Transcript Elasticities Revisited

Elasticities Revisited
AG BM 102
“Falling crop prices will redistribute profits
from grain farmers to food processors. The
livestock and dairy industries will also benefit
from cheaper feed.”
Introduction
• Elasticities are a valuable analytical tool
• Allow qualitative and often quantitative
answer to what the effects of a change will
be
• Helps to understand why markets behave
as they do
Some formulas
Q  a  bP
Demand Elasticity
  b( P / Q )
1
1
Supply Elasticity
Q  a  bP
  b( P / Q )
1
1
Elasticity and total revenue
• If demand is inelastic, higher prices will
increase revenue
• If demand is elastic, lower prices will
increase revenue
• The item to put on sale is the one with
elastic demand
• If you are going to try to increase profits by
raising the price of something, choose
something with inelastic demand
Why Are Farm Prices So Volatile?
• Farm prices move much more than other
prices
• Elasticity of demand is usually inelastic
• Elasticity of supply in short run is also
inelastic
Why is Farm-level Demand So
Inelastic?
• Food demand is inelastic because food is
a necessity
• Farm price is a small portion of food price,
yet quantities are about the same
• Looking at elasticity formula farm demand
becomes even more inelastic than food
demand
• R=retail, F = farm
  b( P / Q )
1
1
R  b( PR / Q)
F  b( PF / Q)
If
PF  0.5 PR then F  0.5R
Farm and Retail Milk Price
$/gal
2000-2015
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
farm
retail
margin
0.00
2000
2001
2002
Data: USDA
2003
2004
2005
2006
2007
year
2008
2009
2010
2011
2013
2014
2015
Index of Farm and Retail Milk Prices
Jan 2000 - Jul 2015
225
200
175
150
125
100
75
farm
retail
50
Jan 2000 = 100
25
0
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Why is Farm Supply Inelastic
•
•
•
•
•
In short run, biology prevents adjustments
One crop per year
Large animals have long production period
In longer run, supply is more elastic
Prices are determined in short run
With demand inelastic a small change in
supply causes larger changes in the
equilibrium price than if it were elastic
With supply inelastic a small change in
demand causes larger changes in the
equilibrium price than if it were elastic
Therefore any change causes big price
moves
Flexibility
The percent change in price in
response to a 1 % change in
quantity
Flexibility
• Applies especially to the demand for
agricultural products
• Useful in recognizing that quantity is
predetermined and prices adjust to clear
market
• Strawberries, tomatoes, other non-storable
products
f  % change
P / % change Q
P  c  dQ
f  d (Q / P)  (1 / b)(Q / P)  1 / 
Concluding Comments
• Need to be at ease with elasticities
• One of the best tools in economics
• You will use them in every other
economics courses you take