Price Flexibility Coefficient, Other Demand ... · PDF filePrice Flexibility Coefficient,...

Price Flexibility Coefficient, Other Demand ElasticitiesDemand Elasticities

10/13/09

AEC 305, Food and Agricultural Marketing PrinciplesAEC 305, Food and Agricultural Marketing Principles

Review From 10/08/09

Identify the four factors that affect the own-price elasticity of demand … and know if it results in the elasticity being more or less elasticelasticity being more or less elastic

Availability of substitutesProportion of budget spent on itemTime horizon (adjustment period)Time horizon (adjustment period)Degree of Necessity

Understand the relationship of changes in price on total revenue given elastic vs inelastic demandtotal revenue, given elastic vs inelastic demandBe able to apply the concept of price elasticity of demand for real-world situations

Total Revenue Changes for aTotal Revenue Changes for a Given Price Change

Price

P2

Price

P22

P1P1

Loss in

Gain inRevenue

Loss in

Gain inRevenue

D1

D2

Revenue Revenue

QuantityQ2 Q1

QuantityQ2 Q1


Inelastic Demand Elastic Demand

Relationship of Price Elasticity ofRelationship of Price Elasticity of Demand to Changes in Total Revenue

Price Total Revenue

Elastic Increase Decrease

Decrease Increase

Inelastic Increase Increase

Decrease DecreaseDecrease Decrease

Note that for:Elastic Demand, Price and Revenue Move in the OPPOSITE Direction


Inelastic Demand, Price and Revenue Move in the SAME Direction

Total Revenue Changes for aTotal Revenue Changes for a Given Price Change

Price

P2

Price

P22

P1P1

Gain in

Loss inRevenue

Gain in

Loss inRevenue

D1

D2

Revenue Revenue

QuantityQ2 Q1

QuantityQ2 Q1


Inelastic Demand Elastic Demand

Application of Demand Elasticities:

U.S. Tobacco Leaf/IndustrySoft DrinksSoft DrinksSnack Foods

For copies of illustrative slides go to class website for slides on 10/08/09class website for slides on 10/08/09


Application of Demand Elasticities pp cat o o e a d ast c t esto Taxing Foods/Beverages

WSJ – soda tax http://online.wsj.com/article/SB124208505896608647.html#printModeNEJM I -- http://content.nejm.org/cgi/content/full/360/18/1805p j g gYou Tube Video: http://blogs.wsj.com/health/2009/05/12/soda-tax-from-youtube-to-new-england-journal-to-congress/NEJM: http://content.nejm.org/cgi/content/full/NEJMhpr0905723Baltimore Sun Editorial: http://www.baltimoresun.com/news/opinion/letters/bal-sodaletter0921,0,3166768.storyM tMercatus:http://www.mercatus.org/PublicationDetails.aspx?id=27272http://www.mercatus.org/PublicationDetails.aspx?id=27916

“A tax of 1 cent per ounce of beverage would increase the cost of a 20-oz soft drink by 15 to 20%. The effect on consumption can be estimated through research on price p g pelasticity (i.e., consumption shifts produced by price). The price elasticity for all soft drinks is in the range of –0.8 to 1.0. (Elasticity of –0.8 suggests that for every 10% increase ( y gg y %in price, there would be a decrease in consumption of 8%, whereas elasticity of 1.0 suggests that for every 10% increase in price, there would be a decrease inincrease in price, there would be a decrease in consumption of 10%.) … With the use of a conservative estimate that consumers would substitute calories in other forms for 25% of the reduced calorie consumption, anforms for 25% of the reduced calorie consumption, an excise tax of 1 cent per ounce would lead to a minimum reduction of 10% in calorie consumption from sweetened beverages, or 20 kcal per person per day, a reduction thatbeverages, or 20 kcal per person per day, a reduction that is sufficient for weight loss and reduction in risk (unpublished data). “Source: The Public Health and Economic Benefits of Taxing Sugar-Sweetened Beverages, New England Journal of Medicine, 9/16/09.

Total Revenue Changes for a Given Price Change: CigarettesGiven Price Change: Cigarettes vs Sodas

Price

P2

Price

P2P2

P1

Loss in

Gain inRevenue

P2

P1

Gain inRevenue

+10% +10%

D1

Loss inRevenue

D1

Loss inRevenue

+10% +10%

QuantityQ2 Q1

QuantityQ2 Q1

-2% -8%


Inelastic Demand = -0.2 Inelastic Demand = -0.8

Other Applications Other Applications –– Taxing Snack Taxing Snack Foods and a “Fat Tax”Foods and a “Fat Tax”Foods and a Fat TaxFoods and a Fat Tax

Taxing Snack Foods: What to Expect for Diet and Tax Revenues. USDA/ERS, August 2004. www.ers.usda.gov/Publications/AIB747/aib74708 pdf74708.pdf

North Carolina’s Proposed “Fat” Tax:North Carolina s Proposed Fat Tax:http://www.kentucky.com/1084/story/967279.html?story_link=email_msg

Price Volatility in Ag MarketsPrice Volatility in Ag Markets

Most agricultural commodities and food items tend to exhibit a very inelastic demand schedule … which leads to volatile/flexible prices, relative to changes in quantitiesSometimes ag economists (and farmers) are more interested in how quantity changes affect prices (price flexibility coefficient)affect prices (price flexibility coefficient) than how price changes affect quantity (own-price elasticity of demand)price elasticity of demand)


pp. 78-79 Schrimper

Price Flexibility Coefficient

Percentage Change in Price Given a 1% Change in QuantityApproximated by the Inverse of the Elasticity of DemandInelastic Demand Characterizes More Flexible Prices Via a Larger Price Flexibility Coefficient

PFC =

P2-P1

P1=

% Change In Pε =1

PFCQ2-Q1

Q1

=% Change In Q ε D


Price Flexibility Coefficients: Interpretation

If the own-price elasticity of demand is -0.5 (-1/2), then the price flexibility coefficient is which is interpreted as:

_______1/-0.5 = -2

Each 1% increase in quantity leads to a decline in price holding2%to a _____decline in price, holding all other factors constant

2%


Price Response for a GivenPrice Response for a Given Quantity Change

PriceP2

Price

PFC >1 PFC <1

P1

P2

P1

PFC >1 PFC <1

D1

D2

QuantityQ2 Q1

QuantityQ2 Q1


Inelastic Demand Elastic Demandε < 1 ε > 1

Movements vs Shifts in the Demand Curve

So far in evaluating point (or arc) elasticities of demand and price flexibility coefficients we have been analyzing either the quantity responsiveness (with own-price elasticities) or the price responsiveness (with price flexibility coefficients) along a given

fp ( p y ) g g

demand curve, holding all other factors constant.

Recall our demand shifters:Changes in the prices of substitutes or complimentsChanges in the prices of substitutes or complimentsChanges in incomeChanges in tastes and preferencesChanges in the size or composition of the population

Now we are going to analyze the direction of the shift AND how responsive quantity is to changes in one of these demand shifters


Measuring the Effects of DemandMeasuring the Effects of Demand Shifters on Quantity Demanded

Price Price

P1

P2

P1

P2

D3

D2

QuantityQ1 Q2 Quantity

D1 D1

Q1 Q3Q2


Q1 Q3

A Change in Quantity Demand A Change in DemandQ2

Demand Shifters/Direction of the Shift

Demand Shifter Direction of the Shift

Price of Substitutes Shifts Demand to the _____right

Shifts Demand to the _____

Price of Complements Shifts Demand to the _____

left

left


Income (Normal Good) Shifts Demand to the _____

Shift D d t th

right

right

l fShifts Demand to the _____

Population Size or Composition


Shif D d h

left

rightp


Tastes and Preferences Shifts Demand to the _____

left

varies

Cross-Price Elasticity

Measures how the quantity demanded of one commodity responds to changes in the price of another commodity, holding all other factors constant

=% Change In QI

factors constant

ε QI PJ.

QI(2) –QI(1)

QI(1)IJ = =

% Change In PJ

εPJ QI

. =PJ(2) – PJ(1)

PJ(1)

=

Substitutes: EIJ > 0Complements: EIJ < 0Independent: EIJ = 0

J(1)

depe de IJ 0


Cross-Price Elasticity

QI(2) –QI(1)

Q % Change In QIQI PJIJ =

QI(1)

PJ(2) – PJ(1)

P

=% g QI

% Change In PJ

ε QI

PJ

PJ

QI

. =

PJ(1)

Assume the price of the jth commodity increases from $0 75 toAssume the price of the jth commodity increases from $0.75 to $1.00, which causes the quantity of the ith commodity to increase from 10 to 15. What is the cross-price elasticity for the ith commodity? Are commodities i and j substitutes or compliments?y j p


Cross-Price Point Elasticity ofCross Price Point Elasticity of Demand

Price of Pizza

Price of Hamburgers

Quantity of Pizzas

Q

QI(2) –QI(1)

($) ($)

10 4 50IJ =

QI(1)

PJ(2) – PJ(1)

P

ε

10 5 55PJ(1)

What is the Cross-Price Elasticity of Demand for a given change in the Price of Hamburgers w.r.t. the Quantity of Pizza?


Cross Price Elasticity for Pizza

Assume:

QPizza = 40 – 2.0PPizza +5 PHB - 2 PBeer +0.0008 Inc Assume:

Ppizza = $10.00 PHB = $4.00

Q P =ε QPIZZA PHBXPBeer = $5.00

INC = $25,000QPIZZA,PHB

=PHB QPIZZA

X =

What is the cross price elasticity for pizza with respect to the changes in hamburger prices?


Cross Price Elasticity for Pizza

Assume:


Ppizza = $10.00 PHB = $4.00

Q P =ε QPIZZA PHBX

4.005 0 4PBeer = $5.00

INC = $25,000QPIZZA,PHB

=PHB QPIZZA

X =50

5 0.4

What is the cross price elasticity for pizza with respect to the changes in hamburger prices?


Interpretation

Each 1% increase in the price of phamburgers results in a _____ increase in the quantity demanded for pizza

0.4%

Each 10% increase in the price of hamb ge s es lts in a inc ease in4 0%hamburgers results in a _____ increase in the quantity demanded for pizza

4.0%


Income Elasticity

Measures the responsiveness of quantity demanded (Q) to income (INC), changes, holding all other factors constant

Q2- Q1

Q1% Change In Qε Q INC.INC =

INC2-INC1

INC1

=% Change In INC

ε =INC Q

.

1Normal Good: INC > 0 (e.g. beef, sports tix, computers)Inferior Good: INC < 0 (e.g. Ramen noodles, generic items)ε

ε

Assume income increases from $25,000 to $30,000, which causes quantity purchased to increase from 50 to 54. What is the income elasticity? Is this a normal or inferior good?

Income Elasticity for Pizza

Assume:


Ppizza = $10.00 PHB = $4.00

INC =ε =INC.

QPIZZA

PBeer = $5.00INC = $25,000

INC =ε =INC QPIZZA

What is the income elasticity for pizza?

0000825,000 = 0 40


.00008 X ,

50= 0.40

Income Elasticities for Some Foods –T bl 4 3 S h iTable 4.3 Schrimper

IncomeIncome Elasticity

Beef .39

Pork .66

Chicken .08

Turkey - .13

Eggs .29 USDA Elasticity Data BaseEggs .29

Cheese .42

Milk .12

Butter .54

USDA Elasticity Data Base

http://www.ers.usda.gov/DButter .54

Margarine - .34

Sugar .01

Coffee 82

ata/Elasticities/Query.aspx


Coffee .82

Source: Huang, AJAE, 1996b

Journal Entry # 11

Read pages 6-10 of the article, Fruit and p g ,Vegetable Consumption by Low-Income Americans: Would a Price Reduction Make a Difference? ERS/USDA, January 2009,www.ers.usda.gov/publications/err70/A h 5 i i i h hAnswer the 5 questions -- turn in with the rest of the set on 10/27/09

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