—Elasticity Case Study Assignment
Economics 11
The articles below are all drawn from the Aplia Econ Blog and deal with ELASTICTY
and some review material. Choose one of the 6 that strikes your interest and use
the following procedure to complete the assignment:
1.
READ THROUGH THE ARTICLE
HI-LIGHT,
MARGINAL NOTES
2.
USE THE URL
3.
BEGIN WORK ON THE QUESTIONS
AT THE BOTTOM OF THE ARTICLE TO
ACCESS THE ON-LINE VERSION WHERE YOU CAN FOLLOW THE
HYPERLINKS TO SUPPORTING ARTICLES FOR A FULLER
UNDERSTANDING OF THE TOPIC
MAKE
NOTE OF THE TYPE OF QUESTION [IN RED] AND RESPOND
ACCORDINGLY—WRITE OUT FULL RESPONSES AS IF YOU WERE TAKING
A DATA RESPONSE TEST
4.
USE “ECONOMICS THROUGH DIAGRAMS” ON
SCHMOODLE IF YOU NEED SOME THEORY EXPLANATION/REVIEW
5.
As always, I encourage you to work
with 1-2 partners so that you can talk
your way through the material; but
the written work MUST be completed
by each student.
THIS WORK WILL BE EVALUATED AS A
DATA RESPONSE ACTIVITY—HOWEVER I
REALIZE THAT YOU HAVE BEEN
PREPARING ELASTICITY ON YOUR OWN
[SO DON’T PANIC]
1.
ELASTICITY OF SUPPLY + RESOURCE ALLOCATION
FRIDAY, JANUARY 20, 2006
Do Renewable Fuels Mean World Hunger?
by Chris Makler
Sky-high oil prices and concerns over global warming have
sparked a debate about renewable energy sources. One such
alternative is to use biological fuels (rather than fossil fuels
like oil) to power automobile cars. Willie Nelson has started
selling BioWillie, a form of diesel made in part from
vegetable oil. And ethanol, a form of gasoline made from
corn, has begun to take off as a viable alternative to
traditional gasoline in cars.
The possibility of using corn to produce fuel is one that is
obviously attractive to the nation's corn growers. But if the
United States were to start using corn as a significant source
of energy, would that mean that the rest of the world would
have less to eat? Would poor children go starving just so
yuppies could drive their SUVs? This article in the New
York Times examines that possibility, but some simple
economic analysis shows that these fears are unfounded.
Consider the market for corn in Iowa. Usually, demand in the
market comes from animal feed producers and food
processors, who make the corn into corn syrup for use in
things like Danish pastries. However, this year, demand for
corn increased because there are more buyers in the corn
market: namely, ethanol producers.
In the short run--that is, after the corn has been harvested in
a given year--the supply of corn is fixed. This is sometimes
called a momentary supply curve. (You can see the fixed
supply of corn in the picture in the article--it's that giant 35foot pile in the main photo!) Therefore higher demand
translates into higher prices, as is shown in Figure 1.
In the long run, though, higher prices for corn will mean that more corn will be produced.
(In fact, as the article mentions, the U.S. government actually pays corn farmers NOT to
farm 35 million acres of corn.) Because of these agricultural subsidies, in fact, third-world
farmers are priced out of the market--so they don't plant corn. Higher demand for corn, in
the long run, would mean that both U.S. producers and world producers would have more
incentive to plant corn. Therefore, the long-run supply curve of corn is much more elastic
(i.e., much flatter) than the momentary supply curve--so the same shift in the demand
causes a smaller increase in prices, and enough corn to be planted to satisfy the need for
food and fuel, as shown in Figure 2. In the long run, an increase in the demand for corn
increases the amount of corn produced and consumed in the world.
1[application]. The article quotes Lester R. Brown, an agriculture expert in Washington,
D.C., and president of the Earth Policy Institute, as saying, "We're putting the supermarket
in competition with the corner filling station for the output of the farm." Draw a PPF showing
how much food and fuel an economy can produce with a given amount of corn. What aspect
of your drawing represents the tradeoff that Mr. Brown describes? Now draw another PPF
showing how much food and fuel an economy can produce if twice as much corn is planted.
In what sense are short-run tradeoffs different from those in the long run?
2[application]. Draw a supply and demand graph of the market for corn taking into account
elasticity. What would happen in this diagram if the United States stopped paying corn
farmers NOT to farm that 35 million acres of corn?
3[application]. Much of the corn grown in the United States is used for animal feed. What
effect would an increase in the price of Iowa corn have on the market for hamburgers?
Draw a supply and demand diagram taking into account relative elasticity of hamburgers to
illustrate the impact.
4[evaluation +application]. Discuss some of the short-run tradeoffs that might be rendered
irrelevant by long-term market adjustments. Use the market mechanism model to illustrate
and explain what should happen and how elasticity (and other factors) may influence the
smooth functioning of the price system.
Labels: Elasticity, Resource Allocation, Supply and Demand
http://econblog.aplia.com/2006/01/do-renewable-fuels-mean-world-hunger.html#links
2. PED + XED + YED
TUESDAY, FEBRUARY 15, 2011
The illogicality of off-brand Q-tips (or why some savings
decisions make more sense than others)
by Chrissie Deist
Cross Price Elasticity of Demand measures how closely related two
goods are to one another—ie: how substitutable. How complementary
XED = %^Qd Good A / %^P Good B
+XED = substitutes; -XED = complements
Income Elasticity of Demand measures how sensitive demand is to
changes in income and determines whether a good is normal (+YED) or inferior (YED)
YED = %^Qd / %^Y Y = Income
While perusing the aisles of Safeway the other day, I pondered the rationality of my grocery
selections. I bought the Q-tips brand ear swabs instead of the Safeway brand equivalent
which would have saved me about $0.70, but reluctantly opted not to buy my favorite kind
of chocolate because it was selling for $3.99 rather than the frequent sale price of $2.99 a
bar. I selected the grape tomatoes at $1.99 a carton instead of my preferred cherry
tomatoes at $3.99 a carton, but bought a fancy bottle of salad dressing for $4.59 in spite of
a myriad of cheaper alternatives.
Why did I spend the extra money on Q-tips when I could have used it to buy chocolate
instead? Why forgo the expensive tomatoes but not the pricier salad dressing? The answers
lie largely in the economic concept of elasticity. Price elasticity of demand describes how
much a change in the price of a good affects the quantity demanded for that good. If a good
has very elastic demand, then a small change in the price will have a large effect on how
much of that good is demanded. Conversely, the price of a good with inelastic demand can
rise substantially without having much effect on the quantity demanded. For example, my
choice to stop buying chocolate bars in response to an increase in price suggests my
demand for them is relatively elastic.
Cross-price elasticity of demand refers to how much a change in the price of one good
affects the demand for another good. The switch from cherry to grape reflects a positive
cross-price elasticity of demand, because my demand for grape tomatoes increased when
the price of cherry tomatoes rose. This illustrates one determinant of elasticity: the
availability of viable alternatives or substitutability. Although I do prefer cherry tomatoes to
grape, it is a slight preference, so when cherry tomatoes are not on sale, I substitute grape
tomatoes for cherry and save $2.
Another determinant of a good’s price elasticity is the percentage of one’s overall budget
that a good requires. I eat a lot of chocolate; therefore, only buying it when it goes on sale
adds up to far more savings over time than choosing to buy the generic Q-tips, which I only
buy every six months or so. Because I find off-brand Q-tips mildly frustrating (the cotton
doesn’t seem to stay properly attached), choosing the off-brand to save $1.40 a year would
probably be one of the least worthwhile money-saving sacrifices I could make.
A third determinant of price elasticity is necessity. While food in general is perhaps the most
necessary good I buy, my actual need for chocolate is (somewhat) less pressing.
Reluctantly, I postponed my chocolate purchase in hopes that next time it would be on sale.
While normal people do not consider the elasticity of their demand for various grocery
items, their actions are inevitably guided to some degree by the prices of alternatives, the
weight of the expenditure in their overall budget, and the necessity of the good. But why
stop at the checkout line? While it might be most natural to illustrate the elements of
elasticity with groceries, economists believe the same decision-making behaviors apply
when people buy any good or service. So, next time you’re considering whether to sacrifice
or splurge on anything from cupcakes to cell phone plans, remember that some savings
make more of an impact on your budget than others.
Discussion Questions:
1[explanation] Instead of talking about one type of tomatoes versus another, how does my
demand for Roma tomatoes compare to my demand for tomatoes in general? How does a
narrow or broad definition of a good relate to its elasticity?
2[application]. The income elasticity of demand refers to the change in the quantity
demanded that results from a change in the buyer’s income, rather than the price of the
good. Suppose I got a raise. How would a dramatic increase in my income affect my
demand elasticity for an expensive treat, like steak? Would the effect be the same on all
goods? What about my demand for ramen noodles? Draw a S&D diagram for steak and one
for noodles to illustrate the differing effects.
3[application]. If the producers of a good have conducted research that suggests demand
for their good is highly price elastic, how might this affect their pricing decisions? Draw a
diagram(s) to illustrate the effect of a price increase and a price decrease on producer
revenue.
4[application + evaluation]. Recently, there have been “sin taxes” proposed in some states
on a number of goods, including artificial tanning, tattoos, and sugary sodas. Economists
call these Pigouvian taxes. They are taxes placed on goods that the government believes
are socially unappealing. Suppose the demand for artificial tanning is very elastic, while the
demand for sugary soda is not. Compare the effects of two equal sized taxes on the
equilibrium market price, the equilibrium quantity consumed, and the tax revenue raised.
Labels: Elasticity, Price Elasticity of Demand
http://econblog.aplia.com/2011/02/illogicality-of-off-brand-q-tips-or-why.html#links
3. ELASTICITY + PRICE CONTROLS
MONDAY, FEBRUARY 12, 2007
Fueling Protests and Cars
by William Chiu
Tortillas—a central component of the Mexican diet—have been a source of recent uproar
in Mexico. Rising tortilla prices fueled protests in Mexico City two weeks ago. Many people
in Mexico earn only $5 per day, and with the price of tortillas approaching $0.45 per pound,
protests were inevitable.
Tortilla prices may be fueling the protests, but it's the growing demand for corn among
American ethanol producers that's fueling the rise in tortilla prices. As more and more
ethanol plants come online in the U.S., the number of buyers in the corn market increases,
putting upward pressure on corn prices. Rising corn prices mean rising input prices for
tortilla makers and rising tortilla prices for consumers. So does fueling your Honda Accord
with ethanol-laced gasoline take tortillas off the plates of Mexicans? The answer depends on
the time horizon: the short run or the long run.
Three characteristics in the market for corn make it highly competitive. First, there are
many corn producers in the United States, Mexico, and the rest of the world. Second, corn
tastes about the same no matter which farmer sells you the corn. Third, there are few
barriers to new corn producers entering the market in the long run.
In the short run, however, firms cannot exit or enter the market. Rising ethanol production
in the U.S. creates a higher demand for corn. The market demand for corn shifts to the right
from D1 to D2, increasing the price of corn from P1 to P2. Corn producers react to the
higher price by producing more corn (moving from q1 to q2). The higher demand for corn
also causes corn producers to earn an economic profit.
How does this affect the tortilla market in Mexico? Corn is a major input for tortillas—as
corn prices rise, the cost of tortilla production rises. The supply of tortillas shifts to the left
from S* to S**. The price of tortillas increases and the quantity of tortillas consumed
decreases. The reduction in tortilla supply causes the price of tortillas to rise sharply in
Mexico because tortillas are essential to the Mexican diet (the demand for tortillas is fairly
inelastic). As a result, the financial burden of higher corn prices falls on tortilla consumers
more so than the producers.
Fortunately, as the Los Angeles Times reports,
help is on the way for the people of Mexico. In the long run, firms may exit or enter the
market. Unusually high short-run profits in the corn market will undoubtedly cause more
farmers to plant corn in the long run. As they do, the supply of corn will shift to the right
from S1 to S2. As more farmers plant corn in the long run, profits return to normal and the
price of corn falls. In the long run, as the diagrams suggest, it's possible that the higher
demand for ethanol will have no effect on corn and tortilla prices.
Click here for another Aplia perspective on food prices and ethanol.
Discussion Questions
1[application]. How would a price ceiling at P* affect the Mexican tortilla market? Draw a
diagram, taking into account elasticity, that illustrates the effect of the price ceiling.
2[application + evaluation]. Should the Mexican government subsidize tortilla producers
until corn prices fall back to previous levels? Draw a diagram, taking into account elasticity,
that illustrates the effect of the subsidy and how it impacts all stakeholders.
3[evaluation]. Are Mexicans worse off or better off due to the increase in U.S. ethanol
production? Compare the long-run and short-run impacts and effects on various
stakeholders.
Labels: Elasticity, Perfect Competition, Price-taker, Resource Allocation, Supply and
Demand
http://econblog.aplia.com/2007/02/fueling-protests-and-cars.html#links
4. INCOME ELASTICITY
THURSDAY, AUGUST 13, 2009
The Demand for Natural Light
by Ryan Knapp
Income Elasticity of Demand measures how sensitive demand is to
changes in income and determines whether a good is normal (+YED) or inferior (YED)
YED = %^Qd / %^Y Y = Income
I once participated in a blind taste test involving eight light beers. Faced with eight unmarked cups, I was certain I’d prefer the priciest, and presumably classiest, light beer in the
field. Alas, I chose Natural Light. For me, the cheap and down-market “Natty Light” is the
choicest light beer on offer. But people who have (or think they have) a more refined palate
gladly pay for a more expensive option like Heineken or Bud Light.
With the economic downturn, however, cash-strapped beer drinkers appear to be
switching to cheaper beers like Busch, Natural Light, and Keystone. As average incomes
declined in the United States, sales of these cheaper options have increased substantially.
Meanwhile, sales of ‘premium’ brands like Budweiser and Heineken were reportedly down
18% and 14% respectively from a year ago in July 2008.
Discussion Questions
1[explanation]. If, other things being equal, a reduction in average income leads to an
increase in the demand for Natural Light, what type of good is “Natty Light”? If, during the
same period, the demand for Bud Light declines, what type of good is Bud Light?
2[analysis]. What additional information would be useful if you were trying to use changes
in average income and beer sales to determine whether a particular brand of beer was a
normal or inferior good?
3[evaluation]. What strategy might a large beer company adopt to protect itself from an
economic downturn?
4[calculation]. Information Resources, Inc. reports that sales of Bud Light were down about
7% from a year ago in July 2008. Let’s assume that the price of Bud Light is fixed, so that
the percentage decrease in sales is the same as the percentage decrease in the quantity of
Bud Light demanded. Assume that personal income per capita in the United States
declined by about 3.4% over the same period. Keeping in mind that factors other than
income probably affected Bud Light sales over this period, use these numbers to come up
with a rough estimate of the income elasticity for Bud Light. Is the income elasticity of
demand for Bud Light elastic or inelastic? Would you characterize Bud Light as a luxury or a
necessity? Explain your reasoning.
Labels: Demand, Elasticity
http://econblog.aplia.com/2009/08/demand-for-natural-light.html#links
5. PRICE ELASTICITY OF S&D +
INCENTIVES
MONDAY, AUGUST 14, 2006
The Organ Shortage
by Brandon Fuller
Newspaper ads on every college campus beckon cash-strapped students to sell their
plasma, sperm, or eggs to the appropriate medical intermediaries. It's Adam Smith's
invisible hand at work: People need plasma for blood transfusions; students with excess
plasma need cash. Plasma banks facilitate the transaction and everyone's better off.
The enterprising student will wonder whether he can collect on other spare parts--say, a
kidney. He cannot. The sale of human organs, whether it benefits a living kidney donor or
the family members of a recently deceased heart donor, is illegal in the United States. Why,
asks the latest Freakonomics column, is selling a kidney illegal in a country where
thousands of people die each year waiting for kidney transplants? Read the column to see
what Stephen Dubner and Steven Levitt have to say about the organ shortage.
1[interpretation]. Suppose the graph above represents a market for transplantable kidneys
from live donors. Under current law, the price of a kidney is restricted to zero. At a zero
price, 15,000 people (most likely friends and family of the recipients) supply a kidney to
eligible patients each year. What's the shortage of kidneys at a zero price?
2[analysis]. Beyond the 15,000 charitable donors our hypothetical supply curve takes a
more familiar, upward-sloping shape. Each point on the supply curve represents the seller's
cost of providing a transplantable kidney. According to Dubner and Levitt, what are some of
the costs that influence the supply decisions of living kidney donors? (Think about forgone
wages, medical risks, and the fact that supplying a kidney is a one-time event.)
3[application]. In our hypothetical market for kidneys shown in the graph, what price clears
the transplantable kidney market? (See an actual economic estimate of kidney prices in this
paper by Gary Becker and Julio Jorge Elias.) Notice that closing the kidney shortage with a
free market adds to the cost of a transplant (already upwards of $200,000). Might the
additional cost of procuring a kidney price some patients out of the market altogether? That
is, would an increase in the price of a transplant reduce the quantity of transplants
demanded? Do you think the quantity of transplants demanded is sensitive or insensitive to
price (is the price elasticity of demand for transplants perfectly inelastic)? Use the elasticity
determinants to decide and draw a diagram to illustrate the implications of the above.
4[analysis + interpretation]. If you're like most normal people, the prospect of a market for
kidneys raises all kinds of moral and ethical questions. According to the column, Alvin Roth
helped devise a program that uses incentives to elicit organ donations from strangers, but
stops short of a free market for organs. How does the New England Program for Kidney
Exchange align the incentives of non-related donors and recipients without monetary
incentives?
5[evaluation]. Evaluate the advantages and disadvantages of a free market for organs.
Check out the Freakonomics website for more about creative solutions to the organ
shortage.
Labels: Elasticity, Incentives, Organs, Shortage, Supply and Demand
http://econblog.aplia.com/2006/08/organ-shortage.html#links
6. SUPPLY & DEMAND +
ELASTICITY
MONDAY, JANUARY 22, 2007
California Freezing
by Brandon Fuller
Freezing temperatures destroyed significant portions of fruit and vegetable crops in
California over the weekend of January 13. An article from the LA Times documents the
cold snap's immediate impact on wholesale prices for citrus. The cold snap will be felt in
other markets as well: an article in the Seattle Times assesses potential impacts on apple
and pear prices, and a USA Today piece considers the fallout in the labor market for
farmhands in California.
Discussion Questions
1[analysis + application]. According to the LA Times article: "The freeze has left the nation
with about 14 million 40-pound cartons of California navel oranges—less than half of what
America would eat between now and next season…" The sharp reduction in the supply of
navel oranges will cause prices to rise, but by how much? To what extent will consumers
substitute away from citrus towards other fruits in response to higher prices? Is demand for
navel oranges relatively unresponsive to price changes (less elastic), or will consumers
simply switch from citrus to alternative fruits when prices rise (more elastic)? Use each of
the elasticity determinants to determine the relative elasticity of navel oranges and draw a
diagram illustrating the impact of the freeze on orange prices and Qd.
2[application]. As the LA Times article mentions, California is the major producer of navel
oranges for domestic consumption and also exports a significant amount of fruit. Fruit
distributors will try to import as much citrus as possible from places like Mexico and Chile.
That is, the supply of citrus exports from the U.S. will plunge and the demand for citrus
imports will rise. What do you expect to happen to world citrus prices? Draw a diagram to
illustrate.
3[application + analysis]. The USA Today article notes that many California farmhands will
be laid off in the wake of the freeze. What will happen to farmhand wages and employment
levels in California? Given that undocumented migrant workers will not be eligible for
unemployment insurance, what do you expect to happen in markets for low-skilled labor in
other parts of the United States? Draw a diagram, taking into account relative elasticity, to
illustrate the impacts—use the elasticity determinants to decide if the demand and/or supply
for farmworkers is relatively elastic or inelastic.
4[evaluation]. Should the government intervene in this market or allow the market
mechanism to work towards a long-run equilibrium?
Labels: Elasticity, Labor, Supply and Demand
http://econblog.aplia.com/2007/01/california-freezing.html#links