Question

In a study conducted on aggregate farm products, it was estimated that the elasticity coefficient lay between \(.20\) and .25. Theses figures suggest that the prices of agricultural products would have to fall by 40 to 50 percent in order for consumer increase their purchase by a mere 10 percent which in turn indicates that consumer apparently put a low value on additional agricultural output as compared with alternative goods. Why is this so?

Short answer

The elasticity coefficient range of 0.20 to 0.25 for aggregate farm products indicates inelastic demand, meaning a change in price would have a relatively small effect on quantity demanded. Prices would need to fall dramatically (40 to 50 percent) to increase consumer purchases by 10 percent. This observation suggests that consumers place low value on additional agricultural output compared to other goods. This could stem from agricultural products being basic necessities consumers have already satisfied, their preference for alternative goods that provide more utility or status, the substitutive effect of switching consumption to relatively pricier goods viewed as higher value when farm product prices drop, or an income effect where price decreases increase consumers' purchasing power, allowing for increased purchases of preferred alternative goods.

Step-by-step solution

Understand Price Elasticity of Demand

Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good or service to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. In this case, the PED for agricultural products is estimated to be between 0.20 and 0.25.

Analyze the given Elasticity Coefficient Range

For agricultural products, the PED range of 0.20 to 0.25 indicates that the demand for these products is inelastic. Inelastic demand means that a change in the price of the good or service will have a relatively small effect on the quantity demanded. This is because the percentage change in quantity demanded is less than the percentage change in price.

Calculate the Change in Price Needed for a 10% Increase in Quantity Demanded

We are given that consumers would need to increase their purchases by 10%. To determine the required price change, we can use the formula for PED: \[PED = \frac{\% \, Change \, in \, Quantity \, Demanded}{\% \, Change \, in \, Price}\] We can rewrite this as: \[\% \, Change \, in \, Price = \frac{\% \, Change \, in \, Quantity \, Demanded}{PED}\] Using the given PED range (0.20 to 0.25) and the desired 10% increase in quantity demanded, we can plug in the values to find the required price change: \[\% \, Change \, in \, Price = \frac{10\%}{0.20\, to\, 0.25} = 40\%\, to\, 50\%\]

Discuss the Low Value of Additional Agricultural Output

This result tells us that prices of agricultural products would have to fall by 40% to 50% for consumers to increase their purchases by only 10%. This situation suggests that consumers put a low value on additional agricultural output compared to alternative goods. There can be several reasons for this, including: 1. The nature of the goods: Agricultural goods are often basic necessities, and consumers may already have met their essential needs, reducing the desire for additional consumption. 2. Preference for alternative goods: Consumers may prefer other goods or services that provide greater utility, status, or enjoyment. 3. Substitution effect: As prices for agricultural products decrease, consumers might tend to shift consumption to other, relatively more expensive goods or services that they perceive as having higher value. 4. Income effect: Consumers' real incomes (purchasing power) might increase with the decrease in agricultural product prices, which allows them to purchase more of the alternative goods and services they prefer.

Key concepts

Inelastic Demand

When demand for a product is described as inelastic, it means that changes in its price will have only a small effect on the quantity demanded. For farmers and agricultural products, this can be especially important. The price elasticity of demand (PED) for agricultural products was found to range between 0.20 and 0.25. This means that these products have inelastic demand.

In inelastic demand, a significant price drop does not lead to a proportionate increase in the quantity demanded. For example, even if prices for farm goods were to fall by a substantial margin, consumers would not significantly increase their consumption. This is because the goods are often basic necessities and consumers already meet their requirements at existing consumption levels.

• **Basic Necessities**: Since many farm products are staples, there's a limit to how much more one can consume. • **Existing Needs**: Consumers' current consumption likely already satisfies their essential requirements.

Aggregate Farm Products

Aggregate farm products refer to the total output of farm-produced goods. This includes a wide range of items such as grains, vegetables, fruits, and livestock products. The elasticity of these aggregate products is crucial in understanding market dynamics.

Farm products typically have inelastic demand because they are essential for survival, forming a stable part of most diets. Most people consume a similar amount regardless of price changes, as changes in consumption of basic foodstuffs have limits. - **Staple Goods**: These products form the basis of a standard diet. - **Limited Consumption Variation**: There is a low potential for increased consumption, explaining the small demand elasticity.
The overall demand for these products doesn't fluctuate much even when prices vary. This is different from luxury goods, which can see considerable shifts based on price changes.

Consumer Preferences

Consumer preferences refer to the desires and priorities that influence individual choices and purchasing habits. With agricultural products, consumer preferences play a vital role in demand elasticity. Although farm products are essential, consumer preferences for alternative, higher utility goods can affect demand, even when prices drop.

Several preferences influence how consumers might respond to changes in agricultural product prices:

• **Satisfaction**: Basic food products largely provide essential utility rather than surplus satisfaction.
• **Utility Comparison**: Consumers often prioritize goods that provide more enjoyment or status.
• **Diverse Preferences**: People may allocate financial resources to non-essential or luxury goods which could offer a higher perceived value or entertainment.

These factors suggest that lowering prices on essential goods does not necessarily drive significant additional consumption, as preferences often lie with other types of goods.

Elasticity Coefficient

The elasticity coefficient is a numerical measure that indicates how responsive the quantity demanded of a product is to changes in price. For agricultural products, this coefficient lies between 0.20 and 0.25, signifying inelastic demand.

Understanding this coefficient helps in predicting consumer behavior in response to price changes. If the elasticity coefficient is less than 1, as it is here, demand is inelastic, meaning that the percentage change in quantity demanded is less than the percentage change in price.

• **Small Response to Price Changes**: Consumers don't react strongly to price changes in essentials. • **Market Planning**: Knowing the coefficient aids in forecasting how changes in price might affect total revenue.
The elasticity coefficient provides insights into how pricing strategies might affect sales volumes and revenues, particularly crucial for industries dealing with essential goods like food.