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Ag Ec 2183: The Agricultural Marketing System Fall 2008 Professor Artz In-lab exercise – Elasticity of demand and budget shares (25 points) September 18/19, 2008 In-lab problems 1. a. The price elasticity of rice in the US is estimated at -0.55. If the price increases 10%, how would you expect quantity sold to change? Is demand for rice elastic or inelastic? b. The cross price elasticity of rice and chicken is -0.33. Are chicken and rice substitutes or complements? c. The cross price elasticity of rice and potatoes is 0.018. Are rice and potatoes substitutes or complements? 2. In a recent opinion piece in the The Economist magazine, the author writes, “Higher incomes in India and China have made hundreds of millions of people rich enough to afford meat and other foods. In 1985 the average Chinese consumer ate 20kg (44lb) of meat a year; now he eats more than 50kg. China’s appetite for meat may be nearing satiation, but other countries are following behind: in developing countries as a whole, consumption of cereals has been flat since 1980, but demand for meat has doubled.” Based on this passage, what can you infer about the income elasticity for meat relative to that for grain? 3. Recently a number of food processing companies have introduced several new kinds of frozen potato products in retail food outlets. How is this likely to affect the price elasticity of demand for frozen French fries in retail food stores? Briefly explain the logic of your answer. 4. If the price elasticity of demand for sweet corn from your roadside stand is -2.5, would you want to raise or lower the price you are charging in order to increase total revenue? Explain. 5. The attached spreadsheet contains data from the Bureau of Labor Statistics’ Consumer Expenditure Survey, 2006. (http://www.bls.gov/cex). a. Calculate Income After Taxes minus Expenditures for each household income group in row 15. (Hint: enter the formula “=B10-B13” in B15 and drag across to copy) b. Calculate the share of income after taxes spent on food, gasoline, apparel and entertainment for each household income group in rows 24 through 27. i. Hint: Use an absolute reference. An absolute reference in an Excel formula is denoted by $. In this example, income after taxes data are in row 10. If I calculate the share of food expenditures in row 24 as (=B18/B10) and then drag this formula down to copy into row 25 to calculate the share for gasoline, the formula will change as follows: “=B19/B11”. The B19 reference is correct (it refers to the cell with the annual expenditures for gasoline) but the B11 is not correct (now instead of dividing by income, you are dividing by age!). To prevent this, you should enter the formula =(B18/B$10) in B24. Then when you drag the formula down, it will always refer to row 10 in the denominator. Also, don’t use $B$10 – because if you drag the formula to the right to calculate shares for the other income groups, it will always divide by the income for the all households. (although, there may be other times when this is exactly what you want to do). c. Graph the expenditure shares by household income group in a stacked column chart. i. Steps: Highlight the data for expenditure shares (A24:N27). Insert a column chart – choose 2-D column and stacked column (the middle one). ii. Add the horizontal axis labels, axis titles, and chart title. d. Calculate the expenditure on food that would result from a 10% increase in food prices, assuming NO adjustment in quantity (i.e., demand is completely inelastic or ε = 0) i. Hint multiply the expenditures by 1.10 (Be sure you understand this!) e. Calculate the expenditure on gasoline that would result from a 100% increase in gasoline prices, assuming NO adjustment in quantity (i.e., demand is completely inelastic or ε = 0) Written Response (in a Word document) Compare the data for very low income households with very high income households. Which households are more likely to change their consumption patterns in response to increasing food and gasoline prices? Explain why. How would you expect these households to respond to increasing prices? Drawing on the data and your calculations, explain why demand for gasoline and food is more elastic for low income consumers than for high income consumers. How can you reconcile this with the fact that demand for both food and gasoline are very inelastic? Include the graph you made in your response. Be sure to include the source of the data. Use a professional style (no first person, please!). Submit only your response to question 5 in a Word document to receive credit for this lab. Please name your files LastName_FirstInitial_Lab3 and submit it through the Blackboard assignment link for Lab 3.