Transcript Consumer Demand

Created by Tad Mueller
Northeast Iowa Community College
“Anyone can be an economist, All you
must learn are two words, Supply and
Demand”
Chapter 8
Consumer Demand

Various quantities of a commodity that an
individual is willing and able to buy as the price
of the commodity varies holding all other
factors constant.
Consumer Demand


Demand begins with individual consumer
Inverse relationship between quantity and price

Two dimensional, Price and Quantity
Downward sloping demand



As price goes up demand goes down
Begin with individual’s utility function and a
budget constraint
Substitution effect


consumers buy what’s cheaper
Income effect
“income” increases if prices fall
 Allows me to buy better (higher priced) items

Retail Poultry Deflated Price and Consumption
$1.80
73
$1.70
$1.60
$1.50
74
75
$1.40
70
76
78
71
$1.30
72
77
79
$1.20
80
84
86
88
81
$1.10
82
89
83
85
87
90
91
92
93
94 97
$1.00
95
96
98
$0.90
35
45
55
65
Per Capita Consumption in Pounds
75
Pork Deflated Price and Consumption, Retail
$2.00
82
$1.90
83
$1.80
81
80
87
$1.70
86
90
91
$1.60
88
84
85
89
97
$1.50
00
96
98
93
$1.40
92
99
94
95
$1.30
$1.20
$1.10
$1.00
48
50
52
54
56
Per Capita Consumption in Pounds
58
Beef and Pork Demand Index, 1997 Base
250
200
150
100
50
Beef
Pork
0
1980
1985
1990
Source: Research Institute on Livestock Pricing
1995
2000
Demand is a function of

Price of substitutes


Price of complements



Pizza is a complement to cheese
Consumer income


Kraft Cheese vs. Generic
Higher income allows me to buy better products
Taste and preferences
IS NOT FUNCTION OF THE GOOD’S
OWN PRICE
Change in Demand or
in Quantity Demanded
Moving from A to B due to a
price decline is a change in
quantity demand.
Px
A
A shift of the demand
curve from D1 to D2 is
a change in demand.
B
C
D1
D2
Qx
Five factors effecting aggregate
demand for a product

Exports


New product development



Ethanol
Advertising
New information


China
Dairy products help you loose weight
Product differentiation

Kraft vs. Generic
Income effect on food demand

Food is normal good
Income
demand
 Particularly important for meats
 Emerging economies


Services are a normal good

Income
services
Inverse Demand

Price is a function of quantity


P = f(Q)
Important in agriculture
Short run supplies are relatively fixed
 Prices change to clear the market

Supply

The amount of a given commodity that will be
offered for sale per unit time as the price varies,
other factors held constant.
Supply

Derived from cost function
Production function
 Input - output relationship


Assume that firms seek to
Maximize profits
 Minimize costs


Supply starts with individual firm
Production Function
Output
Total Product
Decreasing returns to the input
Increasing returns to the input
Input
Opportunity cost


The opportunity cost of commodity A is income
forgone by not producing commodity B.
Measures of opportunity cost
Market value of input
 Expected return over other cost of not producing
commodity B.

Cost Curves

Average variable cost = AVC



Average fixed cost = AFC



Total variable cost / Q
Variable costs change with Q
Total fixed cost / Q
Fixed costs do not change with Q
Average total cost = ATC
= AVC+AFC
Cost curves
Cost
AVC
Q
Cost curves
Cost
ATC
AVC
AFC
Q
Cost Curves

Marginal cost = MC


Change in total cost by producing 1 more
TC /
Q
Cost curves
Cost
MC
ATC
AVC
Q
Supply curve

Upward sloping curve
Optimal output @ MC = MR
 MR = Price => Optimal at MC=Price
 The last unit of input just pays for itself

Optimal Q at P=MC
Cost
MC
P2
ATC
AVC
P1
Q1
Q2
Q
Cost curves and supply

Shut down if P < AVC



Lose on every unit produced
P>AVC make some payment to fixed cost
In the long run everything is variable

Short run defined by having fixed cost
Market supply curves
S1
Px
A
S2
Move from A to B is a
change in quantity
supplied due to a price
decline.
B
C
Move from B to C is a
shift in supply.
Qx
Supply shifts from change . . .





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in input prices
in returns for competing enterprises
in technology on yields or costs
in price of joint products
in yield and/or price risk
institutional constraints
Worksheet

General Economics – Supply and Demand
Economies of scale



Average total costs changes as the output of a
firm changes
You can have increasing, decreasing or constant
economies of scale.
Need to consider


Short run cost curve (SRATC)
Long run cost curve (LRATC)
US Pork Sector Study Financial
results for 2000
1000 hd Net Profit
1-2
65%
2-3
77%
3-5
79%
5-10
78%
10-50
77%
50-500
90%
500+
95%
Breakeven
Net Loss
24%
15%
16%
13%
12%
5%
5%
11%
8%
5%
9%
11%
5%
0%
US Pork Sector Study
Stay in price until 2003 (%)
1000 hd
1-2
2-3
3-5
5-10
10-50
50-500
500+
$36
16
18
18
16
22
4
28
$39
36
42
39
39
49
61
50
$42
69
71
70
75
74
88
89
$45
86
87
90
92
91
97
94
$48
90
97
94
98
96
99
100
Weekly Prices and Slaughter, 1998-99
Million
$45
2.2
Price
$40
2.0
$35
$30
1.8
$25
1.6
Slaughter
$20
1.4
$15
1.2
$10
1
14
27
40
53
66
79
92
105
Processing cost curves
Specialized plants
High fixed cost
Cost
SRATC
Q
So what???
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Short run price implications
Supply chain management
Open market or contract

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Packing plants
Ethanol plants
Soybean processing
Biodiesel
Supply and Demand Summary


Demand originates with individual consumer’s
utility and budget constraint
Supply originates with individual firm’s marginal
cost curve
Consumption is not demand
Consumption =
•
Beginning stocks + production + imports
– exports – ending stocks
Per capita consumption =
•
consumption / population
Percapita Boneless Meat Consumption
100
90
80
70
60
50
40
30
20
10
0
1970
1975
1980
Beef
1985
Pork
1990
Poultry
1995
2000
Equilibrium P and Q
P
S
Equilibrium price is
where Qs = Qd.
Pe
D
Qe
Q
Price elasticity


A measure of responsiveness of the quantity
supplied or demanded to changes in prices.
Percentage change in quantity for a 1% change
in price.
Relative measures

Elastic
|Ep| > 1
 Changes in quantity are greater than changes in price


Unit Elasticity
|Ep| = 1
 Changes in quantity are the same as changes in price


Inelastic
|Ep| < 1
 Changes in quantity are less than changes in price

In other words

If the price would decrease by 10%
With elastic demand amount bought would increase
by more than 10%
 With unit elasticity amount purchased would
increase by exactly 10%
 With inelastic demand amount purchased would
increase by less than 10%

Price elasticity & total revenue


TR (total revenue) = P (price) x Q (quantity)
Elastic demand


P and TR inversely related
Inelastic demand

P and TR directly related
Income elasticity




Percentage change in quantity for a 1%
change in income
Positive for most food items
Relatively small i.e., 0.2
Ei
Cross-price elasticity



Percentage change in quantity for a 1% change in price
of a substitute or complement
Positive or negative
Much smaller than Ep
Examples of Ag elasticities
Beef
Pork
Chicken
Milk
Grapes
Lettuce
Ep
-.62
-.73
-.53
-.26
-1.38
-.14
Ei
.45
.44
.36
-.22
.44
.23
Own and Cross Price Elasticities
Ep of demand for beef
Beef
Pork
Lamb
Chicken
Other
Income
-.62
.11
.01
.06
-.01
.45
Net change in quantity


Net effect of changes in own price, cross price,
and income multiplied by the appropriate
elasticities.
Addresses the fact that not all else is equal.
Elasticities at various markets



The greater the number of substitutes the
more elastic the demand.
For a given Q, look at % change in P (price)
More elastic at retail level
Elasticities at market levels
P
Hy-Vee T-bone in Ames
Hy-Vee T-bone
All food
All meat
All T-bone
All beef
Q
Derived Demand


The demand for inputs that are used to produce
the final products.
Examples:
Flour => wheat
 Soybean meal => soybeans
 Fed cattle => feeder cattle

Derived Demand
P
Q
Food for Thought

Should food prices be determined by supply and
demand or by the government?
Law Of One Price

“Under competitive market conditions all prices
within a market are uniform, after taking into
account the costs of adding place, time, and
form to the products.”