part two: microeconomics

chapter nine:

The Concept of Elasticity

The Concept of Elasticity Introduction

Consumers will accept an increase in the price of a given product sometime with and sometime without too much reaction. Same applies to producers. Their reaction to price changes can be strong or mild depending on the product. Third situation applies to income. An increase in consumer income can lead to an increase, a decrease, or no change in the consumption of a product. If change, then by how much?
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity Concept of Elasticity

A measure of the sensitivity of consumers and producers to changes in prices and incomes is known as elasticity. Through the use of elasticity estimates, managers can anticipate the probable magnitude of market impact of various of changes. While the number of elasticities is almost limitless, four fundamental elasticity conceptsdemand, supply, cross-price, and incomecan be used to characterize any given market. Definition of elasticity of demand.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity ELASTICITY OF DEMAND

We calculate the elasticity coefficient as:

If the rate of change of the quantity demanded is greater than the rate of change in price, we say the demand relationship is elastic. If the rate of change of quantity is less than the rate of change of price, the relationship is said to be inelastic. If demand for a good is elastic, then we know that consumers are very responsive to price changes.
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND

The concept of elasticity, and elasticity coefficients have a lot to do with rates of change. As you move along a demand curve, both price & quantity are changing simultaneously.

We measure the elasticity of demand coefficient by dividing rate of change in the quantity demanded by rate of change in price for a small segment, or arc, along a given demand curve.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity ELASTICITY OF DEMAND

Algebraically, the relationship may be expressed as:

The mathematical symbol (delta) means change in.

This algebraic formulation is shown geometrically at left.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND

We can modify our basic elasticity formula to eliminate the discrepancy arising from selecting either of the two endpoints of the arc as the initial situation.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND

If the value of the demand elasticity coefficient is between zero and -1 then demand is inelastic. If the value of the coefficient is less than -1, or absolute value is greater than 1), demand is elastic. If the elasticity coefficient should be exactly equal to -1 elasticity is said to be unitary.
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND

Both elastic & inelastic ranges can occur in a single demand curve.
As consumers pass from the elastic to the inelastic range, they must pass through a point (or range) of unitary elasticity.
For a straight line demand curve, as shown, this always occurs at the midpoint on the quantity axis, between the origin & where the demand curve hits the horizontal axis.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity ELASTICITY OF DEMAND - Some Special Cases

The same quantity will be demanded no matter what the price happens to be. The demand function is perfectly vertical. Largely theoretical, but the demand for an item that normally represents a small part of the total budget and is an absolute necessitysuch as table salt, or insulinwill approach this situation.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF DEMAND - Some Special Cases

The manager cannot affect price received, no matter how much is sold. The market will absorb any quantity offered at the prevailing price. This approximates the conditions under which most farmers sell their products, thus, perfectly elastic demand is an important concept in the area of agricultural microeconomics.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity Elasticity of Demand Related to Total Revenue

Elasticity of demand for a good & total revenues of a firm producing it are very much interrelated. Movement along a demand curve, left to right, will result in an increase in quantity consumed and a decrease in the price per unit. As total revenue of the firm is equal to price times quantity, total revenue depends on whether quantity increases at a faster rate than price decreases. The demand elasticity coefficient tells us what will happen to total revenue as price & quantity change together.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity Elasticity of Demand Related to Total Revenue

Price reductions in the elastic range of the demand curve are associated with increases in the total revenue.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity Elasticity of Demand Related to Total Revenue

Price reductions in the inelastic range are associated with reductions in total revenue.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity Elasticity of Demand Related to Total Revenue

When elasticity is unitary, total revenue is at its maximum, as shown here, graphically.
That portion of a straight line demand curve which lies to the left of the midpoint is elastic with respect to price. The portion to the right of the midpoint is inelastic. At the midpoint, demand is unitarily elastic.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity Factors Affecting Demand Elasticity

What are the characteristics of goods that determine whether demand is elastic or inelastic? Number of substitutes. Proportional share of the total budget spent on a good. Luxuries as opposed to necessities. Impulse items. Length of time: SR vs. LR Durable vs. non-durable goods Culture and tradition,(demand for turkey in November)
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity CROSS-PRICE ELASTICITY

The Cross-price elasticity coefficient measures adjustments consumers make in their consumption of one product in response to a change in the price of another.
It measures the extent to which the demands for various commodities are related.

An example: Beef and pork [Price of pork changes. Show its effect on consumption of pork and beef through diagrams. Then explain cross-price elasticity concept]
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity CROSS-PRICE ELASTICITY

To examine consumption of beef as the price of pork is changed, divide the rate of change in the quantity of beef purchased by the rate of change in the price of pork:

which may be modified into an operational form, using midpoints:

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity CROSS-PRICE ELASTICITY

When two commodities are substitutes for each other, the algebraic sign of the cross-price elasticity coefficient will be positive.
If the price of one increases, the quantity of the other commodity purchased will also increase.

Commodities that are complementary to each other have negative cross-price elasticity coefficients.
Dress shirts and neckties serve as an illustration.

The cross-price elasticity between the price of one product and the consumption of another may be quite different when the direction is reversed.
Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

tab

The Concept of Elasticity INCOME ELASTICITY

An income elasticity coefficient shows the extent to which consumers alter their purchases of any good as a result of changes in income.
With slight alterations, our basic elasticity formula can be used to define an income elasticity coefficient: modified into the standard midpoint formula:

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity INCOME ELASTICITY

Normally, we expect the algebraic sign of the income elasticity coefficient to be positive. As a consumer has more income, his consumption of the good in question will increase. It is a normal good. There are a limited number of goodslard, for examplethat exhibit negative income elasticities. As consumers incomes rise, they tend to reduce their consumption of these inferior goods. Example: If they can afford to substitute vegetable shortening for hog lard, they will do so.
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity INCOME ELASTICITY If the income elasticity of demand for a particular good is 0.0, demand for that good is not affected by changes in income. Normally the case for items such as salt and other condiments that are an insignificant part of the budget. If income elasticity of demand is greater than 1.0, an increasing proportion of consumer income is spent on the good, as income increases.

tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity INCOME ELASTICITY Examples are protein sources among the poor in developing countries. Numerous studies have found the income elasticity of demand for milk among the poor to be well above 1.0. Most goods have an income elasticity of less than 1.0, meaning that the proportion of income spent on the good falls as the consumer becomes richer. Most foods in developed countries fall into this category.
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity ELASTICITY OF SUPPLY

The idea of elasticity of supply is almost identical with the concept of elasticity of demand.
The formula is identical, but where the algebraic sign of the elasticity of demand coefficient is normally negative, that of the elasticity of supply coefficient is generally positive.

Since quantity supplied increases as price increases, the supply function slopes upward, to the right, with a positive slope. Hence the positive elasticity of supply coefficient with respect to price.
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

The Concept of Elasticity PRICE DISCRIMINATION

When a firm produces a product sold in two different markets, with different demand elasticities, the firm can probably increase revenues by engaging in price discrimination. An example in the food industry is a vegetable packer that can sell vegetables in either the fresh market (inelastic demand) or the frozen market (elastic demand). Another example is a producer of tomato sauce sells it either as a branded product (inelastic demand) or as a generic (elastic demand).
tab

Agricultural Economics, 3th edition By H. Evan Drummond and John W. Goodwin

2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

END