4 Elasticity approach NCCU 2005 薄利多銷 n

4. Elasticity approach NCCU 2005

薄利多銷? n n n Total expenditure (Total sales) =P×Q Total Cost = direct cost + indirect cost Profit = Total sales - Total Cost n 薄利 implies lowering price n 多銷 means more sales NCCU 2006 2

嚴刑重罰 Or 寓禁於徵 ? n What do you think? l Could reducing the supply of illegal drugs cause an increase in drug-related burglaries? NCCU 2006 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 = $80 x 40 S’ P($/ounce) 80 S 50 D 40 50 Q(1, 000 s of ounces/day) NCCU 2006 4

Using Price Elasticity of Demand: The War on Drugs n n Every year U. S. Government spends about $20 billion on efforts to restrict the supply of drugs Figure (a) l n Figure (b) l n Market for heroin without government intervention Result of government efforts to restrict supply (current policy) Figure (c) l Results of an effective policy of reducing demand NCCU 2006 5

3 conditions in the War on Drugs (a) (b) Price per Unit S 1 A Price per Unit P 2 (c) S 2 B A P 1 S 1 Price per Unit C D 1 Quantity A P 1 P 3 Q 1 S 1 Q 2 Q 1 Quantity NCCU 2006 D 1 D 2 Q 3 Q 1 Quantity 6

Price Elasticity of Demand n Elasticity l A measure of the extent to which quantity demanded and quantity supplied respond to variations in price, income, and other factors. l中文定義: 對價格之敏感度 NCCU 2006 7

Price Elasticity of Demand n Defined l Generally u. A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good l Formally u The percentage change in the quantity demanded that results from a 1 percent change in its price NCCU 2006 8

Price Elasticity of Demand n Measuring Price Elasticity of Demand NCCU 2006 9

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

Price Elasticity of Demand n Measuring Price Elasticity of Demand l Observations l Price elasticity of demand will always be negative (i. e. , an inverse relationship between price and quantity) l For convenience we drop the negative sign NCCU 2006 11

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

Elastic and Inelastic Demand Unit elastic Inelastic 0 Elastic 1 2 3 NCCU 2006 Price elasticity of demand 13

Price Elasticity of Demand n What is the elasticity of demand for pizza? l Originally u Price = $1/slice u Quantity demanded = 400 slices/day l New u Price = $0. 97/slice u Quantity demanded = 404 slices/day, then NCCU 2006 14

Price Elasticity of Demand n What is the elasticity of season ski passes? l Originally u Price = $400 u Quantity demanded = 10, 000 passes/year l New u Price = $380 u Quantity demanded = 12, 000 passes/year, then NCCU 2006 15

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

Price Elasticity (in US) Estimates for Selected Products Good or service Price elasticity Green 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 NCCU 2006 WHY? 17

Question? n Why is the price elasticity of demand more than 14 times larger for green peas than for theater and opera performances? NCCU 2006 18

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

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

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

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

Calculating Price Elasticity of Demand 20 D 16 Price 12 A 8 4 1 2 3 4 5 Quantity NCCU 2006 23

Calculating Price Elasticity of Demand 20 D Question What is the price elasticity of demand when P = $4? 16 Price 12 A 8 4 1 2 3 4 5 Quantity NCCU 2006 24

Price Elasticity and the Steepness of the Demand Curve 12 What is the price elasticity of demand when P = $4? D 1 Price 6 4 D 2 4 6 12 Quantity NCCU 2006 25

Price Elasticity and the Steepness of the Demand Curve For D 2 when P = $1 12 Price 6 D 1 4 D 2 1 4 6 10 12 Quantity NCCU 2006 26

Price Elasticity and the Steepness of the Demand Curve Observation 12 Price 6 If two demand curves have a point in common, the steeper curve must be less elastic with respect to price at that point D 1 4 D 2 1 4 6 10 12 Quantity NCCU 2006 27

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

Price Perfectly Elastic Demand Curve Quantity NCCU 2006 29

Price Perfectly Inelastic Demand Curve Quantity NCCU 2006 30

Two Points on a Demand Curve What is the price elasticity of demand? Price 6 4 3 0 A P B Q 4 6 12 Quantity NCCU 2006 31

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

Two Points on a Demand Curve Then the price elasticity of demand between A and B: Price 6 4 3 0 A P B Q 4 6 12 Quantity NCCU 2006 33

Elasticity and Total Expenditure n Total Expenditure = P x Q l n Market demand measures the quantity (Q) at each price (P) Total Expenditure = Total Revenue NCCU 2006 34

The Demand Curve for Movie Tickets 12 D Price ($/ticket) 10 Total Expenditure = $1, 000/day 8 6 4 A 2 0 1 2 3 4 5 6 Quantity (100 s of tickets/day) NCCU 2006 35

The Demand Curve for Movie Tickets 12 D Price ($/ticket) 10 Total Expenditure = $1, 600/day 8 6 B 4 2 0 1 2 3 4 5 6 Quantity (100 s of tickets/day) NCCU 2006 36

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

Again, 薄利多銷? NCCU 2006 38

The Demand Curve for Movie Tickets 12 Total Expenditure = $1, 600/day D Price ($/ticket) 10 8 6 4 2 0 1 2 3 4 5 6 Quantity (100 s of tickets/day) NCCU 2006 39

The Demand Curve for Movie Tickets Total Expenditure = $1, 000/day 12 Price ($/ticket) 10 8 6 4 D 2 0 1 2 3 4 5 6 Quantity (100 s of tickets/day) NCCU 2006 40

Elasticity and Total Expenditure n General Rule l A price increase will increase total revenue when the % change in P is greater than the % change in Q. NCCU 2006 41

The Demand Curve for Movie Tickets 12 Price ($/ticket) 10 8 6 4 2 0 1 2 3 4 5 6 Quantity (100 s of tickets/day) NCCU 2006 42

Total Expenditure as a Function of 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 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 1, 600 Total expenditure ($/day) Price ($/ticket) 10 8 6 4 2 0 1 2 3 4 5 1, 000 6 0 Quantity (100 s of tickets/day) 2 4 6 8 10 Price ($/ticket) NCCU 2006 44 12

Elasticity and Total Expenditure n What do you think? l n Should a rock band raise or lower its price to increase total revenue? Assume NCCU 2006 45

Elasticity and Total Expenditure n What do you think? l n Should a rock band raise or lower its price to increase total revenue? Then Total revenue = $20 x 5, 000 = $100, 000/week l If P is increased 10%, Q will decrease 30% l u Total l revenue = $22 x 3, 500 = $77, 000/week If P is lowered 10%, Q will increase 30% u Total revenue = $18 x 6, 500 = $177, 000/week NCCU 2006 46

Elasticity and Total Expenditure n Rule When price elasticity is greater than 1, changes in price and changes in total expenditures always move in opposite directions. l When price elasticity is less than 1, changes in price and changes in total expenditures always move in the same direction. l NCCU 2006 47

Elasticity and Total Expenditure n Cross-Price Elasticity of Demand l 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 48

Elasticity and Total Expenditure n Cross-Price Elasticity of Demand l Substitute Goods u When the cross-price elasticity of demand is positive l Complement Goods u When the cross-price elasticity of demand is negative NCCU 2006 49

Elasticity and Total Expenditure n Income Elasticity of Demand l The percentage by which quantity demanded changes in response to a 1 percent change in income NCCU 2006 50

Elasticity and Total Expenditure n Income Elasticity of Demand l Normal Goods u Income l elasticity is positive Inferior Goods u Income elasticity is negative NCCU 2006 51

The Price Elasticity of Supply n Price Elasticity of Supply l The percentage change in the quantity supplied that occurs in response to a 1 percent change in price NCCU 2006 52

Calculating the Price Elasticity of Supply Graphically S B 5 Q Price 4 P A 0 12 15 Quantity NCCU 2006 53

A Supply Curve for Which Price Elasticity Declines as Quantity Rises S B 5 A Price 4 2 0 2 3 Quantity NCCU 2006 54

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

A Perfectly Elastic Supply Curve Price (cents/cup) 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 S 14 0 Quantity of lemonade (cups/day) NCCU 2006 56

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

The Price Elasticity of Supply n Economic Naturalist l Why are gasoline prices so much more volatile than car prices? u Differences in markets o Demand for gasoline is more inelastic o Gasoline market has larger and more frequent supply shifts NCCU 2006 58

Greater Volatility in Gasoline Prices than in Car Prices S’ Gasoline Price ($/gallon) S 1. 69 1. 02 D 0 6 7. 2 Quantity (millions of gallons/day) NCCU 2006 59

Greater Volatility in Gasoline Prices than in Car Prices Cars Price ($1, 000 s/car) S’ S 17 16. 4 D 11 12 Quantity (1, 000 s of cars/day) Cars NCCU 2006 60

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

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

End 4. Elasticity approach NCCU 2005