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Overview

Overview. Understanding elasticities and flexibilities Implications on prices and policy Producer and consumer surplus Welfare analysis. Price elasticity. A measure of responsiveness of the quantity supplied or demanded to changes in prices.

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Overview

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  1. Overview • Understanding elasticities and flexibilities • Implications on prices and policy • Producer and consumer surplus • Welfare analysis

  2. Price elasticity • A measure of responsiveness of the quantity supplied or demanded to changes in prices. • % Change in Qd or Qs of a good divided by % change in its own price holding all else equal • % Q / % P

  3. Q0 - Q1 P0 + P1 x Q0 + Q1 P0 - P1 Elasticity of Supply or DemandOwn price and quantity Q / Q P / P Ep = Q P Ep = x Q P Ep =

  4. Price elasticity and curves • Ep changes along a sloping demand or supply curve • Special exceptions

  5. Relative measures • |Ep| > 1 elastic • |Ep| = 1 unitary elastic • |Ep| < 1 inelastic

  6. Price Elasticity & Total Expenditures • Total expenditures by consumers • TE = P x Q • Elastic demand • P and TE inversely related • Inelastic demand • P and TE directly related

  7. Price Elasticity & Total Expenditures P Elastic A B C Inelastic D Q

  8. So what???? Where are you on the demand curve? P 60 X 55 20 Y 15 Q 7 10 11 6

  9. Do the math Q0 - Q1 P0 + P1 Ep = x Q0 + Q1 P0 - P1 Point X: (6-7) / (6+7) X (60+55) / (60-55) = -1/13 X 115/5 = -115/65 = -1.77 => elastic TEx: Before 60x6=360, After 55x7=385 Point Y: (10-11) / (10+11) X (20+15) / (20-15) = -1/21 X 35/5 = -35/105 = -0.33 => inelastic TEy: Before 20x10=200, After 15x11=165

  10. Elasticity and Price Volatility S1 S2 P P1 P2 De P3 Di Q

  11. Elasticity and Price Volatility S2 P S1 Consumers adjust to higher price levels over time. PS PI PL P1 DL DI DS Q

  12. Elasticity and Price Volatility P SS Supplies adjust over time and are more elastic with time. SI SL PS PI PL D Q

  13. Income elasticity • Percentage change in quantity for a 1% change in income • Positive for most food items • Relatively small i.e., 0.2 Q I Ei= x Q I

  14. Income effect on food demand • Food is normal good • Income demand • Positive income elasticity • Particularly important for meats • Emerging economies • Services are a normal good • Income services

  15. Cross-price elasticity of Supply • Percentage change in quantity for a 1% change in price of a another product such as an input • Positive or negative • Much smaller than Ep Qk Pj Epj = x Qk Pj

  16. Cross-price elasticity of Demand • Percentage change in quantity for a 1% change in price of a substitute or complement • Positive or negative • Much smaller than Ep Qk Pj Epj = x Qk Pj

  17. Examples of Ag own price and income elasticities of demand Ep Ei Beef -.62 .45 Pork -.73 .44 Chicken -.53 .36 Milk -.26 -.22 Grapes -1.38 .44 Lettuce -.14 .23

  18. Own and Cross Price Elasticities Ep of demand for beef Beef -.62 Pork .11 Lamb .01 Chicken .06 Other -.01 Income .45

  19. 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.

  20. Elasticities at market levels P Hy-Vee T-bone in Ames Hy-Vee T-bone All T-bone All meat All beef All food Q

  21. Derived Demand • The demand for inputs that are used to produce the final products. • Examples: • Flour => wheat • Soybean meal => soybeans • Fed cattle => feeder cattle • Marketing margin is subtracted from the buyer’s price to get producer price.

  22. Derived Demand P Retail pork chop demand Wholesale pork demand Farm level demand for hogs Demand for corn to feed hogs Demand for inputs to produce corn Q

  23. Derived Supply • Inverse of Derived Demand • From the consumers perspective • Marketing margin is added to the producer’s price to reflect the consumer price.

  24. Elasticities at retail and farm P PR M PF DRetail DFarm Q Qe

  25. Elasticity Summary • Relationship between Q and P • Changes along supply or demand curve • Elasticity and total expenditures • Cross-price and income elasticities • Relative size • Own, cross, and income • Farm v. retail

  26. S Pe D Market Equilibrium • Supply and Demand curves cross • Quantity supplied equals quantity demanded at a market clearing price Qe

  27. S P Pa D Q Excess Supply • The amount the quantity supplied exceeds quantity demanded at a given price ES: Qs-Qd Surplus Qd Qs

  28. Excess Demand • The amount the quantity demanded exceeds quantity supplied at a given price S ED: Qd-Qs Shortage P Pb D Q Qs Qd

  29. Excess Supply and Demand Price Qd Qs ES ED $10 22 13 -- 9 $20 15 15 0 0 $30 8 17 9 --

  30. Policy Analysis • Policy to impact either S or D • What are the objectives? • How does elasticity effect? • What are the impacts? • Winners and losers • Deadweight loss

  31. Consumer Surplus • The difference between what consumers actually paid for a given quantity and the maximum amount the would have paid on an individual basis. • Area above equilibrium price and below the demand curve

  32. Consumer Surplus P Area above equilibrium price and below the demand curve Pe D Q

  33. Producer Surplus • The difference between what producers actually received for a given quantity and the minimum they would have accepted on an individual basis. • Area below equilibrium price and above the supply curve

  34. Producer Surplus S Pe Area below equilibrium price and above the supply curve Q

  35. S & D Analysis P S CS Pe PS D Q Qe

  36. New Sales Tax P T=Pc-Pp S T Impact a Pc CS: -e-f f e P1 PS: -c-d c d Pp G: +d+f b Net: -c-e D1 Q2 Q1 Q

  37. New Sales Tax S P T=Pc-Pp T Impact a Pc CS: -e-f f e P1 PS: -c-d c d Pp G: +d+f b Net: -c-e D1 Q2 Q1 Q

  38. Impact of Elasticity S P T=Pc-Pp T a Pc P1 Pp b D1 Q2 Q1 Q

  39. New Sales Tax P T=Pc-Pp S T a Pc P1 Pp b D Q2 Q1 Q

  40. Price controls: Ceiling Impact S P CS: +c-d PS: -c-e a d Net: -d-e Pe e c Pc b D Q1 Q Qe

  41. Price controls: Floor S P Impact a CS: -c-d Pf c PS: +c-e d Net: -d-e Pe e b D Q1 Q Qe

  42. Price controls: Floor S P a Pf c d Pe e b D Q1 Q Qe

  43. Price controls Surplus S Who holds the surplus? P Pf Pe How will the shortage be filled? Pc D Shortage Q Qe

  44. New Technology P Shift S1 to S2 S1 Impact a CS: +b+c+d S2 P1 PS: +f+g-b b c d P2 Net: +c+d+f+g g f e D Q1 Q2 Q

  45. Welfare Analysis Summary • Measures impact of intervention • Consumer and producer surplus • Measures changes in both prices and quantities • Impact may shift between consumer and producer or may be lost to society as a deadweight loss

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