Saturday, November 17, 2012

Price Elasticity and New Zealand Retail Sales

Statistics New Zealand, with their recent Retail Statistics released a bit of a bombshell:  not only was an decline in retail trade unexpected, but things which (used to) NEVER fall - like supermarket and grocery store sales - declined.

The thing about supermarket and groceries is that, since everyone needs to eat, they are considered "inelastic" goods - changes in the demand for "groceries" is relatively insensitive to changes in their price. If the price of groceries or supermarket items increase, people can't easily substitute away into consuming other alternative commodities, like things sold from "motor vehicle and parts" retailing store  The same thing with petrol: in the short term, the quantity of petrol the country consumes is insensitive to variations in petrol costs.

Prices and quantities always move in opposite ways:  price falls stimulate increased quantities sold, and on the flip side price increases reduce the quantities of good sold. Couple this with the notion of price elasticity.  If the price of an inelastic good goes up then, becuase the quantity sold is relatively insensitive to price, the quantity sold falls by less then the price increase.  A price increase, coupled with a smaller quantity decrease means that the value of total sales should actually increase. 

Similarly, if the price of an inelastic goods falls, then inelasticity means the quantity sold will increase by less then the price decreaseA price decrease coupled with a smaller quantity increase means the total value of sales should decline.

Compare that against "elastic" goods, normally associated with discretionary purchases.  Yes everybody needs food, but not everybody needs a new ball, or other recreational good.  Small changes in the price of recreational goods can lead to comparatively larger changes in the quantities sold. A small price drop will lead to a large quantity increase, and the value of total sales should increase.  A small price increase will lead to a large quantity fall and the value of total sales should fall.

Here's the quarterly changes in Retail Sales of recreational goods (elastic) side-by-side with supermarket goods (inelastic) from Stats NZ's data.

Quarterly Change in Seasonally Adjusted Total Retail Sales:  Recreational Goods
Quarterly Change in Seasonally Adjusted Retail Sales: Supermarkets and Grocery Stores
While the graphs are similar(ish), Recreational goods has spent more time in negative growth than supermarkets.  Most of the period around the Global Financial Crisis (2008 - 2010) recreation good retail sales were spent in decline, compared to approximately 3 quarters for Supermarkets.  When consumer incomes where most uncertain, it was recreational goods whose sales declined comparatively the most.

We can go further than this and look at the comparative elasticities of retails sales for Supermarkets and Recreational Goods.  Statistics New Zealand also estimates and releases Retail trade sales deflators, which allow the separate price and quantity effects which comprise total retail sales to be disentangled from each other.  I've separated changes in price with changes in quantities for Supermarket and Grocery retail sales,and Recreational Goods retail sales and scatter plot each below.
Changes in Prices and Quantities:  New Zealand Supermarket and Recreational Good Retail Trade Data

  Based on the above data, supermarkets can afford to increase their prices by approximately 1.3% each quarter (where the red line above cross the x-axis) before they will start to notice a decline in the volume of stock sold.  In contrast, Recreational Good stores will notice a drop off in quantity sold if they attempt to increase prices by more than 0.16% each quarter (where the green line intercepts the x-axis).

If Recreational Stores don't change prices, they can expect the quantity of goods sold to naturally increase by 0.17% each quarter (where the green line intercepts the y-axis).  However, if supermarkets don't change prices, they can expect the quantity of goods sold to increase 1.5% each quarter (where the red line intercepts the y-axis).  Not only in the natural increase in quantity sold significantly higher for supermarkets (this is the notion that people need to eat), but the effects price has in dampening demand is so much weaker.

In contrast, the natural increase in recreational goods sold is almost non-existant, and the effects of prices increases for recreational goods are dramatic and immediate.  Any attempt to increase prices even just a little bit will lead to a decline in the quantity of recreational goods sold.

Coming back to the reason why the decline in retail sales was a bombshell, was that for the Sept 2012 quarter, the Supermarket Retail Sales deflator increased 0.78%.  Based on estimated price elasticity, the quantity of goods sold should have increased by 0.62%  (Supermarkets can lift prices by 1.3% before quantity declines).  But, in fact, the quantity of supermarket goods sold fell 2.34% for the September 2012 quarter, based on Stats NZ's data.  And the difference between -2.34% actual and a 0.62% estimated is so large that it tells us, the Economists, that something else just might be at play.  Something else that lead to a shock increase in unemployment; that's lead to a decline in import demand; and that's lead to very little consumer price inflation.

All of these point to an issue with what's happening to wealth growth and total incomes within the New Zealand's Household insitutional sector.

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