4.Elasticity approach
薄利多銷?



Total expenditure (Total sales)
=P×Q
Total Cost
= direct cost + indirect cost
Profit = Total sales - Total Cost
 薄利 implies lowering price
 多銷 means more sales
NCCU 2006
Elas 2
嚴刑重罰 Or 寓禁於徵 ?

What do you think?

Could reducing the supply of illegal drugs
cause an increase in drug-related
burglaries?
NCCU 2006
Elas 3
The Effect of Extra Custom
Patrols on the Market for Illicit Drugs
Total Expenditure = P x Q
S
$250
= $50 x 50
S’
$320
= $80 x 40
S’
P($/ounce)
80
S
50
D
40
50
Q(1,000s of ounces/day)
NCCU 2006
Elas 4
Using Price Elasticity of Demand:
The War on Drugs


Every year U.S. Government spends about
$20 billion on efforts to restrict the supply of
drugs
Figure (a)


Figure (b)


Market for heroin without government intervention
Result of government efforts to restrict supply
(current policy)
Figure (c)

Results of an effective policy of reducing demand
NCCU 2006
Elas 5
3 conditions in the War on Drugs
(a)
(b)
Price
per
Unit
S1
Price
per
Unit
P2
(c)
S2
B
A
P1
P3
Quantity
C
D1
D1
Q1
S1
A
A
P1
P1
S1
Price
per
Unit
Q2 Q1
Quantity
NCCU 2006
D1
D2
Q3
Q1
Quantity
Elas 6
Price Elasticity of Demand

Elasticity

A measure of the extent to which quantity
demanded and quantity supplied respond
to variations in price, income, and other
factors.
中文定義:
對價格之敏感度
NCCU 2006
Elas 7
Price Elasticity of Demand

Defined

Generally
A
measure of the responsiveness of the
quantity demanded of a good to a change in
the price of that good

Formally
 The
percentage change in the quantity
demanded that results from a 1 percent change
in its price
NCCU 2006
Elas 8
Price Elasticity of Demand

Measuring Price Elasticity of Demand
Percentage Change in Quantity Demanded
Percentage Change in Price
NCCU 2006
Elas 9
Price Elasticity of Demand

Assume

The price of pork falls by 2% and the
quantity demanded increases by 6%
 Then
the price elasticity of demand for pork is
6
 3
2
NCCU 2006
Elas 10
Price Elasticity of Demand

Measuring Price Elasticity of Demand
Percentage Change in Quantity Demanded
Percentage Change in Price

Observations
 Price elasticity of demand will always be
negative (i.e., an inverse relationship
between price and quantity)
 For convenience we drop the negative sign
NCCU 2006
Elas 11
Price Elasticity of Demand

Measuring Price Elasticity of Demand
> 1: elastic
When
Percentage Change in Quantity Demanded
Percentage Change in Price
is < 1: inelastic
= 1: unit elastic
NCCU 2006
Elas 12
Elastic and Inelastic Demand
Unit elastic
Inelastic
0
Elastic
1
2
3
NCCU 2006
Price elasticity
of demand
Elas 13
Price Elasticity of Demand

What is the elasticity of demand for pizza?

Originally
 Price
= $1/slice
 Quantity demanded = 400 slices/day

New
 Price
= $0.97/slice
 Quantity demanded = 404 slices/day, then
% Change in Quantity 1
 : Inelastic
% Change in Price
3
NCCU 2006
Elas 14
Price Elasticity of Demand

What is the elasticity of season ski passes?

Originally
 Price
= $400
 Quantity demanded = 10,000 passes/year

New
 Price
= $380
 Quantity demanded = 12,000 passes/year, then
% Change in Quantity 20

: Elastic
% Change in Price
5
NCCU 2006
Elas 15
Determinants of
Price Elasticity of Demand
1.
2.
3.
Substitution Possibilities
Budget Share
Time
NCCU 2006
Elas 16
Price Elasticity (in US) Estimates
for Selected Products
Good or service
Price elasticity
Green peas
2.80
Restaurant meals
1.63
Automobiles
1.35
Electricity / gasoline?
1.20
Beer
1.19
Movies
0.87
Air travel (foreign)
0.77
Shoes
0.70
Coffee
0.25
Theater, opera
0.18
NCCU 2006
WHY?
Elas 17
Question?

Why is the price elasticity of demand
more than 14 times larger for
green peas
than for
theater and opera
performances?
NCCU 2006
Elas 18
Discussion

Economic Naturalist
Will higher taxes on cigarettes curb
teenage smoking?
 Why was the luxury tax on yachts such a
disaster?

NCCU 2006
Elas 19
A Graphical Interpretation
of Price Elasticity

For small changes in price
ΔQ Q
Price elasticity   
ΔP P
Where Q is the original quantity and P is the original
price
NCCU 2006
Elas 20
A Graphical Interpretation
of Price Elasticity

Example

Originally
 Price
(P) = $100
 Quantity (Q) = 20

New
 Price
(P) = $105
 Quantity (Q) = 15
5 20 25


 5 : Elastic
5 100 5
NCCU 2006
Elas 21
A Graphical Interpretation
of Price Elasticity of Demand
 P  1 

Pr ice elasticity at A   
 Q  slope 
A
Price
P
P
P-
P
Q
D
Q
Q+
Q
Quantity
NCCU 2006
Elas 22
Calculating Price Elasticity of Demand
20
vertical intercept
20
slope 

4
horizontal intercept
5
D
16
8 1 8 2
A  x 

3 4 12 3
Price
12
A
8
4
1
2
3
4
5
Quantity
NCCU 2006
Elas 23
Calculating Price Elasticity of Demand
20
D
Question
What is the price elasticity
of demand when P = $4?
16
Price
12
A
8
4
1
2
3
4
5
Quantity
NCCU 2006
Elas 24
Price Elasticity and the
Steepness of the Demand Curve
12
What is the price elasticity of
demand when P = $4?


 4  1  1
D1   


12
 2
 4 
 6
D1
Price
6
4
D2
4
6


 4  1 
D2   
2

6

 4 
 12 
12
Quantity
NCCU 2006
Elas 25
Price Elasticity and the
Steepness of the Demand Curve
For D2 when P = $1
12
Price
6


 1  1  1
D2   


 10  6  5
 12 
D1
4
D2
1
4
6
10
12
Quantity
NCCU 2006
Elas 26
Price Elasticity and the
Steepness of the Demand Curve
Observation
12
Price
6
If two demand curves have a
point in common, the steeper
curve must be less elastic with
respect to price at that point
D1
4
D2
1
4
6
10
12
Quantity
NCCU 2006
Elas 27
Price Elasticity Regions along
a Straight-Line Demand Curve
Observation
Price elasticity varies at
every point along a straightline demand curve
Price
a
 1
 1
 1
a/2
b/2
b
Quantity
NCCU 2006
Elas 28
Perfectly Elastic Demand Curve
Perfectly elastic
Price
demand (elasticity   )
Quantity
NCCU 2006
Elas 29
Perfectly Inelastic Demand Curve
Perfectly inelastic
Price
demand (elasticit y  0)
Quantity
NCCU 2006
Elas 30
Two Points on a Demand Curve
What is the price elasticity of demand?
If P  4 and Q  4 then   2
Price
6
If P  3 and Q  6 then   1
A
4
P
B
3
Q
0
4
6
12
Quantity
NCCU 2006
Elas 31
A Graphical Interpretation
of Price Elasticity

The Midpoint Formula
Q Q A  QB  / 2

P PA  PB  / 2
and
Q Q A  QB 

P PA  PB 
NCCU 2006
Elas 32
Two Points on a Demand Curve
Then the price elasticity of
demand between A and B:

2/ 4  6 

 1.4
1/ 4  3
Price
6
A
4
P
B
3
Q
0
4
6
12
Quantity
NCCU 2006
Elas 33
Elasticity and Total Expenditure

Total Expenditure = P x Q


Market demand measures the quantity (Q)
at each price (P)
Total Expenditure = Total Revenue
NCCU 2006
Elas 34
The Demand Curve for Movie Tickets
12
D
Price ($/ticket)
10
Total Expenditure
= $1,000/day
8
6
4
A
2
0
1
2
3
4
5
6
Quantity (100s of tickets/day)
NCCU 2006
Elas 35
The Demand Curve for Movie Tickets
12
D
Price ($/ticket)
10
Total Expenditure
= $1,600/day
8
6
B
4
2
0
1
2
3
4
5
6
Quantity (100s of tickets/day)
NCCU 2006
Elas 36
Elasticity and Total Expenditure

What do you think?

Will increasing the market price always
increase total revenue?
NCCU 2006
Elas 37
Again,
薄利多銷?
NCCU 2006
Elas 38
The Demand Curve for Movie Tickets
12
Total Expenditure
= $1,600/day
D
Price ($/ticket)
10
8
6
4
2
0
1
2
3
4
5
6
Quantity (100s of tickets/day)
NCCU 2006
Elas 39
The Demand Curve for Movie Tickets
Total Expenditure
= $1,000/day
12
Price ($/ticket)
10
8
6
4
D
2
0
1
2
3
4
5
6
Quantity (100s of tickets/day)
NCCU 2006
Elas 40
Elasticity and Total Expenditure

General Rule

A price increase will increase total revenue
when the % change in P is greater than the
% change in Q.
NCCU 2006
Elas 41
The Demand Curve for Movie Tickets
12
Price ($/ticket)
10
8
6
4
2
0
1
2
3
4
5
6
Quantity (100s of tickets/day)
NCCU 2006
Elas 42
Total Expenditure
as a Function of Price
Price ($/ticket)
Total expenditure ($/day)
12
0
10
1,000
8
1,600
6
1,800
4
1,600
2
1,000
0
0
NCCU 2006
Elas 43
Total Expenditure
as a Function of Price
Total revenue is at a maximum at the
midpoint on a straight-line demand curve
12
1,800
1,600
Total expenditure ($/day)
Price ($/ticket)
10
8
6
4
2
0
1
2
3
4
5
1,000
6
0
Quantity (100s of tickets/day)
2
4
6
8
Price ($/ticket)
NCCU 2006
Elas 44
10
12
Elasticity and Total Expenditure

What do you think?


Should a rock band raise or lower its price
to increase total revenue?
Assume
P  $20
Q  5,000
 3
NCCU 2006
Elas 45
Elasticity and Total Expenditure

What do you think?


Should a rock band raise or lower its price to
increase total revenue?
Then
Total revenue = $20 x 5,000 =
$100,000/week
 If P is increased 10%, Q will decrease 30%

 Total

revenue = $22 x 3,500 = $77,000/week
If P is lowered 10%, Q will increase 30%
 Total
revenue = $18 x 6,500 = $177,000/week
NCCU 2006
Elas 46
Elasticity and Total Expenditure

Rule
When price elasticity is greater than 1,
changes in price and changes in total
expenditures always move in opposite
directions.
 When price elasticity is less than 1, changes
in price and changes in total expenditures
always move in the same direction.

NCCU 2006
Elas 47
Elasticity and Total Expenditure

Cross-Price Elasticity of Demand

The percentage by which quantity demanded
of the first good changes in response to a 1
percent change in the price of the second
good
NCCU 2006
Elas 48
Elasticity and Total Expenditure

Cross-Price Elasticity of Demand

Substitute Goods
 When
the cross-price elasticity of demand is
positive

Complement Goods
 When
the cross-price elasticity of demand is
negative
NCCU 2006
Elas 49
Elasticity and Total Expenditure

Income Elasticity of Demand

The percentage by which quantity
demanded changes in response to a 1
percent change in income
NCCU 2006
Elas 50
Elasticity and Total Expenditure

Income Elasticity of Demand

Normal Goods
 Income

elasticity is positive
Inferior Goods
 Income
elasticity is negative
NCCU 2006
Elas 51
The Price Elasticity of Supply

Price Elasticity of Supply

The percentage change in the quantity
supplied that occurs in response to a 1
percent change in price
Q Q
Price elasticity of supply 
P P
 P  1 

Price elasticity of supply   
 Q  slope 
NCCU 2006
Elas 52
Calculating the Price
Elasticity of Supply Graphically
A  4 1212 4  1
S
B
5
Q
Price
4
P
A
B  5 1515 5  1
0
12
15
Quantity
NCCU 2006
Elas 53
A Supply Curve for Which Price
Elasticity Declines as Quantity Rises
A  4 22  2
S
B
5
A
Price
4
5
B  5 3 1 
3
2
0
2
3
Quantity
NCCU 2006
Elas 54
A Perfectly Inelastic Supply Curve
What is the price elasticity of supply of land
within the borough limits of Manhattan?
Price ($/acre)
S
Elasticity = 0 at every
point along a vertical
supply curve
0
Quantity of land in Manhattan
(1,000s of acres)
NCCU 2006
Elas 55
A Perfectly Elastic Supply Curve
Price (cents/cup)
What is the price elasticity of supply of lemonade?
If MC is constant, then the
price elasticity of supply at every point
along a horizontal supply curve is infinite
S
14
0
Quantity of lemonade
(cups/day)
NCCU 2006
Elas 56
The Price Elasticity of Supply

Determinants of Supply Elasticity
Flexibility of inputs
 Mobility of inputs
 Ability to produce substitute inputs
 Time

NCCU 2006
Elas 57
The Price Elasticity of Supply

Economic Naturalist

Why are gasoline prices so much more
volatile than car prices?
 Differences
in markets
o Demand for gasoline is more inelastic
o Gasoline market has larger and more frequent
supply shifts
NCCU 2006
Elas 58
Greater Volatility in
Gasoline Prices than in Car Prices
S’
Gasoline
Price ($/gallon)
S
1.69
1.02
D
0
6 7.2
Quantity
(millions of gallons/day)
NCCU 2006
Elas 59
Greater Volatility in
Gasoline Prices than in Car Prices
Cars
Price ($1,000s/car)
S’
S
17
16.4
D
11 12
Quantity
(1,000s of cars/day)
Cars
NCCU 2006
Elas 60
What do you think?

How would elasticity of supply and
fluctuating demand impact price
volatility?
NCCU 2006
Elas 61
The Price Elasticity of Supply

Unique and Essential Inputs: The
Ultimate Supply Bottleneck

Why does Shaquille O’Neal get paid over
$120 million over a seven-year contract?
NCCU 2006
Elas 62
End
4.Elasticity approach