Transcript Elasticities Revisited

Elasticities Revisited
AG BM 102
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
  (Q  Q1) / ( P  P1) * ( P1) / (Q1)  b( P / Q )
2
2
1
  b( P / Q )
1
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
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 both supply and demand
inelastic a small change in
supply causes larger changes in
the equilibrium quantity than if
either were elastic and much
larger than if both were elastic
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 / 
3.10
18.00
17.00
16.00
15.00
14.00
13.00
12.00
11.00
10.00
9.00
8.00
2.80
2.70
2.60
2.50
2.40
2.30
Retail Whole Milk
Ja
n03
Ja
n02
Ja
n01
Ja
n00
Ja
n99
2.20
Ja
n98
Retail $/gal
3.00
2.90
Class I Mover
Class I Mover $/cwt
Retail and Wholesale Fluid Milk Prices
Concluding Comments
• Need to be at ease with elasticities
• One of the best tools in economics
• You will use them in any other economics
courses you take