Lecture Notes Review: Elasticity and Market Surplus
Environment, Food Waste, and Local Food Choices
Global concern: about hunger, environment, and food waste. One third of all food produced worldwide is wasted. We also pollute by shipping perishables globally.
Personal stance: support for buying seasonal local whole foods. Preference for local farmer's markets unless it is inconvenient (e.g., rain, extreme heat, waking up late, or other plans).
Practical caveats at the market: sometimes avoid onions there due to price ($5 for one onion vs a bag at grocery store); also avoid meat and dairy due to price or taste concerns.
Willingness to buy other items: margarita mix, artisanal soap, tacos from a nearby taco truck. These still count as market purchases and connect to food and local economy.
Market impact: buying locally supports the environment and the community when possible. Recognizes that a single choice can matter for the environment and local producers.
Observations on consumption and constraints: even with good intentions, consumption decisions are influenced by price and convenience.
Widespread waste statistics: about $1{,}000{,}000{,}000{,}000 of food is wasted annually; 25% of all calories produced are never consumed. These numbers motivate examination of consumer choices and pricing signals.
Behavioral nuance: in moments of strong hunger or fatigue, people may switch to less sustainable options (e.g., McDonald’s) despite environmental concerns.
Frequency of local market purchases: at least one potato or similar item from the farmers market once a month, or at least every two months. Driving to the farmers market is common, which may dampen sustainability benefits.
Takeaway: consumer decisions reveal a balance between environmental concerns and price/hunger/inconvenience. Elasticity and demand analysis can help explain actual purchasing behavior beyond stated attitudes.
Demand, Elasticity, and Price Sensitivity
Core idea: asking consumers how much they care about price is less reliable than observing changes in consumption as price changes. Demand curves reveal how consumption responds to price changes (elasticity).
Implication: people may say they care about environmental attributes, but price often drives actual purchases; elasticity is a more reliable measure of behavior than stated preferences.
Clip example (dogs and price): extreme case of price insensitivity. People generally would not accept selling their dog for any price—illustrates a perfectly inelastic demand scenario where quantity demanded remains fixed regardless of price.
Key elasticity categories (demand side):
Perfectly inelastic demand: vertical demand curve; quantity demanded does not respond to price changes.
Relatively inelastic demand: small quantity changes with large price changes. Electricity in many contexts is a good example, especially in hot climates (e.g., Texas). If price doubles, most households still use air conditioning; some adjustments occur (e.g., running washing machine less), but major drivers (HVAC) limit response.
Relatively elastic demand: small price changes lead to large changes in quantity demanded.
Perfectly elastic demand: horizontal demand curve; consumers buy nothing if price deviates even slightly from a single price point.
Visual memory aid: elasticity tends to decrease (become more inelastic) as you move down and to the right along a downward-sloping linear demand curve.
Slopes vs elasticity: slope of a linear demand curve is constant, but elasticity varies along the curve. So, even within a relatively inelastic region, parts of the curve can be more elastic than others.
The Midpoint Method and Numerical Examples
Midpoint elasticity formula (D: price elasticity of demand):
Ed = rac{ rac{Q2 - Q1}{ rac{Q1 + Q2}{2}}}{ rac{P2 - P1}{ rac{P1 + P_2}{2}}}Numerical illustration on a linear demand curve (hypothetical values):
Between $5 and $4: elasticity = 9.1.
Between $4 and $3: elasticity = -2.3.
Between $3 and $2: elasticity = 1. (unit elastic)
Between $2 and $1: elasticity described as relatively inelastic (no specific number provided in transcript).
Between $1 and $0: elasticity = -0.1.
Interpretation: along the same linear demand line, elasticity changes from highly elastic to highly inelastic as price falls.
Practical note: slope is constant on a linear demand curve; elasticity is not. Elasticity is a ratio that changes with the scale of price and quantity.
Additional resource hint: midpoint method tools can visualize how elasticity changes as you adjust price and quantity.
Price Elasticity of Supply
Sign and intuition: elasticity of supply is always positive because the supply curve is upward sloping (prices and quantity supplied move in the same direction).
Relative notions: higher positive values indicate more elastic supply; values between 0 and 1 indicate relatively inelastic supply, values above 1 indicate relatively elastic supply.
Hunger to respond to price changes: suppliers would like to produce more when prices rise and less when prices fall, but this depends on how easily production can be adjusted.
Bakery example (determinants of supply elasticity):
Suppose price for bread doubles. A bakery would ideally want to increase supply, but constraints matter.
Hard-to-find inputs (e.g., specialty flour from a small producer) can limit how quickly they can increase production, reducing elasticity.
Conversely, easily scalable inputs (e.g., all-purpose flour from common suppliers) allow faster production adjustments, increasing elasticity.
Practical implication: the ease of shifting inputs and the rigidity of production processes determine supply elasticity.
Income Elasticity of Demand
Definition: income elasticity measures the response of quantity demanded to changes in consumer income.
Inferior goods: income elasticity < 0. consumption moves in the opposite direction as income rises.
Example: certain goods might be considered inferior as income increases (consumption declines).
Normal goods: divided into two subcategories:
Necessities: income elasticity between 0 and 1. Demand grows slowly with income.
Example: toothpaste. Even if income doubles, toothpaste usage tends to stay near a routine level.
Luxuries: income elasticity > 1. Demand grows more than proportionally with income.
Example: plane tickets; as income rises, people take more vacations and travel more.
Interior vs luxury nuance examples:
Fast food is typically considered an interior (normal, but not a luxury) good, though at very low incomes it could function more like a luxury until a threshold; upon higher incomes the behavior may change.
Lottery tickets can be considered inferior at higher incomes (less lottery spending as income rises) due to the lower relative benefit of large uncertain gains.
Lawn care services are a luxury; consumption rises with income.
Cross-Price Elasticity of Demand
Definition: cross price elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good.
Substitutes: cross-price elasticity > 0. A price rise in good B leads to higher demand for good A.
Complements: cross-price elasticity < 0. A price rise in good B reduces demand for good A.
Unrelated goods: cross-price elasticity ≈ 0.
Practical framing: zero cross-price elasticity indicates unrelated goods; positive indicates substitutes; negative indicates complements.
Real-world example framing: when the price of one good changes, how does demand for a related good respond? This is central for pricing strategy and market competition analysis.
Ford F-150 Case Study: Cross-Price and Income Elasticities in Practice
Scenario: estimate how Ford F-150 sales respond to changes in a competitor's price, fuel prices, and consumer income.
Substitution with Chevy Silverado: cross-price elasticity with Silverado is 1.5.
Silverado price falls by 10%: F-150 sales fall by 1.5 imes (-10\%) = -15\%.
Interpretation: consumers view Silverado and F-150 as substitutes; lower Silverado price reduces F-150 demand.
Gas price effect: cross-price elasticity with gas is -0.8.
Gas price increases by 20%: F-150 sales fall by (-0.8) imes 20\% = -16\%.
Interpretation: gas price increase reduces demand for gas- and fuel-dependent vehicles like the F-150 (complements in usage).
Income effect: income elasticity for Ford F-150s is 3 (luxury good).
A 5% increase in income yields a sales rise of 3 imes 5\% = 15\%.
Takeaway: cross-price and income elasticities provide a quick toolkit to forecast demand responses to competitor pricing, macro conditions, and income shifts.
Consumer and Producer Surplus; Market Efficiency
Conceptual setup: a market contains a range of consumers each with a willingness to pay; there is a single market price. A consumer at a given point on the demand curve may be willing to pay more than the price, creating consumer surplus.
Consumer surplus (CS): the area between the demand curve and the price line up to the quantity traded. In a simple diagram, CS is the area of the triangle formed by the price and the highest willingness-to-pay along the market.
Example explanation from clip: Consumer A willing to pay $7 but pays $4; Consumer B willing to pay $5 but pays $4; these consumers gain surplus because they pay less than their willingness-to-pay. The aggregate consumer surplus is the area of the triangle
Triangle area formula: CS = frac{1}{2} imes ext{base} imes ext{height} where base is the quantity traded and height is the difference between willingness-to-pay and price at the relevant segment.
Producer surplus (PS): the area between the price line and the supply curve, up to the quantity traded. Each point on the supply curve represents a marginal producer willing to supply at a given price; producers gain when the market price exceeds their minimum acceptable price.
Example explanation from clip: Producer C willing to sell at $2.50 and receives $4; producer surplus is the area between the price and their cost.
Equilibrium and efficiency: at market equilibrium, total surplus (CS + PS) is maximized; no mutually beneficial trades are left unrealized, so the equilibrium is efficient.
Visual takeaway: CS and PS together can be represented as two triangles under the price line and above/below the respective curves, with total surplus being the area between the demand and supply curves up to the equilibrium quantity.
Practice and Application
Quick exercise prompt from class: determine the optimal production level; this is a CPS (Chapter Problem Set) exercise to be tackled in the next session.
Broader importance: elasticity concepts—demand, supply, income, cross-price—are used by firms to model consumer and producer behavior, assess pricing strategies, and forecast market reactions to policy interventions like taxes or subsidies.
Key Takeaways for Exam Preparation
Slope vs elasticity: slope is constant on a linear demand curve, but elasticity varies along the curve; elasticity tends to decrease as we move down and to the right on a downward-sloping curve.
Elasticity types and meanings:
Perfectly inelastic: quantity does not respond to price; vertical demand curve.
Relatively inelastic: small quantity change with large price change.
Unit elastic: elasticity equals 1; proportional changes in price and quantity.
Relatively elastic: large quantity changes with small price changes.
Perfectly elastic: price sensitivity is extreme; even small price changes produce zero quantity demanded.
Elasticities and their signs:
Price elasticity of demand is typically negative (quantity demanded falls as price rises) but discussed in terms of magnitude for clarity.
Elasticity of supply is always positive.
Income elasticity: negative for inferior goods; between 0 and 1 for necessities; greater than 1 for luxuries.
Cross-price elasticity: positive for substitutes; negative for complements; zero for unrelated goods.
How to use elasticities:
Midpoint method for computing elasticity between two points on a curve.
Use cross-price and income elasticities to forecast how demand for a good responds to changes in competitor prices, income, or the price of related goods.
Market efficiency lens:
Consumer surplus and producer surplus capture the welfare benefits to buyers and sellers; market equilibrium maximizes total surplus, indicating efficiency.
Real-world relevance:
Firms use elasticity concepts to price products, forecast sales, and plan responses to policy changes (e.g., taxes) or external shocks (gas prices, competitor pricing).
ext{Notes: Essential formulas mentioned}
Demand elasticity (midpoint):
Ed= rac{ rac{Q2-Q1}{ rac{Q1+Q2}{2}}}{ rac{P2-P1}{ rac{P1+P_2}{2}}}Cross-price elasticity:
E{xy}= rac{ rac{ riangle Qx}{Qx}}{ rac{ riangle Py}{P_y}}Income elasticity:
E_Y= rac{ rac{ riangle Q}{Q}}{ rac{ riangle Y}{Y}}Producer/consumer surplus (triangle area):
CS= frac{1}{2} imes ext{base} imes ext{height},PS= frac{1}{2} imes ext{base} imes ext{height}