Measurement

and
Interpretation
of Elasticities
Chapter 5
 Discussion Topics
 Own price elasticity of demand:
A unit free
measure of demand response to a good’s own-
price change
 Cross price elasticity of demand:
A unit free
measure of demand response to other good’s
price change
 Income elasticity of demand:
A unit free
measure of demand response to an income
change
 Other general properties of demand curves
 How can we use these demand elasticities
2
 Key Concepts Covered…
Own price elasticity = % in Qi for a given % in Pi
Represented as ηii
i.e., the effect of a change in the price for hamburger on
hamburger demand: ηHH = % in QH for a given % in PH

Cross price elasticity = % in Qi for a given % in Pj

 Represented as ηij
i.e., the effect of a change in the price of chicken on
hamburger demand: ηHC = % in QH for a given % in PC

Income elasticity = %Qi for a given %Income

 Represented as ηiY
i.e., the effect of a change in income on hamburger
demand: ηHY = %QH for a given %PY
3 Pages 70-76
 Key Concepts Covered…
Arc elasticity = elasticity estimated over a range of
prices and quantities along a demand curve

Point elasticity = elasticity estimated at a point on

the demand curve

Price flexibility = reciprocal (the inverse) of the

own price elasticity
 % in Pi for a given % in Qi

4 Pages 70-76
 Own Price Elasticity
of Demand

5
 Own Price Elasticity of Demand
Own price Percentage change in quantity demanded (Q)
elasticity of ηii =
Percentage change in its own price (P)
demand
$
Point Elasticity Approach:
Single point
Own price
Q P Q Pa Pa on curve
elasticity of   Pb
demand Qa Pa P Q a
% Δ in Q Q
% Δ in P Qa Qb

Q = (Qa – Qb)
 The subscript
• a stands for after price change
P = (Pa – Pb) • b stands for before price change
6 Pages 70-72
 Own Price Elasticity of Demand
Own price Percentage change in quantity Specific range
elasticity of ηii =Percentage change in own price $ on curve
demand
Pa
Arc Elasticity Approach: P
Own price Pb
Q P Q P
elasticity of  
demand Q P P Q Qa Q b
Q

where: Q
Equation 5.3
Avg Price
P = (Pa + Pb) 2
Avg Quantity
Q = (Qa + Qb) 2  The subscript
Q = (Qa – Qb) • a stands for after price change
• b stands for before price change
P = (Pa – Pb)
7 Page 72
 Interpreting the Own Price
Elasticity of Demand
If Elasticity Demand is said % in
Measure is: to be: Quantity is:
Less than Greater than
Elastic % in Price
–1.0
Equal to Unitary Same as % in
–1.0 Elastic Price
Greater than Less than %
Inelastic in Price
–1.0
Note: The %Δ in Q is in terms of the absolute value
8 of the change Page 72
 Own Price Elasticity of Demand

Snow Leopard was a previous

version of Apple’s OS
9
 Own Price Elasticity of Demand
What does a own-price elasticity of -2.25
mean?
 For a 10% increase in price we get a
22.5% decrease in quantity purchase
 Example of an elastic demand with respect to
own-price changes

10
 Own Price Elasticity of Demand

ηii = -0.2 to -0.3

11
 Own Price Elasticity of Demand
Why is ηii a unit free measure?
 Why do we get the same value regardless if the
quantity is measured in tons versus pounds?
 Example of Soybean Meal
Qb = 2.25 tons Pb = $350/ton Qa = 2.50 tons Pa =
$300/ton
tons
ηSS 
 2.50 tons – 2.25 tons   $300 / ton
 $350 / ton 
2.50 tons $300 / ton
0.25 tons $50 ton  0.25   50 
 
2.50 tons $300 ton  2.50   300 
 0.10 
     0.60
 0.167 
12
 Own Price Elasticity of Demand
Lets recalculate the above elasticity but this time
in terms of lbs.
Qb = 4,500 lbs Pb = $0.175/lb
Qa = 5,000 lbs Pa = $0.150/lb

ηlbs 
 5000 lbs – 4, 500 lbs   $0.150 / lb $0.175 / lb 
SS 5, 000 lbs $0.150 / lb
500 lbs $0.025 lb  500   0.025 
 
5, 000 lbs $0.150 lb  5, 000   0.150 
 0.10 
     0.60 ←Same as previous value
 0.167 
13
 Demand Curves Come in a
Variety of Shapes
$

14
 Demand Curves Come in a
Variety of Shapes
$
The two extremes
Perfectly Inelastic
∆P
Perfectly Inelastic:
A price change does
not change quantity Perfectly Elastic
purchased
 Can you think of a
good that would have Q
this characteristic?

15 Page 72
 Demand Curves Come in a
Variety of Shapes
$
Inelastic Demand
∆P

∆P Elastic Demand

Q
∆Q ∆Q

16 Page 73
 Demand Curves Come in a
Variety of Shapes
$

Elastic where (–%Q ) > % P

Unitary Elastic where (–%Q) = % P

Inelastic where (–%Q )< % P

Q
A single demand curve can exhibit
various types of own-price elasticity
17 Page 73
 Example of Arc Own-Price Elasticity of Demand

Unitary elasticity
–% Change in Q = % Change in P
18
ηii= –1.0 Page 73
 Elastic demand

Inelastic demand

19 Page 73
 Elastic Demand Curve
$
With the price decrease from Pb to Pa
 What happens to producer revenue (or
consumer expenditures)?
Pb

Pa

0 Q
Qb Qa
20
 Elastic Demand Curve
$
An elastic demand curve → a
larger % ↑in quantity demanded
than the absolute value of the %
price change (a price decrease)
Pb
Cut in
price Pa

0 Q
Qb Qa
21
 Elastic Demand Curve
$
Producer revenue (TR) = price x quantity
• Revenue before the change (TRb) is Pb x Qb
Represented by the area 0PbAQb
C
• Revenue after the change is (TRa) is Pa x Qa
Pb A Represented by the area 0PaBQa

Pa B

0 Q
Qb Qa
22
 Elastic Demand Curve
Change in revenue (∆TR) is TRa – TRb
$ → ∆TR = 0PaBQa – 0PbAQb
→ ∆TR = QbDBQa – PaPbAD
Red Box Purple Box
C
Pb A
 →TR ↑
D  %Q
B ↑ is greater than %P ↓
Pa
 When you have elastic
demand
 ↑ in price → ↓ total
revenue (expenditures)
 ↓ in price → ↑ total
revenue (expenditures)

0 Q
Qb Qa
23
 Inelastic Demand Curve
$

Pb
Cut in
price Pa
Results in smaller %
increase in quantity
demanded

Q
Qb Q a
24
 Inelastic Demand Curve
$
With price decrease from Pb to Pa
What happens to producer revenue or
Pb consumer expenditures)?

Pa

Q
Qb Qa
25
 Inelastic Demand Curve
Producer revenue (TR) = price x quantity
$
Revenue before the change (TRb) is Pb x Qb
 Represented by the area 0PbAQb
Revenue after the change is (TRa) Pa x Qa
Pb A
 Represented by the area 0PaBQa

Pa B

0 Q
26 Qb Q a
 Inelastic Demand Curve

$
Change in revenue (∆TR) is TRa – TRb
∆TR = 0PaBQa – 0PbAQb
∆TR = QbDBQa – PaPbAD
Red Box Purple Box

Pb A
 →TR ↓
 % Q increase is less than %P decrease
Pa B
D  When you have
inelastic demand
 ↑ in price → ↑ total
revenue
 ↓ in price → ↓ total
revenue
0 Q
27 Qb Q a
 Revenue Implications
Own-price Cutting the Increasing the
Elasticity is: Price Will: Price Will:
Elastic Increase Total Decrease Total
(ηii< -1) Revenue Revenue
Unitary Elastic Not Change Not Change
(ηii= -1) Revenue Revenue
Inelastic Decrease Total Increase Total
(-1< ηii < 0) Revenue Revenue

Typical of Agricultural Commodities

28 Page 81
 Elastic Demand Curve
$
Consumer surplus (CS)
Before price cut CS is area PbCA
C After the price cut CS is area PaCB
A
Pb

Pa B

0 Q
Qb Qa
29
 Elastic Demand Curve
$
The gain in consumer surplus
after the price cut is area
C PaPbAB = PaCB – PbCA
Pb A

B
Pa

0 Q
Qb Qa
30
 Inelastic Demand Curve
$
Inelastic demand and
price decrease
Pb A Consumer surplus increases
by area PaPbAB
Pa B

0 Q
Qb Q a
31
 Retail Own Price Elasticities
• Beef and veal= -0.62
• Pork = -0.73
• Fluid Milk = -0.26
• Wheat = -0.11
• Rice = -0.15
• Carrots = -0.04
• Non food = -0.99

Source: Huang, (1985) Page 79

32
 Interpretation
Let’s use rice as an example
Previous Table: own price elasticity of –0.15
→ If the price of rice drops by 10%, the quantity
of rice demanded will increase by 1.5%
$ Demand
Curve With a price drop
 What is the impact on rice
Pb A
producer revenues?
10% drop B
Pa  What is the impact on
consumer surplus from rice
consumption?
1.5% increase
0 Q
Q B Qa
33
 Own Price Elasticity Example
1. The local Kentucky Fried Chicken outlet typically
sells 1,500 Crunchy Chicken platters per month at
$3.50 each

2. The own price elasticity for the platter is estimated

to be –0.30
Inelastic demand
3. If the KFC outlet increases the price of the platter
to $4.00:
a. How many platters will the KFC outlet sell
after the price change?__________
b. The KFC outlet’s revenue will change by
$__________
c. Will consumers be worse or better off as a
34 result of this price change?_________
 The answer…
1. The local KFCsells 1,500 crunchy chicken platters per
month at $3.50 each. The own price elasticity for this
platter is estimated to be –0.30. If the local KFC outlet
increases the price of the platter by 50¢:

a. How many platters will the chicken sell? 1,440

Solution:
-0.30 = %Q%P
P Avg. Price
-0.30= %Q[($4.00-$3.50) (($4.00+$3.50) 2)]
%P
-0.30= %Q[$0.50$3.75]
-0.30= %Q0.1333
→ %Q=(-0.30 × 0.1333) = -0.04 or –4%
35 → New quantity = (1–0.04)×1,500 = 0.96×1,500 = 1,440
 The answer…
b. The Chicken’s revenue will change by +$510
Solution:
Current revenue = 1,500 × $3.50 = $5,250/month
New revenue = 1,440 × $4.00 = $5,760/month
→revenue increases by $510/month =
$5,760 - $5,250
c. Consumers will be __worse___ off as a result of
this price change
Why? Because price has increased

36
 Another Example
1. The local KFC outlet sells 1,500 crunchy chicken
platters/month when their price was $3.50. The own
price elasticity for this platter is estimated to be
–1.30. If the KFC increases the platter price by 50¢:
Elastic demand
a. How many platters will the chicken sell?
__________

b. The Chicken’s revenue will change by

$__________

c. Will the consumers be worse or better off as a

result of this price change?

37
 The answer…
1. The local KFC outlet sells 1,500 crunchy chicken
platters/month when the price is $3.50 . The own price
elasticity for this platter is estimated to be
–1.30. If the KFC increases the platter price by 50¢:

a. How many platters will the KFC outlet sell? 1,240

Solution:
-1.30 = %Q%P
-1.30= %Q[($4.00-$3.50) (($4.00+$3.50) 2)]
-1.30= %Q[$0.50$3.75]
-1.30= %Q0.1333
%Q=(-1.30 × 0.1333) = -0.1733 or –17.33%
→ New quantity = (1 ̶ 0.1733)×1,500 = 0.8267 ×1,500
= 1,240
38
 The answer…
1. b. The Chicken’s revenue will change by –$290
Solution:
Current revenue = 1,500 × $3.50 = $5,250/mo
New revenue = 1,240 × $4.00 = $4,960/mo
→Revenue decreases by $290/mo = ($4,960 –
$5,250)
c. Consumers will be worse off as a result of this
price change
Why? Because the price increased.

39
 Income Elasticity
of Demand

40
 Income Elasticity of Demand
Income Percentage change in quantity demanded (Q)
elasticity of ηY = Percentage change in income (I)
demand
Q I Q I
ηy  
Q I I Q
where:
I = (Ia + Ib) 2 ηY : A quantitative measure of
Q = (Qa + Qb) 2 changes or shifts in quantity
demanded (ΔQ) resulting from
Q = (Qa – Qb)
changes in consumer income (I)
I = (Ia – Ib)

Page 74-75
41
 Interpreting the Income
Elasticity of Demand
When the income
The good is classified as:
elasticity is:
Greater than 0.0 A normal good
A luxury (and a normal)
Greater than 1.0 good
Less than 1.0 but A necessity (and a
greater than 0.0 normal) good

Less than 0.0 An inferior good

Page 75
42
 Example
Assume Federal income taxes are cut
and disposable income (i.e., income fter
taxes) is increased by 5%
Assume the chicken income elasticity of
demand is estimated to be 0.3645
What impact would this tax cut have
upon the demand for chicken?
 Is chicken a normal or an inferior good?
Why?
44
 The Answer
1. Assume the government cuts taxes, thereby
increasing disposable income (I) by 5%. The income
elasticity for chicken is 0.3645.

a. What impact would this tax cut have upon the

demand for chicken?
Solution:
0.3645 = %QChicken  % I
→ 0.3645 = %QChicken  .05
→%QChicken = .3645 .05 = .018 or + 1.8%

b. Chicken is a normal but not a luxury good since the

income elasticity is > 0 and < 1.0
45
 Cross Price Elasticity
of Demand

46
 Cross Price Elasticity of Demand
Cross Price Percentage change in quantity demanded
elasticity of ηij =
Percentage change in another good’s price
demand
Qi Pj Qi Pj i and j are goods
ηij   (i.e., apples,
Qi Pj  Pj Q i
where: oranges, peaches)
Pj = (Pja + Pjb) 2
Qi = (Qia + Qib) 2 ηij provides a quantitative measure
Qi = (Qia – Qib) of the impacts of changes or shifts in
Pj = (Pja – Pjb) the demand curve as the price of
other goods change
Page 75
47
 Cross Price Elasticity of Demand
If commodities i & j are substitutes (ηij > 0):
Pi↑→Qi↓, Qj↑
i.e., strawberries vs. blueberries, peaches vs.
oranges
If commodities i & j are complements (ηij < 0):
Pi↑→Qi↓, Qj↓
i.e., peanut butter and jelly, ground beef and
hamburger buns
If commodities i & j are independent (ηi j= 0):
Pi↑→Qi↓, Qj is not impacted
i.e., peanut butter and Miller Lite Page 75
48
 Interpreting the Cross Price
Elasticity of Demand
If the Cross-Price The Good is
Elasticity is: Classified as a:
Positive Substitute
Negative Complement
Zero Independent

Page 76
49
 Some Examples
Price That is Changing
Quantity
Changing Prego Ragu Hunt’s
Prego -2.550 0.810 0.392
Ragu 0.510 -2.061 0.138
Hunt’s 1.029 0.535 -2.754
Off diagonal values are all positive
Values in red along → These products are substitutes
the diagonal are own
price elasticities
Page 80
50
 Some Examples
Price Change
Spaghetti
Sauce Prego Ragu Hunt’s
Prego -2.550 0.810 0.392
Ragu 0.510 -2.061 0.138
Hunt’s 1.029 0.535 -2.754
Note: An increase in Ragu spaghetti sauce price
has a bigger impact on Hunt’s spaghetti
sauce demand (ηRH = 0.535) than an increase
in Hunt’s spaghetti sauce price on Ragu
demand (ηHR = 0.138)
Page 80
51
 Some Examples
Price Change
Spaghetti
Sauce Prego Ragu Hunt’s
Prego -2.550 0.810 0.392
Ragu 0.510 -2.061 0.138
Hunt’s 1.029 0.535 -2.754
A 10% increase in Ragu spaghetti sauce
price increases the demand for Hunt’s
spaghetti sauce by 5.35%

Page 80
52
 Some Examples
Price Change
Spaghetti
Sauce Prego Ragu Hunt’s
Prego -2.550 0.810 0.392
Ragu 0.510 -2.061 0.138
Hunt’s 1.029 0.535 -2.754
A 10% increase in Hunt’s spaghetti
sauce price increases Ragu spaghetti
sauce demand by 1.38%

Page 80
53
 Example
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60
a. If the price of hamburger buns rises by 5%,
what impact will that have on hamburger
consumption?
b. What is the demand relationship between these
products?

54
 The Answer
1. The cross price elasticity for hamburger demand
with respect to the price of hamburger buns is
equal to –0.60
a. If the price of hamburger buns rises by 5%,
what impact will that have on hamburger
consumption? -3.0%
Solution:
-0.60 = %QH  %PHB
-0.60 = %QH  .05
%QH = .05  (-.60) = -.03 or – 3.0%
b. What is the demand relationship between these
products?
These two products are complements as
evidenced by the negative sign on the associated
cross price elasticity
55
 Another Example
2. Assume a retailer:
i) Sells 1,000 six-packs of Pepsi/day at a price of
$3.00 per six-pack
ii) The cross price elasticity for Pepsi with respect
to Coca Cola price is 0.70

a. If the price of Coca Cola rises by 5%, what impact

will that have on Pepsi sales?

b. What is the demand relationship between these

products?

56
 The Answer
a. If the price of Coca Cola rises by 5%, what impact
will that have on Pepsi consumption?
Solution:
.70 = %QPepsi  %PCoke
.70 = %QPepsi  .05 = .035 or 3.5%
New quantity of Pepsi sold = 1,000  1.035 =
1,035 six-packs, 35 additional six packs
New value of sales = 1,035  $3.00 = $3,105 or
$105/day extra

b. What is the demand relationship between these

products?
The products are substitutes as evidenced by the
positive sign on this cross price elasticity
57
 Price Flexibility
of Demand

58
 Price Flexibility
 The price flexibility is the reciprocal (inverse) of the
own-price elasticity
• If the calculated elasticty is - 0.25, then the
flexibility = 1/(-0.25) = - 4.0

 Price Flexibility interpretation: %∆P ÷ %∆Q

59
 Price Flexibility
 This is a useful concept to producers when forming
expectations for the current year
• i.e., Assume USDA projects an additional 2% of
supply will likely come on the market
• Given above price flexibility then producers know
the price will likely drop by 8%, or:
%Price = - 4.0 x %Quantity
= - 4.0 x (+2%)
= - 8%
→If supply ↑ by 2%,
price would ↓ by 8%

Note: make sure you use the negative sign for both the
elasticity and the flexibility.
60
 Revenue Implications
Own-Price Resulting Increase in Decrease in
Elasticity Price Supply Will Supply Will
Flexibility
Increase Decrease
Elastic < -1.0 Revenue Revenue
Unitary Not Change Not Change
= -1.0
elastic Revenue Rrevenue
Between 0 Decrease Increase
Inelastic Revenue Revenue
and -1.0

Characteristic of a large number

of agricultural commodities Page 81
61
 Changing Price Response Over Time

Short run effects Long run effects

 Over time consumers respond in greater

numbers
 This is referred to as a recognition lag
 With increasing time, price elasticities tend
62 to increase → flatter demand curve Page 77
 Implications of Agriculture’s
Inelastic Demand Curve
$

Pb A  Small ↑ in supply will cause

agricultural product prices
Pa to ↓ sharply
 Explains why major
program crops receive
Federal government
Increase in subsidies
supply
0 Q
Qb Q a
63
 Inelastic Demand Curve
Price

Pb A While this ↑ the costs of

government programs
Pa B and hence budget deficits,
remember consumers
benefit from cheaper food
costs.

0
Qb Q a Quantity
64
 Demand Characteristics
Which market is riskier for producers…
elastic or inelastic demand?

Which market would you start a business

in?

Which market is more apt to need

government subsidies to stabilize producer
incomes?

65
 The Market Demand Curve
Price

What causes movement

along a demand curve?

Quantity
66
 The Market Demand Curve
Price

What causes the demand

curve to shift?

Quantity
67
 In Summary…
Know how to interpret all three elasticities
Know how to interpret a price flexibility
Understand revenue implications for
producers if prices are cut (raised)

Understand the welfare implications for

consumers if prices are cut (raised)

Know what causes movement along versus

68
shifts the demand curve
 Chapter 6 starts a series of
chapters that culminates in a
market supply curve for food
and fiber products….

69