — how much a price hike hurts your wallet and affects your willingness to pay. Elasticity depends on things like availability of substitutes, on whether the item is a necessity, and on how much of your budget it takes. So, demand elasticity is just how much price changes mess up your next trip to the grocery store.
A great example of an iron triangle and price elasticity of demand working together is the story of Epipens, the autoinjectors of epinephrine for people with serious allergies. In 2007, Mylan bought the exclusive marketing rights for the Epipen from Merck, then launched an expensive lobbying campaign for legislation requiring schools to stock epinephrine auto-injectors, effectively increasing demand for their product. Additionally, Mylan raised the price of a two-pack of EpiPens from about $100 in 2007 to over $600 by 2016, despite the actual cost of epinephrine being around $1 per dose. That the president of Mylan was the daughter of a U.S. senator was not a coincidence.
So what does elasticity have to do with tariffs?
Tariffs are taxes on imports, but who bears the burden?—The foreign producer or the domestic consumer? The answer depends on relative price elasticities of demand. If demand is inelastic, consumers are less sensitive to a price increase and they will pay most of the tariff. If demand is inelastic and the foreign country can’t find a different place to sell the higher-priced goods, then producers will bear more of the tariff to keep the customers buying.
Let’s put this simply: If our government puts tariffs on products we must have (and there are no other sources for them), then we, the consumers, will pay the tariffs. On the other hand, if tariffs are placed on consumer goods that we don’t really need (or there are other goods we can buy instead), then the foreign country will have no choice but to drop the price, thus effectively paying the tariff, in order to keep us buying the product.
I could explain the two graphs, but I think you get the idea. I’ll leave you with three takeaways:
- If a political party says that tariffs are paid only by the manufacturing company, it is wrong and should probably shut up and sit down.
- If a political party says that tariffs are paid only by the consumer, it is wrong and should probably shut up and sit down.
- Regardless of who ends up paying the tariffs, fewer goods will be sold. (C’mon! Look at the graphs!). There will be shortages. It is possible that these shortages will spur domestic production.
Okay, now that you know more about tariffs, go ahead and write to your elected representatives. If you put a check in the envelope, it might even get read...by someone.