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 = $80 x 40
S’
80
P($/ounce)

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)
 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 5
 3 conditions in the War on Drugs

(a) (b) (c)

Price Price S2 Price
per per per
Unit Unit Unit
S1 B S1 S1
P2

A A A
P1 P1 P1

C
P3

D1 D1 D1
D2

Q1 Q2 Q1 Q3 Q1
Quantity Quantity Quantity

NCCU 2006 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
Percentage Change in Quantity Demanded
When is < 1: inelastic
Percentage Change in Price
= 1: unit elastic

NCCU 2006 Elas 12

 Elastic and Inelastic Demand

Unit elastic

Inelastic Elastic

Price elasticity
0 1 2 3 of demand

NCCU 2006 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. Substitution Possibilities
2. Budget Share
3. Time

NCCU 2006 Elas 16

Price Elasticity (in US) Estimates
for Selected Products

Good or service Price elasticity

Green peas 2.80 WHY?
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 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 

P
A
Price

P- P
Q

Q Q+ Q
Quantity

NCCU 2006 Elas 22

 Calculating Price Elasticity of Demand

vertical intercept 20
slope   4
20 horizontal intercept 5
D

16

8 1 8 2
12 A  x  
3 4 12 3
Price

A
8

1 2 3 4 5

Quantity

NCCU 2006 Elas 23

 Calculating Price Elasticity of Demand

20 D Question
What is the price elasticity
16
of demand when P = $4?

12
Price

A
8

1 2 3 4 5

Quantity

NCCU 2006 Elas 24

 Price Elasticity and the
Steepness of the Demand Curve

What is the price elasticity of

demand when P = $4?
12

 
D1  4  1  1
D1     
 4  12  2
 6
6
Price

 
4  4  1 
D2     2
 4  6 
D2  12 

4 6 12

Quantity

NCCU 2006 Elas 25

 Price Elasticity and the
Steepness of the Demand Curve

12 For D2 when P = $1

D1  
 1  1  1
6 D2     
 10  6  5
 12 
Price

D2

4 6 10 12

Quantity

NCCU 2006 Elas 26

 Price Elasticity and the
Steepness of the Demand Curve

12 Observation
If two demand curves have a
point in common, the steeper
curve must be less elastic with
D1
6
respect to price at that point
Price

D2

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 straight-
line demand curve

a  1
 1
Price

a/2  1

b/2 b
Quantity

NCCU 2006 Elas 28

 Perfectly Elastic Demand Curve

Perfectly elastic
demand (elasticity   )
Price

Quantity

NCCU 2006 Elas 29

 Perfectly Inelastic Demand Curve

Perfectly inelastic
demand (elasticity  0)
Price

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
6

4
A If P  3 and Q  6 then   1
Price

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:

6

2/ 4  6
 1.4
4
A 1/4  3
Price

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

10

8
Total Expenditure
Price ($/ticket)

= $1,000/day
6

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

10

8
Total Expenditure
Price ($/ticket)

= $1,600/day
6
B
4

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
D
= $1,600/day
10

8
Price ($/ticket)

0 1 2 3 4 5 6
Quantity (100s of tickets/day)

NCCU 2006 Elas 39

The Demand Curve for Movie Tickets

12 Total Expenditure
= $1,000/day
10

8
Price ($/ticket)

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

10

8
Price ($/ticket)

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

10 1,600

Total expenditure ($/day)

8
Price ($/ticket)

1,000
6

0 1 2 3 4 5 6 0 2 4 6 8 10 12
Quantity (100s of tickets/day) Price ($/ticket)

NCCU 2006 Elas 44

 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
P
A
4
Q
Price

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
4
Price

5
B  5 3 1 
2 3

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?

S
Price ($/acre)

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

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
Price (cents/cup)

14 S

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

0 6 7.2
Quantity
(millions of gallons/day)

NCCU 2006 Elas 59

 Greater Volatility in
Gasoline Prices than in Car Prices

Cars
S’
Price ($1,000s/car)

17
16.4

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