Chapter 8 – Purchasing Power: Income and the Price of Food

I. Purchasing powerA. Takes the price of products into

account as well as a person’s income

B. Income / price1. $100 / $2.50 = 40 Big Macs / week

C. Increase in purchasing power can come from:

1. Increase in income

a. $200 / $2.50 = 80 Big Macs

2. Decrease in price

a. $100 / $1.25 = 80 Big Macs

II. Elasticities

A. Quantify changes

1. Tell how much, and in what direction, consumption changes in response to changes in price and/or income

B. Can use income elasticities to examine how changes in income affect diet and nutrition

1. If income goes up (down), how much more (less) of a

particular food will a family purchase

C. Can use elasticity of demand to find out how much an

increase in supply will lower the price of a product1. Helps government decide

which commodities to direct research money to

III. Price elasticity of demandA. Percentage change in quantity demanded given a 1% change in the product’s own price

B. Inelastic demand (necessities)1. OPED < 1

2. OPED = -0.26 (corn & cassava)

- Price increases by 1% consumption decreases by 0.26%

C. Elastic demand (luxuries)1. OPED > 1

2. OPED = -1.73 (livestock products)

- Price falls by 1% consumption increases by 1.73%

D. Price elasticities get smaller as income increases (Table 8.5)1. Beans OPED

low income (I) = -0.82low income (II) = -0.78middle income (III) = -0.64high income (IV) = -0.45high income (V) = -0.25

IV. Income and demand for foodA. Income substantially

influences the demand for food by low- income consumers

1. Poor people spend a high proportion of their income on food

country per capita disposableincome

share spentfor food

U.S. $9,935 14%Japan $6,915 20%South Africa $1,399 33%Thailand $571 43%Philippines $554 52%Honduras $475 46%Bangladesh $240 60%

B. Bennett’s law: As income goes up less is spent on starchy foods and more is spent on higher quality proteins (animal products) p.126

V. Income elasticity of demand (IED)A. The percentage change in

quantity demanded that results from a 1% change in income

1. IED = 0.58 means an increase in per capita income of 1% results in an

increase in demand for food of 0.58%

B. Income elasticities of demand for food decline as income increases (Table 8.2-p.128)

1. Eggs IEDLowest income group = 1.93Middle income group = 0.63Highest income group = 0.11

C. Income elasticities vary by commodity (Table 8.3-p.129)

1. Cassava = –3.5

2. Rice = 1.99

3. Milk = 2.27

D. Types of Goods

1. Normal Gooda. Income elasticity between 0 and 1.

b. Income goes up by 1%, demand for the good goes up, but by less than 1%.

2. Luxury good

a. Income elasticity greater than 1 (elastic)

b. Income goes up 1% demand for the good goes up by more

than 1% (IED for poultry in Indonesia = 1.5)

3. Inferior good

a. Income elasticity < 0 (negative)

b. Income goes up 1% demand for the good goes down(IED for roots and tubers in central

Africa = -0.21)

VI. Elasticities & policy

A. If know elasticity, can calculate how much price will fall with increase in supply

1. OPED = % Q / % P

2. -0.19 = 1 / % P

3. % P = -5.26

4. For 1% increase in production, price will fall by 5%

B. Policymakers can use these calculations to determine the nutritional effects of increasing production of certain foods

1. Want to improve nutrition of poorest groups

a. Try to increase supply of those commodities that have inelastic demand (necessities) for low-

income groups (Table 8.5-p.132 & 8.6-p.134)

C. Policy implications

1. Increase the incomes of the poor

a. Greater IED for food increase in their incomes will result in greater nutritional gains

2. Promote increases in production of foods with inelastic OPED

a. These are the necessities that the poor spend most of their food budget on

b. Price will fall more with increase of supply of these foods

Q of oranges

Price

Demand

Supply1

Supply2

Q of rice

Price

Demand

Supply1

Supply2

D. A policy dilemma1. Increase in supply of food with inelastic OPED results in decrease in total revenue received by farmers

(TR = P * Q)

a. Price falls by 1% - quantity sold goes up by < 1% decrease

in total revenue

b. Increase in Q does not make up for drop in P

2. Increase in supply of food with elastic OPED results in increase in total revenue received by farmers

a. Price falls by 1% - quantity sold goes up by > 1% increase

in total revenueb. Drop in P is more than offset

by increase in Q

3. Policy that helps low-income consumers hurts the income of farmers

E. Policy dilemma #21. Increase in income increases demand for food2. Increase in demand causes food prices to rise decreasing purchasing power3. Demand increases must be met by supply increases