E LASTICITY Economics 101. ELASTICITY 彈性 … is a measure of how much buyers and sellers respond...

ELASTICITYEconomics 101

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.

DETERMINANTS OF PRICE ELASTICITY OF DEMAND 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

DETERMINANTS OF PRICE ELASTICITY OF DEMAND 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

SUMMARY

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.

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

P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in p rice

CALCULATING ELASTICITY

1.1

1.0

1.44 1.5

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 = (1.44-1.5)/1.5= -4%% change in price = (1.10-1)/1= 10%Elasticity=-4%/10%=-0.4

CALCULATING ELASTICITY: POINT APPROACH

Case 2: Price falls from 1.1 to 1.

% change in qty = (1.5-1.44)/1.44= 4.16%% change in price = (1-1.10)/1.10= -9.09%Elasticity=4.16%/-9.09%=-0.457

POTENTIAL PROBLEM OF POINT ELASTICITY (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.

MIDPOINT METHOD FORMULA

P rice e las tic ity o f d em an d =( ) / [( ) / ]

( ) / [( ) / ]

Q Q Q QP P P P2 1 2 1

2 1 2 1

2

2

ARC ELASTICITY(MIDPOINT METHOD)Case 1: Price rises from 1 to 1.1. % change in qty = (1.44-1.5)/1.47 = -4.1% % change in price = (1.10-1)/1.05 = 9.5% Elasticity=-4.1%/9.5% =-0.432Case 2: Price falls from 1.1 to 1. % change in qty = (1.5-1.44)/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.

OTHER TYPES 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.

SUMMARY

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

Product Market ElasticityAutomobilesChevette U.S. -3.2Civic U.S. -4Consumer productsmusic CDs Aus -1.83cigarettes U.S. -0.3liquor U.S. -0.2football games U.S. -0.275Utilitieselectricity (residential) Quebec -0.7telephone service Spain -0.1water (residential) U.S. -0.25water (industrial) U.S. -0.85

OWN-PRICE ELASTICITIES

SLOPE AND ELASTICITY

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

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(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity0

$5

90

Demand1. A 22%increasein price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100

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2. . . . leads to a 22% decrease in quantity demanded.

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

$5

80

1. A 22%increasein price . . .

Demand

(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

1000

Price

$5

50

1. A 22%increasein price . . .

2. . . . leads to a 67% decrease in quantity demanded.

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,consumers willbuy any quantity.

1. At any priceabove $4, quantitydemanded is zero.

3. At a price below $4,quantity demanded is infinite.

LINEAR DEMAND CURVE

Vertical intercept: perfectly elastic Upper segment: elastic Middle: Unit elastic Lower segment: inelastic Horizontal intercept: perfectly inelastic

TOTAL REVENUE AND ELASTICITY

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

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Demand

Quantity

Q

P

0

Price

P × Q = $400(revenue)

$4

100

TOTAL REVENUE AND ELASTICITY

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.

INCOME ELASTICITY OF DEMAND

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.

NORMAL OR INFERIOR?

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

NECESSITY OR LUXURY? 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.

INCOME ELASTICITY

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

Item Market ElasticityConsumer productscigarettes U.S. 0.1liquor U.S. 0.2food U.S. 0.8clothing U.S. 1newspapers U.S. 0.9Utilitieselectricity (residential) Quebec 0.1telephone service Spain 0.5

INCOME ELASTICITY

PRICE ELASTICITY OF SUPPLY

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.

FORMULA

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

P rice e las tic ity o f su p p ly =

P ercen tag e ch an g e in q u an tity su p p lied

P ercen tag e ch an g e in p rice

SUMMARY

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

SLOPE AND ELASTICITY

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

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(a) Perfectly Inelastic Supply: Elasticity Equals 0

$5

4

Supply

Quantity1000

1. Anincreasein price . . .

2. . . . leaves the quantity supplied unchanged.

Price

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(b) Inelastic Supply: Elasticity Is Less Than 1

110

$5

100

4

Quantity0

1. A 22%increasein price . . .

Price

2. . . . leads to a 10% increase in quantity supplied.

Supply

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(c) Unit Elastic Supply: Elasticity Equals 1

125

$5

100

4

Quantity0

Price

2. . . . leads to a 22% increase in quantity supplied.

1. A 22%increasein price . . .

Supply

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(d) Elastic Supply: Elasticity Is Greater Than 1

Quantity0

Price

1. A 22%increasein price . . .

2. . . . leads to a 67% increase in quantity supplied.

4

100

$5

200

Supply

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(e) Perfectly Elastic Supply: Elasticity Equals Infinity

Quantity0

Price

$4 Supply

3. At a price below $4,quantity supplied is zero.

2. At exactly $4,producers willsupply any quantity.

1. At any priceabove $4, quantitysupplied is infinite.

DETERMINANTS OF PRICE ELASTICITY OF SUPPLY 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.

Item Horizon Price Elasticitydistillate short run 1.57gasoline short run 1.61pork long run 0.23tobacco long run 7housing long run 1.6 - 3.7

PRICE ELASTICITIES OF SUPPLY

APPLICATION OF ELASTICITY

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?

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Quantity ofWheat

0

Price ofWheat

3. . . . and a proportionately smallerincrease in quantity sold. As a result,revenue falls from $300 to $220.

Demand

S1 S2

2. . . . leadsto a large fallin price . . .

1. When demand is inelastic,an increase in supply . . .

2

110

$3

100

OTHER APPLICATIONS

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

QUIZ 1

Beachfront resorts: inelastic supply Automobile: elastic supply Suppose a rise in population doubles the

demand for both products. Price? Quantity? Consumer spending?

QUIZ 2

Why? 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.