Archive for the '1.2 Elasticity' Category

Sep 28 2012

Bad crop equals higher incomes for farmers – what’s up with that?

Despite Record Drought, Farmers Expect Banner Year

Listen to the story above. According to the report, farmers in the American Midwest have seen their incomes reach new highs this year, despite the terrible harvest resulting from a nationwide drought.

This is curious. The drought starved crops of water, forcing farmers to harvest in the middle of the growing season, essentially destroying much of their harvest for the year. So the question is, how does a BAD harvest result in GOOD incomes for farmers?

Believe it or not, the answer to this riddle requires an understanding of elasticity; specifically, price elasticity of demand (PED). PED measures the responsiveness of consumers to a change in the price of a good. The PED for a good can be measured between two prices by using a simple formula:

  • PED = the percentage change in the quantity of a good demanded divided by the percentage change in the good’s price.

The result of this calculation, which is known as the PED coefficient, will always be a negative number. Why will the PED coefficient be negative? Think back to the law of demand, which states that there is always an INVERSE relationship between price and quantity demanded of a good. Since PED measures how much the quantity demanded changes in response to a particular change in price, the coefficient of PED must be negative, since price and quantity always change in the opposite direction.

So back to our farmers who are enjoying high incomes despite the terrible harvest. What does this have to do with PED? Well, that’s what I want you to figure out. In the comments below, explain how an understanding of price elasticity of demand can help us understand why farmers whose crops were largely destroyed by drought ended up earning higher incomes than they expected.

 

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