Newsflash: lower prices cause more demand!

The Australian Institute of Health and Welfare have just released a report on the Welfare of Australians. News Limited has already run with the AIHW claim that child care is apparently becoming less affordable. This conclusion is based solely on the fact that people are spending more of their income on child care. Yet this tells us nothing about the price of child care services, clearly the price of something can fall but people can still spend more money on it in total. Computers and airline tickets come to mind.

Amazingly, in contradiction of their main findings, AIHW actually admit that child care prices (after accounting for government subsidies) have fallen over the last 15 years:

Over the last 15 years, policy changes have had a clear impact on trends in affordability of child care. Most recently, the Australian Government Child Care Benefit (CCB), introduced in 2000, resulted in greater affordability of child care services for many families.

They also show that demand for child care has increased. In 1991 there were 260 000 children in child care and by 2004 there were 650 000.

So prices have fallen, demand has increased but people have spent more of their income on it. Hardly groundbreaking results. For economists, it simply means that the price elasticity of child care services is greater than one, in other words that the demand for child care services is elastic. (This Japanese paper estimates the price elasticity at two.) This is not surprising since goods that have easily available substitutes (you can always look after your own kid rather than use child care) generally exhibit elastic demand.

In light of this, I wonder under what circumstances AIHW would concede that the affordability of child care had fallen. Their problem stems from trying to use the proportion of what people spend on a good to measure whether something is affordable. Using their guidelines, we could quite simply increase affordability by raising prices, causing the amount of income spent on child care to fall (remember the elasticity) and abracadabra suddenly households have less 'stress' since they no longer spend so much on child care.