Download Elasticities Examples - Department of Agricultural Economics

Elasticities
Examples
Own-Price Elasticity
of Demand
Chapter 5
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Example
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
Rice producer
Revenue?
10%
10%drop
drop
Consumer
surplus?
1.467%
1.467%increase
increase
Q
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The answer…
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:
a. How many platters will the chicken sell?__1,440____
Solution:
-0.30 = %∆Q÷%∆P
-0.30= %∆Q÷[($4.00-$3.50) ÷(($4.00+$3.50) ÷2)]
-0.30= %∆Q÷[$0.50÷$3.75]
-0.30= %∆Q÷0.1333
%∆Q=(-0.30 × 0.1333) = -0.04 or –4%
So new quantity is 1,440, or (1-.04) ×1,500,
or .96 ×1,500
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
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:
a. How many platters will the chicken sell?__________
b. The Chicken’s revenue will change by $__________
c. Consumers will be ____________ off as a result of
this price change.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The answer…
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:
a. How many platters will the chicken sell?__1,440____
b. The Chicken’s revenue will change by $__+$510___
Solution:
Current revenue = 1,500 × $3.50 = $5,250 per month
New revenue = 1,440 × $4.00 = $5,760 per month
So revenue increases by $510 per month, or $5,760
minus $5,250
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
1
The answer…
Another Example
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:
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:
a. How many platters will the chicken sell?__1,440____
a. How many platters will the chicken sell?__________
b. The Chicken’s revenue will change by $__+$510___
b. The Chicken’s revenue will change by $__________
c. Consumers will be __worse___ off as a result of this
price change.
c. Consumers will be ____________ off as a result of
this price change.
Why? Because price increased.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The answer…
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:
a. How many platters will the chicken sell?__1,240____
Solution:
-1.30 = %∆Q÷%∆P
-1.30= %∆Q÷[($4.00-$3.50) ÷(($4.00+$3.50) ÷2)]
-1.30= %∆Q÷[$0.50÷$3.75]
-1.30= %∆Q÷0.1333
%∆Q=(-1.30 × 0.1333) = -0.1733 or –17.33%
So new quantity is 1,240, or (1-.1733) ×1,500,
or .8267 ×1,500
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The answer…
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:
a. How many platters will the chicken sell?__1,240____
b. The Chicken’s revenue will change by $__- $290___
Solution:
Current revenue = 1,500 × $3.50 = $5,250 per month
New revenue = 1,240 × $4.00 = $4,960 per month
So revenue decreases by $290 per month,
or $4,960 minus $5,250
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The answer…
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:
a. How many platters will the chicken sell?__1,240____
b. The Chicken’s revenue will change by $__- $290___
Income Elasticity
of Demand
c. Consumers will be __worse___ off as a result of this
price change.
Why? Because the price increased.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
2
Some Examples
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
Commodity
Elastic
Elastic
Introduction to Agricultural Economics,
Penson, Capps, Rosson, and Woodward
5th
Inferior
Inferiorgood
good
ed
Luxury
Luxurygood
good
Page 79
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Example
Assume the government cuts taxes, thereby increasing
disposable income by 5%. The income elasticity for
chicken is .3645.
a. What impact would this tax cut have upon the
demand for chicken?
b. Is chicken a normal good or an inferior good? Why?
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
The Answer
The Answer
1. Assume the government cuts taxes, thereby
increasing disposable income (I) by 5%. The income
elasticity for chicken is .3645.
1. Assume the government cuts taxes, thereby
increasing disposable income by 5%. The income
elasticity for chicken is .3645.
a. What impact would this tax cut have upon the
demand for chicken?
Solution:
.3645 = %∆QChicken ÷ %∆ I
.3654 = %∆QChicken ÷ .05
%∆QChicken = .3645 ×.05 = .018 or + 1.8%
a. What impact would this tax cut have upon the
demand for chicken? _____+ 1.8%___
b. Is chicken a normal good or an inferior good? Why?
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Chicken is a normal good but not a luxury since the
income elasticity is > 0 but < 1.0
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Some Examples
Cross Price Elasticity
of Demand
Item
Prego
Ragu
Hunt’s
Prego
-2.5502
.8103
.3918
Ragu
.5100
-2.0610
.1381
Hunt’s
1.0293
.5349
-2.7541
Values
Valuesin
inred
redalong
along
the
thediagonal
diagonalare
areown
own
price
priceelasticities…
elasticities…
Page 80
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
3
Some Examples
Some Examples
Item
Prego
Ragu
Hunt’s
Item
Prego
Ragu
Hunt’s
Prego
-2.5502
.8103
.3918
Prego
-2.5502
.8103
.3918
Ragu
.5100
-2.0610
.1381
Ragu
.5100
-2.0610
.1381
Hunt’s
1.0293
.5349
-2.7541
Hunt’s
1.0293
.5349
-2.7541
An
Anincrease
increasein
inthe
theprice
priceof
of
Ragu
RaguSpaghetti
SpaghettiSauce
Saucehas
hasaa
bigger
biggerimpact
impacton
onHunt’s
Hunt’s
Spaghetti
SpaghettiSauce
Saucethan
thanvice
vice
versa.
versa.
Page 80
Values
Values off
off the
the diagonal
diagonal are
are
all
indicating these
these
all positive,
positive, indicating
products
as
products are
are substitutes
substitutes as
prices
priceschange…
change…
Page 80
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Some Examples
Item
Prego
Prego
Ragu
Hunt’s
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Some Examples
Ragu
Hunt’s
Item
Prego
-2.5502
.8103
.3918
Prego
.5100
-2.0610
.1381
Ragu
1.0293
.5349
-2.7541
Hunt’s
AA10%
10%increase
increasein
inthe
theprice
priceof
of
Ragu
RaguSpaghetti
SpaghettiSauce
Sauceincreases
increases
the
thedemand
demandfor
forHunt’s
Hunt’sSpaghetti
Spaghetti
Sauce
Sauceby
by5.349%…..
5.349%…..
Ragu
Hunt’s
-2.5502
.8103
.3918
.5100
-2.0610
.1381
1.0293
.5349
-2.7541
But…a
But…a10%
10%increase
increasein
inthe
theprice
priceof
of
Hunt’s
Hunt’sSpaghetti
SpaghettiSauce
Sauceincreases
increases
the
thedemand
demandfor
forRagu
RaguSpaghetti
Spaghetti
Sauce
Sauceby
byonly
only1.381%…..
1.381%…..
Page 80
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Example
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The Answer
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60.
a. If the price of hamburger buns rises by 5 percent,
what impact will that have on hamburger
consumption?
b. What is the demand relationship between these
products?
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Page 80
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60.
a. If the price of hamburger buns rises by 5%, what
impact will that have on hamburger consumption?
____ - 3% ______
Solution:
-.60 = %∆QH ÷ %∆PHB
-.60 = %∆QH ÷ .05
%∆QH = .05 × (-.60) = -.03 or – 3%
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
4
The Answer
The Answer
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60.
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60.
a. If the price of hamburger buns rises by 5%, what
impact will that have on hamburger consumption?
___ - 3% _____
a. If the price of hamburger buns rises by 5%, what
impact will that have on hamburger consumption?
___ - 3% _____
b. What is the demand relationship between these
products?
b. What is the demand relationship between these
products?
These two products are complements as evidenced
by the negative sign on this cross price elasticity.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Another Example
The Answer
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.
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.
a. If the price of Coca Cola rises by 5 percent, what
impact will that have on Pepsi consumption?
a. If the price of Coca Cola rises by 5 percent, what
impact will that have on Pepsi consumption?
b. What is the demand relationship between these
products?
Solution:
.70 = %∆QPepsi ÷ %∆PCoke
.70 = %∆QPepsi ÷ .05 = .035 or 3.5%
New quantity sold = 1,000 × 1.035 = 1,035
New value of sales = 1,035 × $3.00 = $3,105
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The Answer
The Answer
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.
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.
a. 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__
a. 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__
b. What is the demand relationship between these
products?
b. What is the demand relationship between these
products?
The products are substitutes as evidenced by the
positive sign on this cross price elasticity!
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
5
Demand Characteristics
Price Flexibility
of Demand
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
¾ Which market is riskier for
producers…elastic or inelastic demand?
¾ Which market would you start a business
in?
¾ Which market is more apt to need
government subsidies to stabilize producer
incomes?
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
6