4.Elasticity approach

NCCU 2006 Elas 2 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 3 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 4 The Effect of Extra Custom Patrols on the Market for Illicit Drugs Q(1,000s of ounces/day) P($/ounce) 50 S D S’ Total Expenditure = P x Q S $250 = $50 x 50 S’ $320 = $80 x 40

NCCU 2006 Elas 5 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) Market for heroin without government intervention Figure (b) Result of government efforts to restrict supply (current policy) Figure (c) Results of an effective policy of reducing demand

NCCU 2006 Elas 6 3 conditions in the War on Drugs D 2 C Q 2 B S 2 P 2

NCCU 2006 Elas 7 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 8 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 9 Price Elasticity of Demand Measuring Price Elasticity of Demand

NCCU 2006 Elas 10 Assume The price of pork falls by 2% and the quantity demanded increases by 6%  Then the price elasticity of demand for pork is Price Elasticity of Demand

NCCU 2006 Elas 11 Price Elasticity of Demand Measuring Price Elasticity of Demand 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 12 Price Elasticity of Demand Measuring Price Elasticity of Demand When is > 1: elastic < 1: inelastic = 1: unit elastic

NCCU 2006 Elas 13 Elastic and Inelastic Demand 3 Price elasticity of demand Inelastic Unit elastic Elastic 210

NCCU 2006 Elas 14 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

NCCU 2006 Elas 15 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

NCCU 2006 Elas 16 Determinants of Price Elasticity of Demand 1. Substitution Possibilities 2. Budget Share 3. Time

NCCU 2006 Elas 17 Price Elasticity (in US) Estimates for Selected Products Good or servicePrice elasticity Green peas2.80 Restaurant meals1.63 Automobiles1.35 Electricity / gasoline?1.20 Beer1.19 Movies0.87 Air travel (foreign)0.77 Shoes0.70 Coffee0.25 Theater, opera0.18 WHY?

NCCU 2006 Elas 18 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 19 Discussion Economic Naturalist Will higher taxes on cigarettes curb teenage smoking? Why was the luxury tax on yachts such a disaster?

NCCU 2006 Elas 20 A Graphical Interpretation of Price Elasticity For small changes in price Where Q is the original quantity and P is the original price

NCCU 2006 Elas 21 A Graphical Interpretation of Price Elasticity Example Originally  Price (P) = $100  Quantity (Q) = 20 New  Price (P) = $105  Quantity (Q) = 15

NCCU 2006 Elas 22 A Graphical Interpretation of Price Elasticity of Demand Quantity Price P D A Q P - P Q + Q Q P

NCCU 2006 Elas 23 Calculating Price Elasticity of Demand 20 Quantity Price 1 D A

NCCU 2006 Elas 24 Calculating Price Elasticity of Demand 20 Quantity Price D A Question What is the price elasticity of demand when P = $4?

NCCU 2006 Elas 25 D1D1 D2D Price Elasticity and the Steepness of the Demand Curve Quantity Price What is the price elasticity of demand when P = $4?

NCCU 2006 Elas D1D1 D2D For D 2 when P = $1 Price Elasticity and the Steepness of the Demand Curve Quantity Price

NCCU 2006 Elas 27 Price Elasticity and the Steepness of the Demand Curve 12 Quantity Price D1D1 D2D Observation If two demand curves have a point in common, the steeper curve must be less elastic with respect to price at that point

NCCU 2006 Elas 28 Price Elasticity Regions along a Straight-Line Demand Curve Quantity Price b/2 a/2 a b Observation Price elasticity varies at every point along a straight- line demand curve

NCCU 2006 Elas 29 Perfectly Elastic Demand Curve Quantity Price

NCCU 2006 Elas 30 Perfectly Inelastic Demand Curve Quantity Price

NCCU 2006 Elas A B 3 P Q 6 12 What is the price elasticity of demand? Two Points on a Demand Curve Quantity Price 0

NCCU 2006 Elas 32 A Graphical Interpretation of Price Elasticity The Midpoint Formula and

NCCU 2006 Elas 33 Two Points on a Demand Curve Then the price elasticity of demand between A and B: Quantity Price A B 3 P Q

NCCU 2006 Elas 34 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 35 D A Total Expenditure = $1,000/day The Demand Curve for Movie Tickets 12 Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 36 D B Total Expenditure = $1,600/day The Demand Curve for Movie Tickets 12 Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 37 Elasticity and Total Expenditure What do you think? Will increasing the market price always increase total revenue?

NCCU 2006 Elas 38 Again, 薄利多銷 ?

NCCU 2006 Elas 39 D Total Expenditure = $1,600/day The Demand Curve for Movie Tickets 12 Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 40 D Total Expenditure = $1,000/day The Demand Curve for Movie Tickets 12 Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 41 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 42 The Demand Curve for Movie Tickets 12 Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 43 Total Expenditure as a Function of Price Price ($/ticket) Total expenditure ($/day) ,000 81,600 61,800 41,600 21,000 00

NCCU 2006 Elas 44 Total Expenditure as a Function of Price 1,800 Price ($/ticket) Total expenditure ($/day) ,600 1, Quantity (100s of tickets/day) Price ($/ticket) Total revenue is at a maximum at the midpoint on a straight-line demand curve

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? Assume

NCCU 2006 Elas 46 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 47 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 48 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 49 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 50 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 51 Elasticity and Total Expenditure Income Elasticity of Demand Normal Goods  Income elasticity is positive Inferior Goods  Income elasticity is negative

NCCU 2006 Elas 52 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

NCCU 2006 Elas B P Q S 12 4 A Calculating the Price Elasticity of Supply Graphically Quantity Price 0

NCCU 2006 Elas A 3 5 B A Supply Curve for Which Price Elasticity Declines as Quantity Rises Quantity Price 0 S

NCCU 2006 Elas 55 A Perfectly Inelastic Supply Curve Quantity of land in Manhattan (1,000s of acres) Price ($/acre) 0 S Elasticity = 0 at every point along a vertical supply curve What is the price elasticity of supply of land within the borough limits of Manhattan?

NCCU 2006 Elas 56 Quantity of lemonade (cups/day) Price (cents/cup) 0 14 S If MC is constant, then the price elasticity of supply at every point along a horizontal supply curve is infinite What is the price elasticity of supply of lemonade? A Perfectly Elastic Supply Curve

NCCU 2006 Elas 57 Determinants of Supply Elasticity Flexibility of inputs Mobility of inputs Ability to produce substitute inputs Time The Price Elasticity of Supply

NCCU 2006 Elas 58 Economic Naturalist Why are gasoline prices so much more volatile than car prices?  Differences in markets oDemand for gasoline is more inelastic oGasoline market has larger and more frequent supply shifts The Price Elasticity of Supply

NCCU 2006 Elas 59 Greater Volatility in Gasoline Prices than in Car Prices Quantity (millions of gallons/day) Price ($/gallon) S’ D S Gasoline

NCCU 2006 Elas 60 Greater Volatility in Gasoline Prices than in Car Prices Price ($1,000s/car) D 17 S’ 11 Quantity (1,000s of cars/day) Cars S Cars

NCCU 2006 Elas 61 How would elasticity of supply and fluctuating demand impact price volatility? What do you think?

NCCU 2006 Elas 62 Unique and Essential Inputs: The Ultimate Supply Bottleneck Why does Shaquille O’Neal get paid over $120 million over a seven-year contract? The Price Elasticity of Supply

4.Elasticity approach End