Introduction to Agricultural & Resource Economics
Introduction to Agricultural & Resource Economics ARE 201
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This 5 page Class Notes was uploaded by Norbert Terry on Thursday October 15, 2015. The Class Notes belongs to ARE 201 at North Carolina State University taught by Michael Walden in Fall. Since its upload, it has received 8 views. For similar materials see /class/223759/are-201-north-carolina-state-university in Agricultural & Resource Econ at North Carolina State University.
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Date Created: 10/15/15
Lecture 6 Price and Revenue Elasticity 1 Although demand curves are downward sloping and supply curves are upward sloping their degree ofquotsteepnessquot or quot atnessquot can vary 2 What does this mean A quotsteepquot demand curve like 1 D 20 30 4D 50 q uantity means consumers don t change their purchasing behavior as much as with a more quot atquot demand curve like price 10 20 30 40 50 quantity Likewise with a quotsteepquot supply curve like price 10 20 30 40 50 q uantity businesses don t change their production as much when price changes as with a more quot at supply curve like price 10 20 30 40 50 q uantity Steep demand curves are more likely with quotnecessitiesquot and quot atquot demand curves are more likely with quotluxuriesquot A steep supply curve is more likely for products or services that take a long time to develop pharmaceuticals surgeons electricity whereas a at supply curve is more likely for products or services that can be quickly produced food clothes 3 Economists have developed measures of the relative steepness or atness of demand and supply curves For demand curves the measure is called price elasticity of demand a Measured as proportional change in quantity boughtproportional change in price This will be a negative number 0quot Ifthe number is a quotfractionalquot negative number that is between 0 and 1 then the demand curve is relatively steep and we call it price inelastic Ifthe number is a quotlargequot negative number like 15 3 35 technically a number smaller than 1 remember 2 is quotsmallerquot than 1 then this demand curve is relatively at and we call it price elastic Ifthe price elasticity of demand is exactly 1 it is called unit elastic 0 BIG SIGNIFICANCE OF THIS FOR BUSINESS If demand curve is price inelastic then increasing the price will increase revenues to the business Revenues are P x Q Price inelastic means when P rises Q falls but the drop in Q is not large so the new P x Q is larger I ll give an example later But if the demand curve is price elastic then increasing the price will decrease revenues Price elastic means when P rises Q falls a lot so the new P x Q is smaller d Example 1 Mr Pizza sells 200 pizzas per week when he prices each pizza at 10 whereas he sells 150 pizzas per week when he charges 15 per pizza Formula for price elasticity of demand change in quantitv sold average quantitv sold change in price average price 50175 028 07 5 1250 040 This demand curve is price inelastic so revenue increases when the price is increased Revenue at 10 per pizza 10 x 200 2000 Revenue at 15 per pizza 15 x 150 2250 Example 2 The CAT bus system has 5000 weekly riders when each ride is priced at 1 The CAT bus system has 3000 weekly riders when each ride is price at 120 Using the formula the price elasticity of demand is calculated as 20004000 50 277 20 110 18 This demand curve is price elastic so revenue decreases when the price is increased Revenue at 1 1 x 5000 5000 Revenue at 120 120 x 3000 3600 If the demand curve is price inelastic then what39s to prevent the business from constantly increasing price to increase revenues There are two reasons First is competition If other competing businesses don t follow the business constantly increasing its price will lose customers Second is the fact that as the price rises and quantity sold falls demand curves tend to become price elastic 4 Price elasticity of supply Measures how the quantity produced by business changes when the price changes Will be a positive number businesses supply more when the price increases and they supply less when the price decreases Is price inelastic if the number is between 0 and 1 and is price elastic if the number is greater than 1 Formula change in guantity produced average guantity produced change in price average price Example 1 When the price of corn is 2 per bushel farmers grow 5 million bushels When the price of corn is 250 per bushel farmers grow 11 million bushels Price elasticity of supply 6 8 075 341 price elastic 50 225 022 Example 2 When their average salary is 100000 there are 1 million surgeons When their average salary is 250000 there are 12 million surgeons Price elasticity of supply 02 11 018 021 price inelastic 150000 175000 086 V39 Income Elasticity Measures how quantity purchased changes when income of the buyer changes Positive for normal goods negative for inferior goods Calculation change in quantitv sold average quantitv sold change in income average income Example 1 Marla buys 3 steaks a month when her income is 30000 but she buys 7 steaks a month when her income increases to 50000 Calculation 45 08 16 Steakis anormal good 20000 40000 05 Example 2 Marla buys 10 fast food hamburgers a month when her income is 30000 but she buys 6 fast food hamburgers when her income is 50000 Calculation 4 8 05 l0 Therefore a fast food hamburger is an 20000 40000 5 inferior good
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