Elasticity & Total Revenue

I recently read an article from the Toronto Star, "Are milk prices too high?" written by Kenyon Wallace. I chose this article for two reasons: One, because I love cows (yes, it's an odd animal to love, I know) and two, because I found it quite fascinating to look at the differences of the farming industry between Canada and the USA. I have a very fond appreciation for farmers, especially dairy farmers: There is no way you'd find me up at 4am every morning milking cows! The farming industry as a whole seems to be a dying one which is why the government needed to step in. Fresh fruits, grains and milk products are a necessity of life and being able to get these goods from our own backyard is extremely important; we can then keep prices affordable, Canadians employed and ensure a higher quality product.

In Canada, we have something called a "supply management system" in which the government sets a quota for each farmer. This reduces over-production and helps farmers focus on providing a better quality product rather than wasting their time searching for buyers. The price of milk is also set by committee's which take into consideration all the factors of production cost's etc. When this article was written in November 2011, Canadians were paying about 59 cents more per litre than in the USA. Prices in the US are determined by free-market wholesale of cheese, butter etc. However, according to Wallace, American farmers are also guaranteed a "safety net" from a tax payer funded corporation, so essentially both Canadians and Americans probably end up paying around the same price for a litre of milk, Canadians just pay up front rather than in the form of taxes. Not such a "free-market" after all.

Price ($ per Litre)	Quantity (Litres)	Total Revenue	Elasticity	Type
10	0	0	19	Elastic
9	1000	9000
8	2000	16000	3
7	3000	21000
6	4000	24000	1	Unitary
5	5000	25000
4	6000	24000
3	7000	21000	.33	Inelastic
2	8000	16000
1	9000	9000	.05
0	10000	0

The elasticity co-efficient is a number that economists use to judge whether or not the demand will be responsive to a change in price and just how responsive it is. With this number we can easily identify which price change consumers will most respond to. Higher elasticity numbers mean higher responsiveness and vice-versa.

As you can see from the chart above, the price at which milk would generate the most revenue is $5. Prices of both $4 and $6 generate the same total revenue, which give this an elasticity of 1 or unitary elasticity. All prices above $6 would be considered an elastic demand because their co-efficients are greater than 1 and the demand at a higher price would be greatly affected. All prices below $4 would be considered inelastic because their co-efficients are lower than 1 and the quantity demanded here would not be very responsive to a change in price.

Below are the results in the form of a graph. This graph shows a downward sloping demand curve. Economists use graphs because they can quickly and clearly see which price will generate the most revenue, and how responsive consumers will be to a change in price.

The graph below clearly shows at which point maximum total revenue (TR) will be generated and also the rise and fall of TR.

According to Statistics Canada, the demand for milk has dropped by 18% over the last 20 years in large part due to the price. However, we need to get the facts before making such decisions; the price of milk in the USA may be lower at first look, but consumers end up paying more in the end. This system would create a larger demand  in comparison to Canada; perhaps Canadians should look at doing something similar to help consumers make healthier choices when it comes to their beverages, keep Canadian farmers farming, keep the quality of our perishable goods high and keep them local!


Kenyon Wallace, Toronto Star, Is the price of milk too high?http://www.thestar.com/news/insight/article/1089581--is-the-price-of-milk-too-high
Site accessed on November 1, 2012