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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
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
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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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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Cross-Price Elasticity
Ecp of x,y =
% Qx / % Py
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Cross-Price Elasticity
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