Imagine yourself in an internship this summer. It is your first day on the job and your supervisor asks you to develop answers for the following questions:
- How does the demand for beef respond to changes in the price of beef?
- How does the demand for beef respond to changes in the prices of related goods such as pork, poultry, lamb, or fish?
- How does the demand for beef respond to a change in consumer income levels?
- How does the demand for beef respond to changes in advertising expenditures by the National Cattlemen’s Beef Association (NCBA)?
Having just completed a course on food and agricultural marketing, you notice immediately that each of these questions pertains to a variable that can influence market demand. Question 1 deals with the own-price relationship, question 2 with cross-price relationships, question 3 with an income relationship, and question 4 with the potential for advertising expenditures to exert a favorable influence on consumer preferences.
You are pleased to have been given such a straightforward assignment and begin to draft a memo that provides sensible answers to each question. In response to question 1, you explain that as the price of beef increases, quantity demanded will fall. After all, there is this little idea called “the law of demand” that your professor kept blabbering about. Question 2 is also easy. You simply argue that pork, poultry, lamb, or fish are usually presented as alternative protein choices to beef. Because of this, each can be classified as a substitute to beef. You conclude that as the price of one or more of these products increases, beef demand would increase as well. You find the income question to be a little harder. Nevertheless, being a resourceful person, you log into the University Libraries and locate a study showing that as incomes rise, consumers increase visits to higher-end restaurants. Since these restaurants are more likely to serve expensive table cuts from the loin and rib, you reason that this study provides the evidence you need to make a case that beef is a normal good. As such, you argue that beef demand will increase as consumer incomes rise. Finally, on question 4, you state: “If the NCBA launches a new advertising campaign, it is reasonable to expect beef demand to increase. Especially if the campaign is successful in convincing consumers that beef is a nutritious and convenient menu choice.” You proofread your memo and send it off to your supervisor in an email. She acknowledges receipt with a short reply: “Wow. That was fast. I’ll look at this tonight.”
The next morning you arrive at work and see a hard copy of the memo on your desk. On it is a hand-written note that says: “Tell me something I don’t already know.” Ouch! So much for making a good first impression.
The answers you developed were correct. The problem is that answers this simple are usually not specific enough to support policy or marketing decisions. Your supervisor already had a good idea of the direction of the demand changes. What she really wanted was a better idea about the magnitude of these changes. This is where elasticities can be useful. The aim of this chapter is to help you understand how to compute and use demand and supply elasticities. You will use elasticities to address some basic decision problems in the problem sets of this chapter but will put this knowledge to work in earnest in the next chapter.
The learning objectives for this chapter are as follows:
- Interpret elasticity numbers and compute elasticities using both the point and arc formulas.
- Use demand elasticities to identify normal necessities, normal luxuries, inferior goods, substitutes, and complements in consumption.
- Describe factors that impact the magnitude of own-price demand elasticities.
- Show how the revenue implications of a price change depend on the own-price elasticity of demand.
- Use supply elasticities to identify competing products and joint products in production.
