More sunlight and increasing temperatures indicate that we are heading into the growing season for most crops grown in Idaho. Leading up to this, I expect that many farms and other agricultural businesses conducted financial analyses, such as developing cash flow budgets, to help predict and plan for sales and expenses over the course of 2023. This article examines one type of economic information that can be especially relevant for making estimates of the cash receipts (inflows) portion of a cash flow budget for a crop enterprise: the price elasticity of demand.
What are they?
The price elasticity of demand is a measure of the responsiveness of consumers or buyers of a good to a change in the price of that good. A common representation is for a given percentage change in a good’s price, the quantity demanded adjusts by a corresponding percentage.
Examining the extremes can help us understand how this works. Figure 1 includes graphs of the ends of the spectrum (a and b) and intermediate cases (c and d) of the price elasticity of demand. Each graph has price (P) on the y-axis and quantity demanded (Qd) on the x-axis.
The first extreme example is perfectly elastic demand (a). In this case, the Qd changes fully from any positive amount to zero with any change in P. On the other end of the spectrum is perfectly inelastic demand (b). Under this scenario, Qd does not change at all for any change in P. Both perfectly elastic demand and perfectly inelastic demand are mostly hypothetical but can be useful for grasping the concept.
In the real world, the demand for most goods is somewhere between the extremes (represented in c and d). Under fairly elastic demand (c), for any percentage change (represented by) in P, Qd changes by a percentage amount greater than P did. For fairly inelastic demand (d), for any percentage change in P, Qd changes by a percentage amount less than P did.
Table 1 includes several factors that influence the price elasticity of demand. One key factor that is especially relevant for agriculture is the good’s necessity or luxury status. Since food is necessary for maintaining nutritional health, the price elasticity of demand for many crop-based foods is more inelastic. However, substitutability or tradability is also important in agriculture. If there are many substitutes for the product, then the price elasticity of demand is more elastic.
Lastly, the length of time that a good is on the market matters for all goods. With a longer period on the market, the price elasticity of demand becomes more elastic. The main reason why relates to the substitutability or tradability factor, such as the emergence of more substitute or competitive products as more entrepreneurs enter a market.
With that background, it is time to examine the price elasticity of demand for Idaho crops. I obtained estimates for the top three crops in Idaho in cash receipts terms based on USDA Economic Research Service (ERS) data – alfalfa hay, potatoes and wheat. These estimates are in Table 2 and are broken out by class of wheat. One important note is that these are national estimates for potatoes and wheat, and the estimate for alfalfa hay is from California.
The estimated elasticities of demand are all negative, which reflects the inverse relationship between price and quantity demanded. That is, as prices increase (decrease), quantity demanded decreases (increases). All the estimates are also below an absolute magnitude of 1, which implies that the price elasticity of demand for all the crops is inelastic. A value of zero implies perfectly inelastic demand. The closer to -1 the value is, the more price elastic the demand is.
Regarding differences in the estimates across the crops, the price elasticity of demand for potatoes is a bit higher than for wheat and quite a bit higher than alfalfa hay. The relatively higher price elasticity of demand for potatoes may relate to the availability of substitute vegetables in Americans’ diets. However, it is still inelastic, which implies that even when prices rise, many Americans still need their fries!
Alfalfa hay’s very inelastic demand may be explained by dairy cow (and other livestock) rations being adjusted somewhat infrequently. The differences in the price elasticity of demand across classes of wheat are associated with the ability to substitute classes of wheat in producing wheat-based products. The relatively more price elastic demand for hard red winter (HRW) wheat reflects that it is more substitutable with other classes of wheat (e.g., durum) than hard red spring (HRS) wheat and soft winter white (SWW) wheat.
Why do they matter?
The estimates for price elasticity of demand are important because they allow farmers and other agricultural market participants to form expectations regarding key indicators, such as revenues, as price information as a given crop season emerges. For example, a farmer could combine price information, such as futures prices, with a price elasticity of demand to estimate the likely change in quantity sold in the new price environment. Such estimation can be helpful for the development of financial analysis tools, such as cash flow budgets, before a crop year begins.
Additionally, the elasticity of demand is also an indicator of price volatility. The more inelastic the demand is, the greater volatility one can expect. If the price elasticity of demand is very inelastic, as it is with alfalfa hay and SWW, then price volatility in response to adjustments related to expected supply will be relatively high. Knowing this can allow market participants to form marketing strategies, especially regarding the usage of tools such as marketing contracts, which provide more certainty on the sales price and quantities. Such estimation, analysis, and usage of marketing tools can be important for planning for the future and implementing everyday farm business activities with greater peace of mind.
.jpg?height=auto&t=1723756374&width=285 "60201-oconnell-image011(1).jpg")
