A Penny At A Time

A representation of reality

The Laffer Curve is a representation of how much revenue a government can expect to get for a given rate of tax. The essential idea is that there are always two rates of tax that raise the same amount of money. One is a low rate with a very large base, and the other is a high rate with a small base. Some of the simple minds seem to think if you double the rate on some item, you will generate twice the revenue.

Inelastic demand is an economic condition where doubling the rate would work. Real world conditions where people will buy more of a good regardless of price, are few. People substitute something similar to replace the oppressed item. Cheaper goods that are not as durable for example. If I only need a certain item to work once, durability doesn’t matter much. The underground economy is another effect.

The point of the Laffer Curve is revenue depends on two factors – rate of taxation and the base to which it applies.

Other Applications of two factor logic

Managing your expenses works the same way. You really don’t care about the price in isolation. You care about how much you must spend to accomplish a certain thing. I use an electric drill to provide about ten holes a year. I would be foolish to buy a $400 cordless machine for that. If I bought a 30 year old corded drill at a yard sale for $4.00, I doubt my life would be totally ruined. If I were a trades person who used the drill continuously in my work, I would be foolish not to spend the $400. The payoff in convenience and quality would be worth the investment. Value is function of price and volume. In their case cheap is expensive.

Suppose someone wins $50,000 in a lottery. They decide to spend $40,000 of it to reduce their debt. How should they decide what to pay first. In this case the volume is fixed at $40,000, so only the rate matters. Put the debts in order of interest rate at start at the top. Pay them off in order until the money is used.

Consider a high volume cafe or coffee shop. Should they aggressively shop for creamers? Yes. Two cents per unit is $5,000 a year if you sell 800 cups of coffee each day.

Applying to your budget.

Price is not the unique indicator of value. Volume and price together, given similar quality and convenience, will be fertile ground for management. Just like paying off debt, there should be an order to your approach. It won’t necessarily be the highest ticket items in you spending. Think price per unit and high volume. Then shopping for price will matter. Identify convenience and quality once you find a suspect.

Saving two cents a liter on gas at Costco, might not make sense if you must drive far out of your way to get it . The membership fee might mitigate against it too. But, if you go there three days a week anyway, why not use their fuel?

Remember the volume factor.

A bus pass is a good idea unless I only use it a few times a month.

Suppose I buy a new car once every ten years. By serious effort I can save $5,000 by shopping and negotiating and perhaps taking a colour or engine no one likes. Is that a smart saving?

Maybe. It works out to something less than $5,000 if I consider my trouble of getting the saving, but in easy to see numbers, it is $500 per year. About $10 per week. Is it worth the time investment? Maybe. It depends on what I didn’t do to spend time on shopping. If I took time off work, then maybe not. Is it a real saving or is it just a big number that looks good? If it adds poor reliability, higher insurance costs, potential maintenance issues, or higher fuel costs, likely not. Sometimes paying a little more is a better deal. Again cheap can be expensive.

Achieving Balance

We all want the same thing for less. If we can get it we should. Those savings are real. Sometimes the higher price provides enough extra value that we should take it. When we go looking for prospective savings, we should look for big numbers, but also look for high volume usage. In the latter case, small price variations can lead to meaningful advantage.

I help business owners, professionals, and others understand and manage risk and other financial issues. To help them achieve their goals, I use tax efficiencies and design advantages to acquire more efficient income and larger, more liquid estates.

In previous careers, I have been a partner in a large, international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you. don@moneyfyi.com 705-927-4770

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