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Measurement and  Interpretation of Elasticities Chapter 5
Discussion Topics <ul><li>Own price elasticity of demand </li></ul><ul><li>Income elasticity of demand </li></ul><ul><li>C...
Key Concepts Covered… <ul><li>Own price elasticity </li></ul><ul><li>Income   elasticity </li></ul><ul><li>Cross price   e...
What is Elasticity of Demand? <ul><li>We define  elasticity of demand  as  responsiveness   of the quantity demanded to a ...
Key Concepts Covered… <ul><li>Own price elasticity   =  </li></ul><ul><ul><li>%  Q beef   for a given   %  P beef </li><...
Key Concepts Covered… <ul><li>Arc elasticity  = range along the demand curve </li></ul><ul><li>Point elasticity  = point o...
Key Concepts Covered… <ul><li>Own price elasticity  = %  Q beef   for a given   %  P beef </li></ul><ul><li>Income   ela...
Own Price Elasticity of Demand
Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = P...
Own Price Elasticity of Demand Point elasticity: = [  Q  P]  ×  [P a  Q a ] Own price elasticity of demand Own price e...
Own Price Elasticity of Demand Point elasticity: = [  Q  P]  ×  [P a  Q a ] Own price elasticity of demand Own price e...
Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = P...
Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = w...
Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = w...
Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = w...
Interpreting the Own Price Elasticity of Demand Page 72 If elasticity coefficient is: Demand is said to be: %   in quanti...
Demand Curves Come in a Variety of Shapes
Demand Curves Come in a Variety of Shapes Perfectly inelastic Perfectly elastic Page 72
Demand Curves Come in a Variety of Shapes Inelastic Elastic
Demand Curves Come in a Variety of Shapes Inelastic where  %  Q < %   P Elastic where %  Q > %   P  Page 73 Unitary El...
<ul><li>Demand curves often exhibit all three ranges of elasticity in a single curve. </li></ul><ul><ul><li>Always true wh...
Page 73 Example of arc own-price elasticity of demand Unitary elasticity…a one for one exchange
Page 73 Inelastic demand Elastic demand
P b P a Q b   Q a Price Quantity Elastic Demand Curve 0 Cut in  price Brings about a larger increase in the quantity  dema...
P b P a Q b   Q a Price Quantity Elastic Demand Curve What happened to producer revenue? What happened to  consumer surplu...
P b P a Q b   Q a Price Quantity Elastic Demand Curve Producer revenue increases  since %  P is less that %  Q. Revenue ...
P b P a Q b   Q a Price Quantity Elastic Demand Curve Producer revenue increases  since %  P is less that %  Q. Revenue ...
P b P a Q b   Q a Price Quantity Elastic Demand Curve Producer revenue increases  since %  P is less that %  Q. Revenue ...
Revenue Implications Page 81 Own-price elasticity is: Cutting the price will: Increasing the price will: Elastic Increase ...
P b P a Q b   Q a Price Quantity Elastic Demand Curve Consumer surplus before the price cut was area P b ca. a b 0 c
P b P a Q b   Q a Price Quantity Elastic Demand Curve Consumer surplus after the price cut is Area P a cb. a b 0 c
P b P a Q b   Q a Price Quantity Elastic Demand Curve So the  gain  in consumer surplus after the price cut is area P a P ...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve Cut in  price Brings about a smaller increase in the quantity deman...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve What happened to producer revenue? What happened to  consumer surpl...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve Producer revenue falls  since %  P is greater than %  Q. Revenue ...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve Producer revenue falls  since %  P is greater than %  Q. Revenue ...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve Consumer surplus increased  by area P a P b ab a b 0
Revenue Implications Characteristic of agriculture Page 81 Own-price elasticity is: Cutting the price will: Increasing the...
Retail Own Price Elasticities <ul><li>Beef  and veal= .6166 </li></ul><ul><li>Milk = .2588 </li></ul><ul><li>Wheat = .1092...
Interpretation Let’s take rice as an example, which has an own price elasticity of - 0.1467. This suggests that if the pri...
Example <ul><li>1.  The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each.  The own price elastici...
The answer… <ul><li>1.  The Dixie Chicken sells  1,500  Freddie Burger platters per month at  $3.50  each.  The own price ...
The answer… <ul><li>1.  The Dixie Chicken sells  1,500  Freddie Burger platters per month at  $3.50  each.  The own price ...
The answer… <ul><li>1.  The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each.  The own price elas...
Another Example <ul><li>1.  The Dixie Chicken sells  1,500  Freddie Burger platters per month at  $3.50  each.  The own pr...
The answer… <ul><li>1.  The Dixie Chicken sells  1,500  Freddie Burger platters per month at  $3.50  each.  The own price ...
The answer… <ul><li>1.  The Dixie Chicken sells  1,500  Freddie Burger platters per month at  $3.50  each.  The own price ...
The answer… <ul><li>1.  The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each.  The own price elas...
Income Elasticity of Demand
Income Elasticity of Demand Income elasticity of demand Percentage change in quantity Percentage change in income = where:...
Interpreting the Income Elasticity of Demand Page 75 If the income elasticity is equal to: The good is classified as: Grea...
Some Examples Elastic Page 79 Commodity Own Price elasticity Income  elasticity Beef and veal -0.6166 0.4549 Chicken -0.53...
Some Examples Inferior good Elastic Page 79 Commodity Own Price elasticity Income  elasticity Beef -0.6166 0.4549 Chicken ...
Some Examples Inferior good Luxury good Elastic Page 79 Commodity Own Price elasticity Income  elasticity Beef -0.6166 0.4...
Example <ul><li>Assume the government cuts taxes, thereby increasing disposable income by 5%.  The income elasticity for c...
The Answer <ul><li>1. Assume the government cuts taxes, thereby  increasing  disposable income (I) by  5%.   The income el...
The Answer <ul><li>1. Assume the government cuts taxes, thereby increasing disposable income by 5%.  The income elasticity...
Cross Price Elasticity of Demand
Cross Price Elasticity of Demand Cross Price elasticity of demand Percentage change in quantity Percentage change in anoth...
Interpreting the Cross Price Elasticity of Demand Page 76 If the cross price elasticity is equal to: The good is classifie...
Some Examples Values in red along the diagonal are own price elasticities… Page 80 Item Prego Ragu Hunt’s Prego -2.5502 .8...
Some Examples Values off the diagonal are all  positive , indicating these products are  substitutes  as prices change… Pa...
Some Examples An increase in the price of Ragu Spaghetti Sauce has a  bigger impact on Hunt’s Spaghetti Sauce than vice ve...
Some Examples Page 80 A 10% increase in the price of Ragu Spaghetti Sauce increases the demand for Hunt’s Spaghetti Sauce ...
Some Examples Page 80 But…a 10% increase in the price of Hunt’s Spaghetti Sauce increases the demand for Ragu Spaghetti Sa...
Example <ul><li>1.  The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equal t...
The Answer <ul><li>1.  The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equa...
The Answer <ul><li>1.  The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equa...
The Answer <ul><li>1.  The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equa...
Another Example <ul><li>2.  Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack...
The Answer <ul><li>2.  Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack.  Al...
The Answer <ul><li>2.  Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack.  Al...
The Answer <ul><li>2.  Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack.  Al...
Price Flexibility of Demand
Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity.  If the calcul...
Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity.  If the calcul...
Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity.  If the calcul...
Revenue Implications Characteristic of agriculture Page 81 Own-price elasticity is: Increase in supply will: Decrease in s...
Short run effects Long run effects Over time, consumers respond in greater numbers.  This is referred to as a recognition ...
P b P a Q b  Q a Price Quantity Ag’s Inelastic Demand Curve A small increase in supply will cause the price of Ag products...
P b P a Q b  Q a Price Quantity Inelastic Demand Curve While this increases the costs of government programs and hence bud...
Demand Characteristics <ul><li>Which market is riskier for producers… elastic or inelastic demand? </li></ul><ul><li>Which...
The Market Demand Curve Price Quantity What causes movement along a demand curve?
The Market Demand Curve Price Quantity What causes the demand curve to shift?
In Summary… <ul><li>Know how to interpret all three elasticities </li></ul><ul><li>Know how to interpret a price flexibili...
Chapter 6 starts a series of  chapters that culminates in a market  supply curve  for food and fiber products….
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Agri 2312 chapter 5 measurement and interpretation of elasticities 1

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Agri 2312 chapter 5 measurement and interpretation of elasticities 1

  1. 1. Measurement and Interpretation of Elasticities Chapter 5
  2. 2. Discussion Topics <ul><li>Own price elasticity of demand </li></ul><ul><li>Income elasticity of demand </li></ul><ul><li>Cross price elasticity of demand </li></ul><ul><li>Other general properties </li></ul><ul><li>Applicability of demand elasticities </li></ul>
  3. 3. Key Concepts Covered… <ul><li>Own price elasticity </li></ul><ul><li>Income elasticity </li></ul><ul><li>Cross price elasticity </li></ul>Pages 70-76
  4. 4. What is Elasticity of Demand? <ul><li>We define elasticity of demand as responsiveness of the quantity demanded to a change in the price. </li></ul><ul><ul><li>Degree of responsiveness is measured by an elasticity coefficient — frequently called elasticities . </li></ul></ul><ul><li>Invented by the British Economist Alfred Marshall </li></ul>
  5. 5. Key Concepts Covered… <ul><li>Own price elasticity = </li></ul><ul><ul><li>%  Q beef for a given %  P beef </li></ul></ul><ul><li>Income elasticity = </li></ul><ul><ul><li>%  Q beef for a given %  Income </li></ul></ul><ul><li>Cross price elasticity = </li></ul><ul><ul><li>%  Q beef for a given %  P chicken </li></ul></ul>Pages 70-76
  6. 6. Key Concepts Covered… <ul><li>Arc elasticity = range along the demand curve </li></ul><ul><li>Point elasticity = point on the demand curve </li></ul>Pages 70-76
  7. 7. Key Concepts Covered… <ul><li>Own price elasticity = %  Q beef for a given %  P beef </li></ul><ul><li>Income elasticity = %  Q beef for a given %  Income </li></ul><ul><li>Cross price elasticity = %  Q beef for a given %  P chicken </li></ul><ul><li>Arc elasticity = range along the demand curve </li></ul><ul><li>Point elasticity = point on the demand curve </li></ul><ul><li>Price flexibility = reciprocal of own price elasticity </li></ul>Pages 70-76
  8. 8. Own Price Elasticity of Demand
  9. 9. Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = Point Elasticity Approach Pages 70-72
  10. 10. Own Price Elasticity of Demand Point elasticity: = [  Q  P] × [P a  Q a ] Own price elasticity of demand Own price elasticity of demand Percentage change in quantity Percentage change in price =  Q = (Q a – Q b ); and  P = (P a – P b ) The subscript “a” here stands for “after” while “b” stands for “before” Pages 70-72
  11. 11. Own Price Elasticity of Demand Point elasticity: = [  Q  P] × [P a  Q a ] Own price elasticity of demand Own price elasticity of demand Percentage change in quantity Percentage change in price =  Q = (Q a – Q b ); and  P = (P a – P b ) The subscript “a” here stands for “after” while “b” stands for “before” Single point on curve P a Q a Pages 70-72
  12. 12. Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = Page 72 Arc Elasticity Approach
  13. 13. Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = where: P = (P a + P b )  2; Q = (Q a + Q b )  2;  Q = (Q a – Q b ); and  P = (P a – P b ) Arc elasticity Own price elasticity of demand = [  Q  P] x [P  Q] The subscript “a” here again stands for “after” while “b” stands for “before” Equation 5.3 Page 72
  14. 14. Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = where: P = (P a + P b )  2; Q = (Q a + Q b )  2;  Q = (Q a – Q b ); and  P = (P a – P b ) Arc elasticity Own price elasticity of demand = [  Q  P] x [P  Q] The subscript “a” here again stands for “after” while “b” stands for “before” The “bar” over the P and Q variables indicates an average or mean. Page 72
  15. 15. Own Price Elasticity of Demand Own price elasticity of demand Percentage change in quantity Percentage change in price = where: P = (P a + P b )  2; Q = (Q a + Q b )  2;  Q = (Q a – Q b ); and  P = (P a – P b ) Arc elasticity Own price elasticity of demand = [  Q  P] x [P  Q] The subscript “a” here again stands for “after” while “b” stands for “before” Specific range on curve P b P a Q b Q a Page 72
  16. 16. Interpreting the Own Price Elasticity of Demand Page 72 If elasticity coefficient is: Demand is said to be: %  in quantity is: Greater than 1.0 Elastic Greater than %  in price Equal to 1.0 Unitary elastic Same as %  in price Less than 1.0 Inelastic Less than %  in price
  17. 17. Demand Curves Come in a Variety of Shapes
  18. 18. Demand Curves Come in a Variety of Shapes Perfectly inelastic Perfectly elastic Page 72
  19. 19. Demand Curves Come in a Variety of Shapes Inelastic Elastic
  20. 20. Demand Curves Come in a Variety of Shapes Inelastic where %  Q < %  P Elastic where %  Q > %  P Page 73 Unitary Elastic where %  Q = %  P
  21. 21. <ul><li>Demand curves often exhibit all three ranges of elasticity in a single curve. </li></ul><ul><ul><li>Always true when a demand curve is a straight line. </li></ul></ul>Straight line demand curves are elastic with respect to price at relatively high prices, and inelastic at relatively low prices.
  22. 22. Page 73 Example of arc own-price elasticity of demand Unitary elasticity…a one for one exchange
  23. 23. Page 73 Inelastic demand Elastic demand
  24. 24. P b P a Q b Q a Price Quantity Elastic Demand Curve 0 Cut in price Brings about a larger increase in the quantity demanded c
  25. 25. P b P a Q b Q a Price Quantity Elastic Demand Curve What happened to producer revenue? What happened to consumer surplus? 0 c
  26. 26. P b P a Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b . Revenue after the change was 0P a bQ a . a b 0 c
  27. 27. P b P a Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b . Revenue after the change was 0P a bQ a . a b 0 c
  28. 28. P b P a Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b . Revenue after the change was 0P a bQ a . a b 0 c
  29. 29. Revenue Implications Page 81 Own-price elasticity is: Cutting the price will: Increasing the price will: Elastic Increase revenue Decrease revenue Unitary elastic Not change revenue Not change revenue Inelastic Decrease revenue Increase revenue
  30. 30. P b P a Q b Q a Price Quantity Elastic Demand Curve Consumer surplus before the price cut was area P b ca. a b 0 c
  31. 31. P b P a Q b Q a Price Quantity Elastic Demand Curve Consumer surplus after the price cut is Area P a cb. a b 0 c
  32. 32. P b P a Q b Q a Price Quantity Elastic Demand Curve So the gain in consumer surplus after the price cut is area P a P b ab. a b 0 c
  33. 33. P b P a Q b Q a Price Quantity Inelastic Demand Curve Cut in price Brings about a smaller increase in the quantity demanded
  34. 34. P b P a Q b Q a Price Quantity Inelastic Demand Curve What happened to producer revenue? What happened to consumer surplus?
  35. 35. P b P a Q b Q a Price Quantity Inelastic Demand Curve Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b . Revenue after the change was 0P a bQ a . a b 0
  36. 36. P b P a Q b Q a Price Quantity Inelastic Demand Curve Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b . Revenue after the change was 0P a bQ a . a b 0
  37. 37. P b P a Q b Q a Price Quantity Inelastic Demand Curve Consumer surplus increased by area P a P b ab a b 0
  38. 38. Revenue Implications Characteristic of agriculture Page 81 Own-price elasticity is: Cutting the price will: Increasing the price will: Elastic Increase revenue Decrease revenue Unitary elastic Not change revenue Not change revenue Inelastic Decrease revenue Increase revenue
  39. 39. Retail Own Price Elasticities <ul><li>Beef and veal= .6166 </li></ul><ul><li>Milk = .2588 </li></ul><ul><li>Wheat = .1092 </li></ul><ul><li>Rice = .1467 </li></ul><ul><li>Carrots = .0388 </li></ul><ul><li>Non food = .9875 </li></ul>Page 79
  40. 40. Interpretation Let’s take rice as an example, which has an own price elasticity of - 0.1467. This suggests that if the price of rice drops by 10%, for example, the quantity of rice demanded will only increase by 1.467%. P Q 10% drop 1.467% increase Rice producer Revenue? Consumer surplus?
  41. 41. Example <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –0.30. If the Chicken increases the price of the platter by 50 cents: </li></ul><ul><li>How many platters will the chicken sell?__________ </li></ul><ul><li>b. The Chicken’s revenue will change by $__________ </li></ul><ul><li>c. Consumers will be ____________ off as a result of this price change. </li></ul>
  42. 42. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –0.30 . If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,440 ____ </li></ul><ul><li>Solution: </li></ul><ul><li>-0.30 = %  Q  %  P </li></ul><ul><li>-0.30= %  Q  [($4.00-$3.50)  (($4.00+$3.50)  2)] </li></ul><ul><li>-0.30= %  Q  [$0.50  $3.75] </li></ul><ul><li>-0.30= %  Q  0.1333 </li></ul><ul><li>%  Q=(-0.30 × 0.1333) = -0.04 or –4% </li></ul><ul><li>So new quantity is 1,440, or (1-.04) ×1,500, </li></ul><ul><li>or .96 ×1,500 </li></ul>
  43. 43. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –0.30 . If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,440 ____ </li></ul><ul><li>b. The Chicken’s revenue will change by $__ +$510 ___ </li></ul><ul><li>Solution: </li></ul><ul><li>Current revenue = 1,500 × $3.50 = $5,250 per month </li></ul><ul><li>New revenue = 1,440 × $4.00 = $5,760 per month </li></ul><ul><li>So revenue increases by $510 per month, or $5,760 </li></ul><ul><li>minus $5,250 </li></ul>
  44. 44. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –0.30. If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,440 ____ </li></ul><ul><li>b. The Chicken’s revenue will change by $__ +$510 ___ </li></ul><ul><li>Consumers will be __ worse ___ off as a result of this price change. </li></ul><ul><li>Why? Because price increased. </li></ul>
  45. 45. Another Example <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –1.30 . If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__________ </li></ul><ul><li>b. The Chicken’s revenue will change by $__________ </li></ul><ul><li>c. Consumers will be ____________ off as a result of this price change. </li></ul>
  46. 46. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –1.30 . If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,240 ____ </li></ul><ul><li>Solution: </li></ul><ul><li>-1.30 = %  Q  %  P </li></ul><ul><li>-1.30= %  Q  [($4.00-$3.50)  (($4.00+$3.50)  2)] </li></ul><ul><li>-1.30= %  Q  [$0.50  $3.75] </li></ul><ul><li>-1.30= %  Q  0.1333 </li></ul><ul><li>%  Q=(-1.30 × 0.1333) = -0.1733 or –17.33% </li></ul><ul><li>So new quantity is 1,240, or (1-.1733) ×1,500, </li></ul><ul><li>or .8267 ×1,500 </li></ul>
  47. 47. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –1.30 . If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,240 ____ </li></ul><ul><li>b. The Chicken’s revenue will change by $__ - $290 ___ </li></ul><ul><li>Solution: </li></ul><ul><li>Current revenue = 1,500 × $3.50 = $5,250 per month </li></ul><ul><li>New revenue = 1,240 × $4.00 = $4,960 per month </li></ul><ul><li>So revenue decreases by $290 per month, </li></ul><ul><li>or $4,960 minus $5,250 </li></ul>
  48. 48. The answer… <ul><li>1. The Dixie Chicken sells 1,500 Freddie Burger platters per month at $3.50 each. The own price elasticity for this platter is estimated to be –1.30. If the Chicken increases the price of the platter by 50 cents : </li></ul><ul><li>How many platters will the chicken sell?__ 1,240 ____ </li></ul><ul><li>b. The Chicken’s revenue will change by $__ - $290 ___ </li></ul><ul><li>Consumers will be __ worse ___ off as a result of this price change. </li></ul><ul><li>Why? Because the price increased. </li></ul>
  49. 49. Income Elasticity of Demand
  50. 50. Income Elasticity of Demand Income elasticity of demand Percentage change in quantity Percentage change in income = where: I = (I a + I b )  2 Q = (Q a + Q b )  2  Q = (Q a – Q b )  I = (I a – I b ) = [  Q   I] x [I  Q] Page 74-75 Indicates potential changes or shifts in the demand curve as consumer income (I) changes….
  51. 51. Interpreting the Income Elasticity of Demand Page 75 If the income elasticity is equal to: The good is classified as: Greater than 1.0 A luxury and a normal good Less than 1.0 but greater than 0.0 A necessity and a normal good Less than 0.0 An inferior good!
  52. 52. Some Examples Elastic Page 79 Commodity Own Price elasticity Income elasticity Beef and veal -0.6166 0.4549 Chicken -0.5308 .3645 Cheese -0.3319 0.5927 Rice -0.1467 -0.3664 Lettuce -0.1371 0.2344 Tomatoes -0.5584 0.4619 Fruit juice -0.5612 1.1254 Grapes -1.3780 0.4407 Nonfood items -0.9875 1.1773
  53. 53. Some Examples Inferior good Elastic Page 79 Commodity Own Price elasticity Income elasticity Beef -0.6166 0.4549 Chicken -0.5308 .3645 Cheese -0.3319 0.5927 Rice -0.1467 -0.3664 Lettuce -0.1371 0.2344 Tomatoes -0.5584 0.4619 Fruit juice -0.5612 1.1254 Grapes -1.3780 0.4407 Nonfood items -0.9875 1.1773
  54. 54. Some Examples Inferior good Luxury good Elastic Page 79 Commodity Own Price elasticity Income elasticity Beef -0.6166 0.4549 Chicken -0.5308 .3645 Cheese -0.3319 0.5927 Rice -0.1467 -0.3664 Lettuce -0.1371 0.2344 Tomatoes -0.5584 0.4619 Fruit juice -0.5612 1.1254 Grapes -1.3780 0.4407 Nonfood items -0.9875 1.1773
  55. 55. Example <ul><li>Assume the government cuts taxes, thereby increasing disposable income by 5%. The income elasticity for chicken is .3645. </li></ul><ul><li>What impact would this tax cut have upon the demand for chicken? </li></ul><ul><li>Is chicken a normal good or an inferior good? Why? </li></ul>
  56. 56. The Answer <ul><li>1. Assume the government cuts taxes, thereby increasing disposable income (I) by 5%. The income elasticity for chicken is .3645 . </li></ul><ul><li>What impact would this tax cut have upon the demand for chicken? </li></ul><ul><li>Solution: </li></ul><ul><li>.3645 = %  Q Chicken  %  I </li></ul><ul><li>.3654 = %  Q Chicken  .05 </li></ul><ul><li> %  Q Chicken = .3645  .05 = .018 or + 1.8% </li></ul>
  57. 57. The Answer <ul><li>1. Assume the government cuts taxes, thereby increasing disposable income by 5%. The income elasticity for chicken is .3645. </li></ul><ul><li>What impact would this tax cut have upon the demand for chicken? _____ + 1.8% ___ </li></ul><ul><li>Is chicken a normal good or an inferior good? Why? </li></ul><ul><li>Chicken is a normal good but not a luxury since the income elasticity is > 0 but < 1.0 </li></ul>
  58. 58. Cross Price Elasticity of Demand
  59. 59. Cross Price Elasticity of Demand Cross Price elasticity of demand Percentage change in quantity Percentage change in another price = where: P T = (P Ta + P Tb )  2 Q H = (Q Ha + Q Hb )  2  Q H = (Q Ha – Q Hb )  P T = (P Ta – P Tb ) = [  Q H  P T ] × [P T  Q H ] Page 75 Indicates potential changes or shifts in the demand curve as the price of other goods change…
  60. 60. Interpreting the Cross Price Elasticity of Demand Page 76 If the cross price elasticity is equal to: The good is classified as: Positive Substitutes Negative Complements Zero Independent
  61. 61. Some Examples Values in red along the diagonal are own price elasticities… Page 80 Item Prego Ragu Hunt’s Prego -2.5502 .8103 .3918 Ragu .5100 -2.0610 .1381 Hunt’s 1.0293 .5349 -2.7541
  62. 62. Some Examples Values off the diagonal are all positive , indicating these products are substitutes as prices change… Page 80 Item Prego Ragu Hunt’s Prego -2.5502 .8103 .3918 Ragu .5100 -2.0610 .1381 Hunt’s 1.0293 .5349 -2.7541
  63. 63. Some Examples An increase in the price of Ragu Spaghetti Sauce has a bigger impact on Hunt’s Spaghetti Sauce than vice versa. Page 80 Item Prego Ragu Hunt’s Prego -2.5502 .8103 .3918 Ragu .5100 -2.0610 .1381 Hunt’s 1.0293 .5349 -2.7541
  64. 64. Some Examples Page 80 A 10% increase in the price of Ragu Spaghetti Sauce increases the demand for Hunt’s Spaghetti Sauce by 5.349%….. Item Prego Ragu Hunt’s Prego -2.5502 .8103 .3918 Ragu .5100 -2.0610 .1381 Hunt’s 1.0293 .5349 -2.7541
  65. 65. Some Examples Page 80 But…a 10% increase in the price of Hunt’s Spaghetti Sauce increases the demand for Ragu Spaghetti Sauce by only 1.381%….. Item Prego Ragu Hunt’s Prego -2.5502 .8103 .3918 Ragu .5100 -2.0610 .1381 Hunt’s 1.0293 .5349 -2.7541
  66. 66. Example <ul><li>1. The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equal to –0.60. </li></ul><ul><li>If the price of hamburger buns rises by 5 percent, what impact will that have on hamburger consumption? </li></ul><ul><li>What is the demand relationship between these products? </li></ul>
  67. 67. The Answer <ul><li>1. The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equal to –0.60. </li></ul><ul><li>If the price of hamburger buns rises by 5%, what impact will that have on hamburger consumption? ____ - 3% ______ </li></ul><ul><li>Solution: </li></ul><ul><li>-.60 = %  Q H  %  P HB </li></ul><ul><li>-.60 = %  Q H  .05 </li></ul><ul><li> %  Q H = .05  (-.60) = -.03 or – 3% </li></ul>
  68. 68. The Answer <ul><li>1. The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equal to –0.60. </li></ul><ul><li>If the price of hamburger buns rises by 5%, what impact will that have on hamburger consumption? ___ - 3% _____ </li></ul><ul><li>What is the demand relationship between these products? </li></ul>
  69. 69. The Answer <ul><li>1. The cross price elasticity for hamburger demand with respect to the price of hamburger buns is equal to –0.60. </li></ul><ul><li>If the price of hamburger buns rises by 5%, what impact will that have on hamburger consumption? ___ - 3% _____ </li></ul><ul><li>What is the demand relationship between these products? </li></ul><ul><li>These two products are complements as evidenced by the negative sign on this cross price elasticity. </li></ul>
  70. 70. Another Example <ul><li>2. Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack. Also assume the cross price elasticity for Pepsi with respect to the price of Coca Cola is 0.70. </li></ul><ul><li>If the price of Coca Cola rises by 5 percent, what impact will that have on Pepsi consumption? </li></ul><ul><li>b. What is the demand relationship between these products? </li></ul>
  71. 71. The Answer <ul><li>2. Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack. Also assume the cross price elasticity for Pepsi with respect to the price of Coca Cola is 0.70. </li></ul><ul><li>If the price of Coca Cola rises by 5 percent, what impact will that have on Pepsi consumption? </li></ul><ul><li>Solution: </li></ul><ul><li>.70 = %  Q Pepsi  %  P Coke </li></ul><ul><li>.70 = %  Q Pepsi  .05 = .035 or 3.5% </li></ul><ul><li>New quantity sold = 1,000  1.035 = 1,035 </li></ul><ul><li>New value of sales = 1,035  $3.00 = $3,105 </li></ul>
  72. 72. The Answer <ul><li>2. Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack. Also assume the cross price elasticity for Pepsi with respect to the price of Coca Cola is 0.70. </li></ul><ul><li>If the price of Coca Cola rises by 5 percent, what impact will that have on Pepsi consumption? __ 35 six-packs or $105 per day __ </li></ul><ul><li>What is the demand relationship between these products? </li></ul>
  73. 73. The Answer <ul><li>2. Assume that a retailer sells 1,000 six-packs of Pepsi per day at a price of $3.00 per six-pack. Also assume the cross price elasticity for Pepsi with respect to the price of Coca Cola is 0.70. </li></ul><ul><li>If the price of Coca Cola rises by 5 percent, what impact will that have on Pepsi consumption? __ 35 six-packs or $105 per day __ </li></ul><ul><li>What is the demand relationship between these products? </li></ul><ul><li>The products are substitutes as evidenced by the positive sign on this cross price elasticity! </li></ul>
  74. 74. Price Flexibility of Demand
  75. 75. Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity. If the calculated elasticty is - 0.25, then the flexibility would be - 4.0 .
  76. 76. Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity. If the calculated elasticty is - 0.25, then the flexibility would be - 4.0 . This is a useful concept to producers when forming expectations for the current year. If the USDA projects an additional 2% of supply will likely come on the market, then producers know the price will likely drop by 8%, or: %  Price = - 4.0 x %  Quantity = - 4.0 x (+2%) = - 8% If supply increases by 2%, price would fall by 8%!
  77. 77. Price Flexibility We earlier said that the price flexibility is the reciprocal of the own-price elasticity. If the calculated elasticty is - 0.25, then the flexibility would be - 4.0 . This is a useful concept to producers when forming expectations for the current year. If the USDA projects an additional 2% of supply will likely come on the market, then producers know the price will likely drop by 8%, or: %  Price = - 4.0 x %  Quantity = - 4.0 x (+2%) = - 8% If supply increases by 2%, price would fall by 8%! Note : make sure you use the negative sign for both the elasticity and the flexibility.
  78. 78. Revenue Implications Characteristic of agriculture Page 81 Own-price elasticity is: Increase in supply will: Decrease in supply will: Elastic Increase revenue Decrease revenue Unitary elastic Not change revenue Not change revenue Inelastic Decrease revenue Increase revenue
  79. 79. Short run effects Long run effects Over time, consumers respond in greater numbers. This is referred to as a recognition lag… Page 77 Changing Price Response Over Time
  80. 80. P b P a Q b Q a Price Quantity Ag’s Inelastic Demand Curve A small increase in supply will cause the price of Ag products to fall sharply. This explains why major program crops receive Subsidies from the federal government. a b 0 Increase in supply
  81. 81. P b P a Q b Q a Price Quantity Inelastic Demand Curve While this increases the costs of government programs and hence budget deficits, remember consumers benefit from cheaper food costs. a b 0 P b P a Q b Q a Price a b 0
  82. 82. Demand Characteristics <ul><li>Which market is riskier for producers… elastic or inelastic demand? </li></ul><ul><li>Which market would you start a business in? </li></ul><ul><li>Which market is more apt to need government subsidies to stabilize producer incomes? </li></ul>
  83. 83. The Market Demand Curve Price Quantity What causes movement along a demand curve?
  84. 84. The Market Demand Curve Price Quantity What causes the demand curve to shift?
  85. 85. In Summary… <ul><li>Know how to interpret all three elasticities </li></ul><ul><li>Know how to interpret a price flexibility </li></ul><ul><li>Understand revenue implications for producers if prices are cut (raised) </li></ul><ul><li>Understand the welfare implications for consumers if prices are cut (raised) </li></ul><ul><li>Know what causes movement along versus shifts the demand curve </li></ul>
  86. 86. Chapter 6 starts a series of chapters that culminates in a market supply curve for food and fiber products….

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