Elasticity Overview Macroeconomics of Agriculture AGEC 430 Spring 2010

Market Equilibrium D S D S Quantity Price PePe QeQe D S Initial market equilibrium Initial market equilibrium

Demand/Supply Model Demand equation: Q d = a 0 - a 1 (Price) +  a i (demand shifters) Supply equation: Q s = b 0 +b 1 (price) +  b i (supply shifters) Market equilibrium: Q d = Q s To forecast price, substitute demand and supply definitions into the equation for market equilibrium and solve for price.

Concept of Elasticity Own price elasticity = %  Q/ %  P Price flexibility = %  P/ %  Q Income elasticity = %  Q/ %  Y Cross Price elasticity = %  Q/ %  Px Demand elasticities Related concept

PbPb PaPa Q b Q a Price Quantity Elastic Demand Curve 0 Drop in price Drop in price Brings about a larger increase in the quantity demanded Brings about a larger increase in the quantity demanded c

PbPb PaPa Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. a b 0 c

PbPb PaPa Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. a b 0 c

PbPb PaPa Q b Q a Price Quantity Elastic Demand Curve Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. Producer revenue increases since %  P is less that %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. a b 0 c

PbPb PaPa Q b Q a Price Quantity Inelastic Demand Curve Drop in price Drop in price Brings about a smaller increase in the quantity demanded Brings about a smaller increase in the quantity demanded

PbPb PaPa Q b Q a Price Quantity Inelastic Demand Curve Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. a b 0

PbPb PaPa Q b Q a Price Quantity Inelastic Demand Curve Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. Producer revenue falls since %  P is greater than %  Q. Revenue before the change was 0P b aQ b. Revenue after the change was 0P a bQ a. a b 0

Revenue Implications Own-price elasticity is: A drop in the price will: An increase in price will: ElasticIncrease revenue Decrease revenue Unitary elastic Not change revenue InelasticDecrease revenue Increase revenue

Revenue Implications Own-price elasticity is: A drop in the price will: An increase in price will: ElasticIncrease revenue Decrease revenue Unitary elastic Not change revenue InelasticDecrease revenue Increase revenue