Market Effect Suppose a freeze in florida wipes out 20% of the orange crop. How

Question

Market Effect
Suppose a freeze in florida wipes out 20% of the orange crop. How will this affect
the equilibrium price and quantity of banana? Assume that the orange and banana are substitute to each other.

Price Elasticity of Demand
If the price of a milk increases from $1.00 to $1.25, and demand decreases from 100 to 90 (per day), what is the price elasticity of demand? Is it elastic or inelastic? Should the owner of the store increase the price to $1.25 to increase the total revenue? Why or why not?

Explanation / Answer

Market Effect If a freeze wipes out 20% of the orange crop, this means that the supply of oranges has decreased. This will increase the price of oranges. Since oranges are a substitute good to bananas, an increase in the price of oranges will increase the demand for bananas. This increases the price of bananas and the quantity of bananas demanded. Price Elasticity of Demand The price elasticity of demand is E = dQ/dP * P/Q, where d means "change in" and prices and quantities are measured at the midpoints. E = (100-90)/(1.25-1) * (1.125/95) = 0.47 Since this is less than 1, the demand is price inelastic. We maximize total revenue by setting price elasticity equal to 1. Right now, it is below 1. So, we can increase revenue by increasing the price, which decrease quantity and push price elasticity of demand toward 1.

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