Question

U.S. winter wheat production increased dramatically in 1999 after a bumper harvest. The supply curve shifted rightward; as a result, the price decreased and the quantity demanded increased (a movement along the demand curve). The accompanying table describes what happened to prices and the quantity demanded of wheat.

	1998	1999
quantity demanded (bushels)	1.74 billion	1.9 billion
average price (per bushel)	$3.70	$2.72

a) Using the midpoint method, calculate the price elasticity of demand for winter wheat.

b) What is the total revenue for U.S. wheat farmers in 1998 and 1999?

c) Did the bumper harvest increase or decrease the total revenue of American wheat farmer? How could you have predicted this from your answer to part a?

d) Calculate the price effect and the sales effect of the price change.

Answer 1

a)

According to the mid-point formula, the price elasticity of demand for a product is given by:

Ed = (Q2 – Q1) / [(Q2 + Q1)/2] / (P2 – P1) / [(P2 + P1)/2]

Here, Q1 = 1.74 B, Q2 = 1.9 B. P1 = 3.70 and P2 = 2.72

We find that ed = -0.29

Q1	Q2	P1	P2	Q2-Q1	(Q2+Q1)/2	%Q	P2-P1	(P1+P2)/2	%P	Ed
1.74	1.90	3.70	2.72	0.16	1.82	8.79	-0.98	3.21	-30.53	-0.29

Demand is inelastic because |Ed| < 1.

Total revenue = price x quantity in 1998 = 1.74 B * 3.70 = 6.438 B

Total revenue = price x quantity in 1999 = 1.9 B * 2.72 = 5.168 B

Revenue has fallen when price is reduced because demand is inelastic.