E LASTICITY Economics 101

WHO ARE MORE RESPONSIVE TO CHANGE IN FARE? Taipei MRT System (1) Passenger with single ride (2) Passenger with one-day unlimited pass (3) Passenger with one-month unlimited pass (4) Passenger with Easy Card

ELASTICITY 彈性 … is a measure of how much buyers and sellers respond to changes in market conditions

THE ELASTICITY OF DEMAND 需求彈 性 Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

The (own) price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

C ALCULATING E LASTICITY

CALCULATING ELASTICITY: POINT ELASTICITY 點彈性 Point Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1} Case 1: Price rises from 1 to 1.1 % change in qty = ( )/1.5= -4% % change in price = (1.10-1)/1= 10% Elasticity=-4%/10%=-0.4

C ALCULATING E LASTICITY : P OINT A PPROACH Case 2: Price falls from 1.1 to 1. % change in qty = ( )/1.44= 4.16% % change in price = (1-1.10)/1.10= -9.09% Elasticity=4.16%/-9.09%=-0.457

P OTENTIAL P ROBLEM OF P OINT E LASTICITY (Point) Elasticity level in case 1 is different from (point) elasticity level in case 2

MIDPOINT METHOD (ARC ELASTICITY 弧彈性 ) The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.

M IDPOINT M ETHOD F ORMULA

A RC E LASTICITY (M IDPOINT M ETHOD ) Case 1: Price rises from 1 to 1.1. % change in qty = ( )/1.47 = -4.1% % change in price = (1.10-1)/1.05 = 9.5% Elasticity=-4.1%/9.5% = Case 2: Price falls from 1.1 to 1. % change in qty = ( )/1.47 = 4.1% % change in price = (1-1.10)/1.05 = -9.5% Elasticity=4.1%/-9.5% =-0.432

ELASTIC 具彈性 OR INELASTIC 不具彈 性 ? Inelastic Demand Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one. Elastic Demand Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.

O THER T YPES Perfectly Inelastic 完全不具彈性 Quantity demanded does not respond to price changes. Perfectly Elastic 完全具彈性 Quantity demanded changes infinitely with any change in price. Unit Elastic 單位彈性 Quantity demanded changes by the same percentage as the price.

S UMMARY |E|=0, perfectly inelastic 0<|E|<1, inelastic |E|=1, unit elastic |E|>1, elastic |E|=infinity, perfectly elastic

O WN -P RICE E LASTICITIES

D ETERMINANTS OF P RICE E LASTICITY OF D EMAND Availability of Close Substitutes: More close substitutes=More elastic Example: Butter vs Egg Necessities versus Luxuries: inelastic versus elastic Example: visit a doctor vs sailboat

D ETERMINANTS OF P RICE E LASTICITY OF D EMAND Definition of the Market: Narrowly defined market – more elastic Broadly defined market – less elastic Example: Food vs Ice Cream Time Horizon Longer time horizon – more elastic Shorter time horizon – less elastic

S UMMARY Demand tends to be more elastic : the larger the number of close substitutes. if the good is a luxury. the more narrowly defined the market. the longer the time period.

S LOPE AND E LASTICITY Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. Higher slope, lower elasticity

Copyright©2003 Southwestern/Thomson Learning (a) Perfectly Inelastic Demand: Elasticity Equals 0 $5 4 Quantity Demand An increase in price leaves the quantity demanded unchanged. Price

(b) Inelastic Demand: Elasticity Is Less Than 1 Quantity 0 $5 90 Demand 1. A 22% increase in price... Price leads to an 11% decrease in quantity demanded

Copyright©2003 Southwestern/Thomson Learning leads to a 22% decrease in quantity demanded. (c) Unit Elastic Demand: Elasticity Equals 1 Quantity Price $ A 22% increase in price... Demand

(d) Elastic Demand: Elasticity Is Greater Than 1 Demand Quantity Price $ A 22% increase in price leads to a 67% decrease in quantity demanded.

(e) Perfectly Elastic Demand: Elasticity Equals Infinity Quantity 0 Price $4 Demand 2. At exactly $4, consumers will buy any quantity. 1. At any price above $4, quantity demanded is zero. 3. At a price below $4, quantity demanded is infinite.

L INEAR D EMAND C URVE Vertical intercept: perfectly elastic Upper segment: elastic Middle: Unit elastic Lower segment: inelastic Horizontal intercept: perfectly inelastic

T OTAL R EVENUE AND E LASTICITY Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q

Copyright©2003 Southwestern/Thomson Learning Demand Quantity Q P 0 Price P × Q = $400 (revenue) $4 100

T OTAL R EVENUE AND E LASTICITY With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. With an inelastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately smaller. Thus, total revenue increases.

QUICK QUIZ If Taipei MRT authority would like to increase the total revenue, then what should he do? (1) Raise the single ride fare? (2) Raise the one-day unlimited pass fare? (3) Raise the one-month unlimited pass fare? (4) Raise the discount of Easy Card?

I NCOME E LASTICITY OF D EMAND Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers ’ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

N ORMAL OR I NFERIOR ? Types of Goods Normal Goods Inferior Goods Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. Normal goods: Positive income elasticity Inferior goods: Negative income elasticity

N ECESSITY OR L UXURY ? Goods consumers regard as necessities tend to be income inelastic Examples include food, fuel, clothing, utilities, and medical services. Goods consumers regard as luxuries tend to be income elastic. Examples include sports cars, furs, and expensive foods.

I NCOME E LASTICITY I >0, Normal good I <0, Inferior good Among normal goods: 0<I<1, necessity I>1, luxury

I NCOME E LASTICITY

P RICE E LASTICITY OF S UPPLY Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.

F ORMULA The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

S UMMARY S=0, perfectly inelastic 0<S<1, inelastic S=1, unit elastic S>1, elastic S=infinity, perfectly elastic

S LOPE AND E LASTICITY Because the price elasticity of supply measures how much quantity supplied responds to the price, it is closely related to the slope of the supply curve. Higher slope, lower elasticity

Copyright©2003 Southwestern/Thomson Learning (a) Perfectly Inelastic Supply: Elasticity Equals 0 $5 4 Supply Quantity An increase in price leaves the quantity supplied unchanged. Price

Copyright©2003 Southwestern/Thomson Learning (b) Inelastic Supply: Elasticity Is Less Than $ Quantity 0 1. A 22% increase in price... Price leads to a 10% increase in quantity supplied. Supply

Copyright©2003 Southwestern/Thomson Learning (c) Unit Elastic Supply: Elasticity Equals $ Quantity 0 Price leads to a 22% increase in quantity supplied. 1. A 22% increase in price... Supply

Copyright©2003 Southwestern/Thomson Learning (d) Elastic Supply: Elasticity Is Greater Than 1 Quantity 0 Price 1. A 22% increase in price leads to a 67% increase in quantity supplied $5 200 Supply

Copyright©2003 Southwestern/Thomson Learning (e) Perfectly Elastic Supply: Elasticity Equals Infinity Quantity 0 Price $4 Supply 3. At a price below $4, quantity supplied is zero. 2. At exactly $4, producers will supply any quantity. 1. At any price above $4, quantity supplied is infinite.

D ETERMINANTS OF P RICE E LASTICITY OF S UPPLY Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Time period. Supply is more elastic in the long run.

P RICE E LASTICITIES OF S UPPLY

A PPLICATION OF E LASTICITY Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

Copyright©2003 Southwestern/Thomson Learning Quantity of Wheat 0 Price of Wheat and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220. Demand S1S1 S2S leads to a large fall in price When demand is inelastic, an increase in supply $3 100

O THER A PPLICATIONS A reduction in supply in the world market for oil: the response depends on the time horizon. Policies to Reduce the Use of Illegal Drugs: Drug interdiction Drug education

D ISCUSSION Why? A drought around the world: Total revenue that farmers received from sale of grain rises. However, a drought in Kansas reduces total revenue that Kansas farmers receive.