lectu r 17 elasticity

7/30/2019 Lectu r 17 Elasticity

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Price Elasticity of Demand

Lecture #2


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As We Move Down the Demand

curve, TOTAL REVENUE first increases,reaches a maximum (or peak), and

then decreases.TR

Qd


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Another Curve Ball Folks!

All downward sloping

linear demand curvescan be divided into 3

distinct sections thatdiffer in elasticity.


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Price Changes:

If a price change causes TR to move in the

opposite direction from the price change,

we are in the elastic portion of thedemand curve.


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Price Changes:

Therefore,

if P TR

or

if P TR

Elastic Section of Demand Curve


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Price Changes:

If a price change causes TR to move inthe same direction as the price change,

we are in the inelastic portion of thedemand curve.


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Price Changes:

Therefore,

if P TR

or

if P TR

Inelastic Section of Demand Curve


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Remember:

P

Q

P

Q

Relatively

inelastic

Relativelyelastic


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The two demand curves have the 3sections of elasticity

We use the terms relatively inelastic orelastic here as a means of saying that

over the whole range (3 sections) theaverage elasticity of demand is eitherinelastic or elastic.


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Remember:

P

Q

P

Q

Relativelyinelastic

Relatively

elastic

- 1.10

- .15

- 5.50

- .95

Avg. = - .625 Avg. = - 3.225


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AND,

When:

Ed > 1 elastic demand TR with a P

Ed = 1 unitary demand TR is maximized.

Ed < 1 inelastic demand TR with P


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Practical Use:

Would a producer facing a negativelysloped demand curve for the

commodity he/she sells ever want tooperate in the inelastic range of thedemand curve ?

Generally, NO!!


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P

Qd/ut

TR

Qd/ut

TR1 = TR0

Q0 Q1

P0

P1


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P

Qd/ut

TR

Qd/ut

TR1 = TR0

Q0 Q1

P0

P1

TC


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Want to Maximize Profits

= TR - TC

0 = TR0 - TC0

1 = TR1 - TC1

0 > 1


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Practical Use: Ag. Production

P

Q

Relatively inelastic demand to begin with,why would producers ever want to producein the inelastic portion of a relatively

inelastic market demand curve.

Demand for Ag. Commodities


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But many agricultural commodities areproduced in the inelastic section of an

inelastic market demand curve


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P

Qd/utTR

Qd/ut

TR0

Q1 Q0

P1

P0

LOSS

PROFIT

TR1

TC


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Farm Programs:

D

P

Qd/ut

S0

S1

Acreage reductionprograms, set aside,soil bank, CRP, WRP,quotas, allotments.


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Farm Programs

One of the main reasons we have hadacreage control programs and price

supports in the past was to encourageproducers to collectively reduceproduction.


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Farm Programs

Based on a Supreme Court ruling in 1943, ourConstitution does allow direct government

control of agriculture. However,recognizing that direct government controlmay not be politically palatable to thecitizenry, agricultural producers are

essentially bribed by government to cutproduction. Government offers producersguaranteed prices for their commodities anddirect treasury subsidies in return for

cooperation.


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Farm Programs




cooperation.


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Farm Programs




cooperation.


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The government said, OK farmers, ifyou want these guaranteed

government prices and deficiencypayments, you have to sign a contractagreeing to cut your production by

how much the govt. says to cutproduction.


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The government said, OK farmers, ifyou want these guaranteed

government prices and deficiencypayments, you have to sign a contractagreeing to cut your production by

how much the govt. says to cutproduction.


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Determinants of DemandElasticity

Relatively inelastic demand:

a. Very few acceptable substitutes.

b. Shorter adjustment period.

c. Good is a small proportion of budget.


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Determinants of DemandElasticity

Relatively elastic demand:

a. Many close substitutes.

b. Longer adjustment period.

c. Good is a large proportion of budget.


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Extreme Cases:

P

Qd/ut

D = MR = Mkt Price

Perfectly Elastic Demand

Ed =


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Perfectly Elastic Demand

This is the demand curve that a

Price-taker confronts.

A Price-taker is a producer that has nopricing power. They receive the price

that is determined by market demandand market supply.


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Maximizing Profits: Price Takers

Cotton Market Cotton Producer

MarketDemand

MarketSupply

P

Qd/ut

P

Qd/ut

Pm D = MR

MC

Q*

Q* = profit maximizing output level for producer


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Maximizing Profits: Price Searchers

P

Qd/ut

MR

D

MC

P*

Q*


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Perfectly Inelastic Demand

Demand

P

Qd/ut

Ed = 0


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Remember

1. If a price change causes TR to move inthe same direction as the price change,

demand is inelastic.

2. Demand is more elastic in the long run

than in the short run.


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For Example:

D

D

P P

Qd/ week Qd/ month

Relativelyinelastic

Relativelyelastic


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Income Elasticity of Demand

EI = % Qd / % Id

Measures the sensitivity of DEMAND to

changes in disposable income.


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Engel Curve:

Shows the relationship betweenquantity demanded and disposable

income given a constant price.


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Engel Curve: Normal Good

DisposableIncome

Qd/ut

Engel Curve for aNormal Good

EI > 0


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Luxury Goods

Luxury Goods are Normal Goods butthey have an

EI >= 1Quantity demanded is very senistive to

changes in disposable income


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Necessities

Necessities are Normal Goods but

0 < EI < 1

Quantity demand is not very sensitive tochanges in disposable income


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Engel Curve: Inferior Good

DisposableIncome

Qd/ut

Engel Curve for anInferior Good

EI < 0


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Normal Goods (EI >0)

Luxury Goods (EI >= 1)Necessitites (0 < EI < 1)

Inferior Goods (EI < 0)


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Some Income Elasticities

Beef +.29

Pork +.13

Chicken +.18

Milk +.20

All foods +.18

Non foods +1.25


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Cross-Price Elasticity

Measures how sensitive DEMAND for acommodity is to changes in the price

of a substitute or complimentcommodity


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Ecp of x,y =

% Qx / % Py


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Ecp > 0 Substitute

Ecp < 0 Compliment

Ecp = 0 Independent


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Example:

The Cross-Price Elasticity of Beef andPork would be calculated as:

Ecp, Beef, Pork =

% QBeef / % PPork


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Example

The Cross-Price Elasticity of Pork andBeef would be calculated as:

Ecp, Pork, Beef =

% QPork / % PBeef


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Interpretation?

If the

Ecp, Pork, Beef = + .65

Then for every 1% increase in the price

of beef, the Qd of pork would increase.65%. We also would know that porkand beef are substitutes

lectu r 17 elasticity

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