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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