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 -

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 CustomPatrols on the Market for Illicit Drugs

Q(1,000s of ounces/day)

P($

/ou

nce

)

50

50

S

D

80

40

S’

Total Expenditure = P x QS $250 = $50 x 50S’ $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

Quantity

Price per Unit

P1

Q1

D1

A A

S1

Quantity

Price per Unit

Q1

D1

S1

Quantity

Price per Unit

P1

Q1

S1

D1

(a) (b) (c)

AP1

Q3

P3

D2

C

Q2

B

S2

P2

NCCU 2006 Elas 7

Price Elasticity of Demand

ElasticityA 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


DefinedGenerally

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


Measuring Price Elasticity of Demand

Price in Change Percentage

DemandedQuantity in Change Percentage

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


32

6

NCCU 2006 Elas 11



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



When is

> 1: elastic

< 1: inelastic

= 1: unit elastic



NCCU 2006 Elas 13

Elastic and Inelastic Demand

3

Price elasticityof demand

Inelastic

Unit elastic

Elastic

210

NCCU 2006 Elas 14


What is the elasticity of demand for pizza?Originally

Price = $1/slice Quantity demanded = 400 slices/day

New Price = $0.97/sliceQuantity demanded = 404 slices/day, then

Inelastic :3

1

Price in Change %

Quantity in Change %

NCCU 2006 Elas 15


What is the elasticity of season ski passes?Originally

Price = $400Quantity demanded = 10,000 passes/year

New Price = $380Quantity demanded = 12,000 passes/year, then

Elastic :5

20

Price in Change %

Quantity in Change %

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 service Price elasticityGreen 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

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 NaturalistWill higher taxes on cigarettes curb

teenage smoking?Why was the luxury tax on yachts such a

disaster?

NCCU 2006 Elas 20

A Graphical Interpretationof Price Elasticity

For small changes in price

PΔP

QΔQ elasticity Price

Where Q is the original quantity and P is the original price

NCCU 2006 Elas 21


ExampleOriginally

Price (P) = $100Quantity (Q) = 20

New Price (P) = $105Quantity (Q) = 15

Elastic:55

25

1005

205

NCCU 2006 Elas 22

A Graphical Interpretation of Price Elasticity of Demand

Quantity

Pri

ce

P

D

A

Q

P - P

Q + Q

Q

P

slopeQ

P A

1 at elasticity icePr

NCCU 2006 Elas 23

Calculating Price Elasticity of Demand

20

Quantity

Pri

ce

1

D

A

2 3 4 5

16

12

8

4

45

20

intercept horizontal

intercept verticalslope

3

2

12

8

4

1x

3

8A

NCCU 2006 Elas 24

Calculating Price Elasticity of Demand

20

Quantity

Pri

ce

1 2 3 4 5

16

12

8

4

D

A

QuestionWhat is the price elasticityof demand when P = $4?

NCCU 2006 Elas 25

D1

D2

12

4 6 12

6

4

Price Elasticity and the Steepness of the Demand Curve

Quantity

Pri

ceWhat is the price elasticity ofdemand when P = $4?

2

1

612

1

4

41D

2

126

1

4

42D

NCCU 2006 Elas 26

12

D1

D2

4 6 10 12

6

4

1

For D2 when P = $1


Quantity

Pri

ce

5

1

126

1

10

12D

NCCU 2006 Elas 27


12

Quantity

Pri

ce

D1

D2

4 6 10 12

6

4

1

ObservationIf 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

Pri

ce

b/2

a/2

a

b

1

1

1

ObservationPrice elasticity varies at every point along a straight-line demand curve

NCCU 2006 Elas 29

Perfectly Elastic Demand Curve

Quantity

Pri

ce

) y (elasticit demand

elastic Perfectly

NCCU 2006 Elas 30

Perfectly Inelastic Demand Curve

Quantity

Pri

ce

)0 y (elasticit demand

inelasticPerfectly

NCCU 2006 Elas 31

4

4

6

A

B3

P

Q

1 then 6 and 3 If Q P

2 then 4 and 4 If Q P6

12

What is the price elasticity of demand?

Two Points on a Demand Curve

Quantity

Pri

ce

0

NCCU 2006 Elas 32


The Midpoint Formula

2PPP

2QQQ

BA

BA

/

/

BA

BA

PPP

QQQ

and

NCCU 2006 Elas 33

Two Points on a Demand Curve

Then the price elasticity ofdemand between A and B:

Quantity

Pri

ce

40

6

12

4

6

A

B3

P

Q

41

341/

642/ .

NCCU 2006 Elas 34

Elasticity and Total Expenditure

Total Expenditure = P x QMarket 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)

Pri

ce (

$/ti

cket

)

1 3 4 5 6

10

8

6

4

2

0 2

NCCU 2006 Elas 36

D

B



12


Pri

ce (

$/ti

cket

)

1 3 4 5 6

10

8

6

4

2

0 2

NCCU 2006 Elas 37


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

DTotal Expenditure = $1,600/day


12


Pri

ce (

$/ti

cket

)

1 3 4 5 6

10

8

6

4

2

0 2

NCCU 2006 Elas 40

D



12


Pri

ce (

$/ti

cket

)

1 3 4 5 6

10

8

6

4

2

0 2

NCCU 2006 Elas 41


General RuleA price increase will increase total revenue

when the % change in P is greater than the % change in Q.

NCCU 2006 Elas 42


12


Pri

ce (

$/ti

cket

)

1 3 4 5 6

10

8

6

4

2

0 2

NCCU 2006 Elas 43

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 44

Total Expenditure as a Function of Price

1,800

Price ($/ticket)

To

tal

ex

pe

nd

itu

re (

$/d

ay

)

2 6 8 10 12

1,600

1,000

0 4

12


Pri

ce

($

/tic

ke

t)

1 3 4 5 6

10

8

6

4

2

0 2

Total revenue is at a maximum at themidpoint on a straight-line demand curve

NCCU 2006 Elas 45


What do you think?Should a rock band raise or lower its price

to increase total revenue? Assume

3

0005Q

20P

,

$

NCCU 2006 Elas 46


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


RuleWhen 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


Cross-Price Elasticity of DemandThe 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


Cross-Price Elasticity of DemandSubstitute Goods

When the cross-price elasticity of demand is positive

Complement GoodsWhen the cross-price elasticity of demand is

negative

NCCU 2006 Elas 50


Income Elasticity of DemandThe percentage by which quantity

demanded changes in response to a 1 percent change in income

NCCU 2006 Elas 51


Income Elasticity of DemandNormal Goods

Income elasticity is positive

Inferior GoodsIncome elasticity is negative

NCCU 2006 Elas 52

The Price Elasticity of Supply

Price Elasticity of SupplyThe percentage change in the quantity

supplied that occurs in response to a 1 percent change in price

PP

QQ supply of elasticity Price

slope

1

Q

P supply of elasticity Price

NCCU 2006 Elas 53

15

5B

P

Q

1515155 B

S

12

4A

1412124 A

Calculating the Price Elasticity of Supply Graphically

Quantity

Pri

ce

0

NCCU 2006 Elas 54

2

4

2

A

2224 A

3

5B

3

5135 B

A Supply Curve for Which Price Elasticity Declines as Quantity Rises

Quantity

Pri

ce

0

S

NCCU 2006 Elas 55

A Perfectly Inelastic Supply Curve

Quantity of land in Manhattan

(1,000s of acres)

Pri

ce (

$/ac

re)

0

S

Elasticity = 0 at everypoint along a verticalsupply 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)

Pri

ce (

cen

ts/c

up

)

0

14 S

If MC is constant, then theprice elasticity of supply at every pointalong 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 ElasticityFlexibility of inputsMobility of inputsAbility to produce substitute inputsTime


NCCU 2006 Elas 58

Economic NaturalistWhy are gasoline prices so much more

volatile than car prices?Differences in markets

o Demand for gasoline is more inelastico Gasoline market has larger and more frequent

supply shifts


NCCU 2006 Elas 59

Greater Volatility in Gasoline Prices than in Car Prices

Quantity(millions of gallons/day)

Pri

ce (

$/g

allo

n)

0 6

1.69

S’

D

1.02

7.2

S

Gasoline

NCCU 2006 Elas 60

Greater Volatility in Gasoline Prices than in Car Prices

Pri

ce (

$1,0

00s/

car)

D

17

S’

11Quantity

(1,000s of cars/day)Cars

16.4

12

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 BottleneckWhy does Shaquille O’Neal get paid over

$120 million over a seven-year contract?


4.Elasticity approach

EndEnd

Documents

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 -