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YOU DECIDE: How 'elastic' are lottery sales?

August 10, 2007

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

North Carolina officials are making our two-year-old lottery more attractive to play.

As part of the just-concluded state budget, the lottery rules were changed to permit higher prize payouts. The hope is that better winnings will increase ticket sales and increase profits (net proceeds) to the state.

But wait a minute. Isn't this faulty thinking? If the state pays out more in lottery prizes, won't the amount it keeps decline rather than increase? Won't higher prizes be bad for state coffers, even though they're good for lottery players?

This is a question that's common to more than state lotteries. In fact, it's one of the most fundamental questions in economics; indeed, a question that businesses ask all the time. Can decreasing the price of a product or service actually increase profits for the business? Or, as common sense would suggest, could profits only be expanded if the price goes up?

The answer - fortunately or unfortunately - is "it depends!" If a grocery lowers the price of bread by 20 percent a loaf, and sells twice as many loaves, even though the grocery will make less profit per loaf, it will make more total profits. But if, when bread prices are cut 20 percent, only 5 percent more loaves are sold, not only will the grocery make less profit per loaf, but the total profits from selling bread will also drop.

If you hang around economists like me, you'll find we have a name for this concept: "price elasticity." It's really a simple idea. Think of elasticity as meaning "stretch," in the sense of how much purchases will stretch when the price changes. Products or services where purchases stretch a lot when the price changes are called "price elastic." Products or services where purchases stretch very little when the price changes are called "price inelastic."

Gasoline is a good example of a price-inelastic product. Because most of us are locked in to our driving patterns, the mileage we drive (and hence, the gallons of gas we buy) will change relatively little when gas prices jump. Alternatively, hog dogs are more likely to be a price-elastic product, because when their price rises, many people will switch their purchases to hamburgers.

Now let's get back to the lottery. Evidence indicates that, when a state lottery is relatively new, playing it is price-elastic. This means increasing the prizes or improving the odds of winning - which effectively lowers the price of playing - result in enough new ticket sales to increase the lottery's net revenues (after prizes and other costs) to the state. So North Carolina's decision to permit higher prize payouts was a logical way to bump up lottery revenues.

However, there is a "but" to this story.

The evidence also suggests that as lotteries age, they can change from being price-elastic games to price-inelastic games. This is probably the result of people becoming accustomed to the lottery, of the lottery no longer being new, different or exciting. This also means increasing the prizes or odds of winning won't necessarily work to augment lottery profits to the state. In fact, it would do just the opposite: profits to the state would drop.

The importance of the price elasticity concept to the lottery actually has application to all sources of public revenues.

Take the controversy over tax rates, and whether lowering a tax rate can actually increase tax revenue. The answer depends on the price elasticity of the tax. Taxes that are price elastic, meaning lowering the tax results in a large increase in the economic activity being taxed, will generate more revenues at lower rates. But taxes that are price inelastic will result in less tax revenues when the tax rate is cut.

Of course, as an economist, I'm convinced that economics and economic concepts have wide applicability to many private and public decisions.

Maybe this explanation of the thinking behind changing North Carolina's lottery rules will help you decide I'm not too far off base.

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html

Posted by Dave at August 10, 2007 08:55 AM