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Information and Demand
AGEC689: Economic Issues and Policy
Implications of Homeland Security
Yanhong Jin
AGEC689: Economic Issues and Policy Implications of Homeland Security
Yanhong Jin at TAMU
1
Outline
Outline
Basic economics on demand/supply
Intentional and un-intentional events
Previous studies
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Consumer
Consumer Demand
Demand
Demand is the quantity a good/service
that customers are willing and able to
purchase during a specified period under a
given set of economic conditions.
PA
Derived from the utility maximization
Demand Curve shows the relation
between price and the quantity demanded,
holding all other factors constant.
Strange convention: price is on y-axis.
Law of demand:
Demand
Demand curve slopes down
An increase in the price leads to an decrease in
the quantity demanded.
One important empirical finding in economics.
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Q
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Effects
Effects of
of Factors
Factors Affecting
Affecting the
the Demand
Demand
DA= ƒ(PA,Po,Y,S,Z)
Movement along demand curve
reflecting a change in price and
quantity—own price effects PA
Shifting of demand curve:
Demand
PA
Price of other products, Po
(substitutes/complements).
Income, Y
Taste/preference, S
Information (BSE/AI events), Z
Other factors (excessive media
coverage on the UK FMD)
DA= ƒ(PA,Po,Y,S,Z)
Movement along
demand curve
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Q
Demand
Shifter
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Supply
Supply
Supply: quantity that a firm is willing and
able to supply at a given price, holding
other factors constant.
Factors affecting supply
PA
Supply
Price
Production cost
Technology
Government policy (ag. price support, tax/
subsidies)
Supply curve shows the relation between
price and the quantity supplied, holding
all else constant.
No Law of Supply: supply curve can be
upward/downward sloping, vertical,
horizontal
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Change
Change in
in the
the Supply
Supply Curve
Curve
A change in the
product price causes a
movement along the
supply curve.
A change in any
factors other than the
product price causes a
shift of the supply
curve.
PA
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Supply
Q
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2
Market
Market Equilibrium
Equilibrium
Supply=Demand
Demand
PA
Supply
Q
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Example
Example
Demand
PA
Supply
PA
Demand
Supply
Q
Q
Only demand changes:
Only supply changes:
Shifting inward
Shifting inward
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Example
Example (cont’)
(cont’)
PA
Demand
Supply
PA
Demand
Supply
Q
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Q
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Welfare
Welfare
PA
P2
Demand
Consumer surplus (CS): the area
under the demand curve, above the
market equilibrium price, and up to
the equilibrium quantity. P2P *E
Supply
P*
Producer surplus (PS): the area
above the supply curve, under the
market equilibrium price, and up to
the equilibrium quantity. P1EQ*
E
P1
Social welfare: CS+PS=P2P1E
Q*
Q
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Impact
Impact of
of Adverse
Adverse Event
Event on
on Social
Social Welfare
Welfare
p1
PA
Demand
Supply
CS
PS
E1
P1E1 P1*
P1*E1P
SW
1
P1 E1 P1
At E2
P2E2 P2*
P2*E2P1
P2 E2 P1
p2
At
P1*
E1
E2
P2*
P1
Q2*’ Q1*
Q2
Q1
Q
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Numerical
Numerical Example
Example
p1
PA
Pre-event condition:
Demand
Supply
p2
Demand: Qd=10-P
Supply: Qs=-2+P
Post-event condition:
P1*
P2*
E1
Demand:Qd=8-P
Problem statement: how much is the
welfare change due to the event?
E2
CS
P1
Q2*’ Q1*
Q2
Q1
At
E1
At E2
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PS
SW
P1E1P1*
P1*E1P
=18
=6
=24
P2E2 P2*
=12.5
∆CS=
-6.5
P2*E2P1
=2.5
∆PS=
-3.5
P2 E2 P1
=15
∆SW=
-9
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P1 E1P
1
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Elasticity
Elasticity
Own price elasticity
Cross price elasticity
Income elasticity
others
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Own
Own Price
Price Elasticity
Elasticity
1% increase in the product price leads to an ε%
decrease in the quantity demanded
Formula:
The product price changes from p1 to p2, and the quantity
changes from Q1 to Q2 correspondingly.
 dQ p
if Q is a function of p only
%∆Q  dp Q
Ep =
=
%∆p  ∂Q p if Q is a function of p and others
 ∂p Q
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Types
Types of
of Own
Own Price
Price Elasticity
Elasticity
Elastic: the quantity demanded changes more
than in proportion to a change in price, Ep<-1.
Inelastic: the quantity demanded changes less
than in proportion to a change in price, Ep>-1.
Unitary: the % changes in quantity and price
are the same, Ep=-1.
Special cases:
Completely elastic
Completely inelastic
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Cross
Cross Price
Price Elasticity
Elasticity
What-if Question: If the price of product x
changes, how much does the quantity demanded
of product y will change?
Formula:
E AB =
 dQA
∆QA / QA ∆QA pB  dpB
=
=
∆pB / pB ∆p B QA  ∂QA
 ∂pB
pB
if QA is a functionof pB only(not likely)
QA
pB
if QA is a functionof p B and others
QA
Substitutes: E AB > 0 ; compliments: E AB < 0
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Income
Income Elasticity
Elasticity
Income Elasticity: a measure of responsiveness of
the quantity demanded to income.
EI =
 dQ
∆Q / Q ∆Q I
 dI
=
=
∆I / I
∆I Q  ∂Q
 ∂I
I
if Q is a function of I only
Q
I
if Q is a function of I and others
Q
Normal goods: products for which demand is
positively related to income; EI>0
Inferior goods: products for which consumer
demand declines as income rises; EI<0
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Intentional/Unintentional
Intentional/Unintentional Events
Events
Shifting demand
Causing changes in supply
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Impacts
Impacts of
of Negative
Negative Information
Information
Magnitudes of impacts depending on
Intensity of the event (frequency and severity)
Media coverage of event
Market structure
Duration of impacts can be
Short term: Temporary change in demand
Long term: Permanent shift in demand
(individual preference/taste changed)
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Response
Response
Voluntary actions by consumers and
producers/industry
Concerned corporations/industry formulated self
regulatory policies (food recall)
Consumers decrease their demand for the relevant
product
Media determines its coverage (air time and
duration)
Regulatory actions
Ex-Post VS Ex-Ante response
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Intentional
Intentional Product
Product Tampering
Tampering
Goals of the intentional adulteration or corruption
of goods post production
Express hatred
Create panic
Sudden drop in consumption
High coverage to these events
Spurious claims (HOAX) across the country
Extort money through product liability lawsuits
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The
The Earliest
Earliest Case
Case
02/1978: Jaffa Oranges injected with Mercury
Palestinian Worker injected Israeli Oranges with
Liquid Mercury
Publicity resulted in fruit sales plummeting
throughout Europe
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The
The Famous
Famous Case
Case
1982 in Chicago: Tylenol Cyanide Deaths
7 people died between September 29th and
October 1st because of Cyanide poisoning after
having taken Tylenol.
Received more television news air time than
any incident since the assassination of President
Kennedy
The “FEDERAL
FEDERAL ANTIANTI-TAMPERING ACT”
ACT
enacted after Tylenol poisoning
Cost J&J $100 million
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Chilean
Chilean Fruit
Fruit Scandal
Scandal
Fruits that are exported from Chile to the
U.S. and Japan were injected with Cyanide
in March 1989.
Protest against the living condition of poor
in Chile.
FDA investigation confirmed the claims
leading to full inspection of fruits and
vegetables from Chile.
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Other
Other Historical
Historical Events
Events
Girl Scout cookies & needles: April 1984
Candy Cyanide poisoning in Japan: 1984
Excedrin cyanide deaths in NY : Feb 1986
Lipton Cup-A-Soup cyanide : 1986
Tylenol Cyanide : 1986
Chilean Fruit Scandal: Mar 1989
Goody’s Headache Powder cyanide : 1992
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Non-intentional
Non-intentional Adverse
Adverse Events
Events
Main industry impacted by non-intentional
adverse events are
Food
Products recalled: Hamburgers, Fruit Juices,
Prepared Meals, Fruits and Vegetables
Pharmaceutical
Automobile
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Microbiological
Microbiological Contamination
Contamination
and
Food
Recall
and Food Recall
Microbiological contamination arises due to virus, bacteria
or parasites
Causes immediate health concern among consumers,
especially among elderly, infants, children, and those with
weak immune systems
Food Safety Inspection Services (FSIS) started collecting
data in 1982.
Generally recalls started in 1983 and became more common
after 1988 indicating growth in medical science in ability to
identify these diseases
Products recalled: Hamburgers, Fruit Juices, Prepared
Meals, Fruits and Vegetables
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Types
Types of
of Food
Food Recalls
Recalls by
by FDA
FDA
Class I recalls are for dangerous or defective products that
predictably could cause serious health problems or death. Examples a
food found to contain botulinal toxin, food with undeclared allergens,
a label mix-up on a drug, or a defective artificial heart valve.
Class II recalls are for products that might cause a temporary health
problem, or pose only a slight serious threat. An example is a drug
that is under-strength but does not treat life-threatening situations.
Class III recalls are for products that are unlikely to cause any
adverse health reaction, but violate FDA labeling or manufacturing
regulations. Examples are a container defect (plastic material
delaminating or a lid that does not seal); off-taste, color, leaks in a
bottled drink, and lack of English labeling in a retail food.
http://vm.cfsan.fda.gov/~lrd/recall2.html
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Costs
Costs Associated
Associated with
with Food
Food Borne
Borne Diseases
Diseases
Costs to individuals
Income and productivity loss
Pain and suffering
Leisure time losses
Travel expenditures
Medical expenditures
Costs to corporations/industry
Product recall cost
Product liability costs
Reduced product demand
Product brand and corporation/industry image
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Costs
Costs Associated
Associated with
with Food
Food Borne
Borne
Diseases
Diseases (cont’)
(cont’)
Other societal costs
Outbreak Investigation
Disease Surveillance
Clean up costs
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Impacts
Impacts of
of Food
Food Recalls
Recalls
Small vs. large companies:
Small ones are affected more by food recall
Big Companies are not affected as much due to
Diversification
Procedures for emergency management
Product recall significantly impacts product
demand
Inducing consumption substitution within and cross
product categories
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Costs
Costs Associated
Associated with
with Drug
Drug Recalls
Recalls
Direct costs of drug recall
Indirect costs
Product liability suits
Loss of faith in firms’ products
Costs of rebuilding the image
Spillover effects on manufacturing of substitute
products
More stringent regulations by FDA in future
Insurance expenditures
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Auto
Auto Recalls
Recalls
Costs involved with recalls
Direct costs of recall
Indirect costs:
sales loss
goodwill loss: resale value is significantly impacted
Industry wide impact of recall as
competitors are also affected
Self regulation within an industry
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Agrochemicals
Agrochemicals
Pesticides/Fungicides affects environment
or health
Captan and Iprodione : Human Carcinogens
DDT
: Environment
Endosulfan
: Hormonal imbalance
Alar
: Human Carcinogens
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Example:
Example: Alar
Alar &
& Apples
Apples
Alar pesticide is used in apples and peanuts
High level of exposure can cause cancer
Very high media coverage
Advertisement by National Resource Defense Council
Two episodes of 60 minutes
Cover of the Time Magazine
Major newspapers
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Example:
Example: Alar
Alar &
& Apples
Apples (cont’)
(cont’)
Consumers
School dropped apples from their menu
Parents poured apple juice down the drains
Apple sales plummeted
Producers
Advertised in leading newspaper with technical
details of very small level
Advertising Expenditure $3 million
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Relevant
Relevant Previous
Previous Studies
Studies
Impacts of adverse events on price, consumption
Marsh et al (2004). “Impacts of meat product recalls on consumer demand
in the USA.” Applied Economics Vol. 36:897-909.
Leeming and Turner (2004). “The BSE crisis and the price of red meat in
the UK.” Applied Economics 36:1825-1829.
Impacts of media coverage of adverse events
Verbeke et. al (2000). “Probit analysis of fresh meat consumption in
Belgium: Exploring BSE and Television Communication Impact.”
Agribusiness Vol. 16(2): 215-234.
Effects of market power influencing the price
transmission (retail-farm price margin)
Lloyd et. al (2006). “Food scares, market power and price transmission:
The UK BSE crisis.” European Review of Agricultural Economics Vol.
33(2): 119-147.
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The
The Impacts
Impacts on
on Demand:
Demand: BSE
BSE Cases
Cases
Reference: Leeming and Turner (2004). “The BSE crisis
and the price of red meat in the UK.” Applied Economics
36:1825-1829.
In March 1996 UK suggested a link between BSE and the
invariable fatal human disease.
Beef consumption dropped by 40%
Price changes:
Temporary changes in prices of sheep and pigs: 19% and 21% increases in
1996. Fell back to the pre-crisis levels by 2000.
Cattle price fell by 21% in 1996 and reminded low in 2000, suggesting a
long lasting shit in consumer preferences.
Loss of all export markets
Imposition of a Culling Order (Over 30 month cull, selective cull,
offspring cull), 49 million cattle destroyed.
Studies on the BSE cases in Japan, Canada, US
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Market
Market Power
Power and
and Impacts
Impacts of
of Food
Food Scares
Scares
Reference: Lloyd et. al (2006). “Food scares, market
power and price transmission: The UK BSE crisis.”
European Review of Agricultural Economics Vol. 33(2):
119-147.
Message: Prices at the farm level fell by
more than retail prices in the wake of food
scares (the BSE crisis) due to market power
of food retailers and, thus, the retailerproducer price margin increases.
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