I am interested in the problems of rural areas, where shortages of health care a

Question

I am interested in the problems of rural areas, where shortages of health care are one of the challenges that they face. Sustaining income in the agricultural sector is another challenge, because every income increase to farmers represents an increase in the cost of food to everyone else. The US government would like to keep food prices low for low-income urban families without hurting the income of farmers, which usually means that some tax + subsidy scheme must be put in place by which the gap between what the food buyer pays and the what the farmer receives is paid for by taxpayers. Although this assignment is about food prices, the same problem exists with subsidized health care such as Medicaid and CHIP. The gap between what the qualifying patient pays and the health care industry receives is paid for by taxpayers.

The assignment is intended to help you understand the impact of elasticity on such subsidies, where both food products and health care tend to be highly inelastic.

Let us say that the U.S. Department of Agriculture wants to encourage Americans to eat more fruits and vegetables and will use subsidies to farmers to lower the price of healthy foods for consumers. (In other words, the government will pay part of the price of the food.)

The effectiveness of subsidies depends on the price elasticity of demand for the produce, and we know that food products in general have inelastic demand ranging from 0.27 to 0.81 according to most research [1, 2, 3]. If demand is perfectly inelastic, then there is no point in subsidizing the market because quantity demanded will not change when price changes. However, if demand is somewhat elastic, then the subsidies might be effective.

The following table shows price elasticity of demand for several produce items.

Apples                        price elasticity = | -0.61 | = 0.61

Strawberries             price elasticity = | -1.34 | = 1.34

Lettuce                        price elasticity = | -0.75| = 0.75

Tomatoes                   price elasticity = | -2.31 | = 2.31

Note: the elasticities inside the absolute value bars are shown as negative to indicate that they are demand elasticities. Their absolute value is shown to the right of the second equals sign to indicate that it is a positive number. This allows us to focus on the most important property of an elasticity, which is whether its absolute value is greater or less than 1.

Question 1: Elastic and Inelastic Demand

Which product above has the most price-elastic demand and would therefore show the greatest increase in quantity demanded if the price were lowered?

Question 2: Elastic and Inelastic Demand

For which product(s) is demand inelastic? List all of them.

Question 3: Calculating elasticity (do not refer to the list above to answer this question)

Corn is presently $4.00 per bushel. If we reduce the price by 2.5%, to $3.90 per bushel, we observe that the quantity demanded increases by 1.5%. What is the price elasticity of demand for corn? (Convert the percentages to decimals before computing to avoid confusion interpreting the answer, and express the answer as an absolute value, that is, as a positive number.)

Question 1: Which product above has the most price-elastic demand?

Question 2: For which product(s) is demand inelastic? List all of them.

Question 3: What is the price-elasticity of demand for corn?

Explanation / Answer

(Question 1)

Tomato is the good with most price elastic demand, since the absolute value of its elasticity is maximum (= 2.31).

(Question 2)

Apples and Lettuce are demand inelastic, since absolute value of elasticity is less than 1 for both the goods.

(Question 3)

Price elasticity of demand = % Change in quantity demanded / % Change in price

= 1.5% / (-2.5%)

= -0.60

Absolute value of elasticity = 0.60

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