Elasticity of Demand and Supply Price Elasticity of Demand Determinants of the Price Elasticity of Demand Price Elasticity of Supply Other Elasticity Measures 2003 South-Western/Thomson Learning 1 Why Price Elasticity of Demand Law of demand says that a higher price reduces quantity demanded, BUT BY HOW MUCH the number sold decline by only a little or by a lot? 考 慮 航 空 公 司 希 望 提 高 總 營 收 總 營 收 = 票 價 旅 客 數 票 價 和 旅 客 數 呈 反 向 變 動 應 該 如 何 調 整 票 價? 2 1
Definition of Price Elasticity of Demand Price elasticity of demand measures how responsive consumers react to price change Price elasticity of demand = Percentage change in quantity demanded Percentage change in price See next slide 3 Demand Curve for Tacos The average of $1.10 and $0.90 = $1.00 the change in price is -$0.20 divided by $1.00-20% the average quantity demanded is 100,000 and the change in quantity demanded is 10,000 10% change $1.10 a 0.90 b Price elasticity between a and b = 10% / - 20% = - 0.5 Price per taco D 0 Thousands per day 95 105 4 2
Price Elasticity of Demand Generalize the price elasticity formula The price drops from p to p, other things constant, the quantity demanded increases from q to q The change in price and the change in quantity as Δp and Δq, respectively. E D = q (q + q ) / 2 p (p + p ) / 2 5 Price Elasticity of Demand The focus is on the percent change, we need not be concerned with how output or price is measured In KGs, pounds, tons, etc. In USD, HKD, etc. Q Currency A =2 Currency B 2 Y Y Y = Y 2 X X X X 2 Y Y Y = Y 4 X X 2X X Y X 2X P 6 3
Price Elasticity of Demand Elasticity expresses a relationship between two amounts The percent change in quantity demanded The percent change in price The law of demand states that price and quantity demanded are inversely related, the change in price and the change in quantity demanded have opposite signs the price elasticity of demand has a negative sign 7 Price Elasticity of Demand Referring a negative number gets cumbersome, the price elasticity of demand is represented as an absolute value positive number E D = q ( q + q ) / 2 p ( p + p ) / 2 Ex: absolute value of the elasticity for tacos computed earlier will be referred to as 0.5 rather than 0.5 8 4
Categories of Elasticity Three general categories Inelastic: Elasticity is between 0 and 1.0 The percent change in quantity demanded is smaller than the percent change in price, Quantity demanded is relatively unresponsive to a change in price unit-elastic elasticity with an absolute value of 1.0 If the percent change in quantity demanded equals the percent change in price 9 Elastic Categories price elasticity has an absolute value exceeding 1.0 The percent change in quantity demanded exceeds the percent change in price 10 5
Elasticity and Total Revenue Price elasticity can indicate the effect of a price change on total revenue Total revenue (TR) is the price (p) multiplied by the quantity demanded (q) at that price TR = p x q 11 What happens to total revenue when price decreases? A lower price means producers get less for each unit sold which tends to decrease total revenue However, a lower price increases quantity demanded which tends to increase total revenue Thus, the overall impact of a lower price on total revenue depends on the net result of these opposite effects 12 6
Relation between Elasticity and Total Revenue When demand is elastic, percent increase in quantity demanded percent decrease in price Total revenue increases When demand is unit elastic, percent increase in quantity demanded= percent decrease in price total revenue remains unchanged When demand is inelastic, percent increase in quantity demanded the percent decrease in price total revenue decreases 13 Elasticity and Total Revenue These relationships can be tied together by looking at a linear demand curve See next slide 14 7
Demand, Price Elasticity and Total Revenue q ( q + q ) / 2 q ( p + p ) / 2 E = = D p p ( q + q ) / 2 ( p + p ) / 2 Slope is constant for linear model. The price elasticity of demand is greater on the higher-price end of the demand curve than on the lower-price end. Price per unit $100 90 80 70 60 50 40 30 20 10 0 $25,000 (a) Demand Curve 100 200 500 800 900 1,000 Quality per period (b) Total Revenue D TR = p x q Total revenue Total revenue 0 Quantity per period 500 1,000 15 Demand, Price Elasticity and Total Revenue Consider point a, b on the demand curve. Percent change of quantity 100/150 = 0.67 Percent change of price 10/85 = 12% the price elasticity of demand here is 5.6 Price drop from 90 80 Loss: 10*100=1000 Gain 80*100=8000 TR Consider points d and e Percent change of quantity 100/850 = 12% Percent change of price 10/15 = 67% a price elasticity of 0.2 Price drop from 20 10 Loss: 10*800=8000 Gain 10*100=1000 TR Price per unit $100 90 80 70 60 50 40 30 20 10 0 $25,000 Total revenue 0 a b (a) Demand and Price Elasticity c 100 200 500 800 900 1,000 Quality per period (b) Total Revenue Quantity per period 500 d e D TR = p x q Total revenue 1,000 16 8
Demand, Price Elasticity and Total Revenue Where demand is elastic, a decrease in price will increase total revenue because the gain in revenue from selling more units exceeds the loss in revenue from selling at the lower price. Price per unit $100 90 80 70 60 50 40 30 20 10 0 a b (a) Demand and Price Elasticity Elastic E D > 1 c Unit elastic E D = 1 Inelastic E D < 1 100 200 500 800 900 1,000 Quality per period d e D $25,000 (b) Total Revenue TR = p x q Where demand is inelastic, a price decrease reduces total revenue because the gain in revenue from selling more units is less than the loss in revenue at the lower price. Total revenue Total revenue 0 Quantity per period 500 1,000 17 Constant Elasticity Demand Curves Perfectly elastic Perfectly inelastic Unit elastic D' Priceperunit p E = D D Price per unit E = D 0 Price per unit $10 6 E = D 1 a 雙 曲 線 XY=k b D" 0 Quantity 0 Q Quantity 0 60 100 Quantity per period per period per period Consumers demand all that is offered at the given price, p. If the price rises above p, quantity demanded drops to zero perfectly elastic demand curve. 消 費 者 有 眾 多 選 擇 Quantity demanded does not vary when the price changes no matter how high the price, consumers will purchase the same quantity perfectly inelastic demand curve. 消 費 者 別 無 選 擇 unit-elastic demand curve :Percent change in price results in an identical percent change in quantity demanded. 消 費 金 額 固 定 18 9
論 文 : 從 差 別 訂 價 與 需 求 彈 性 論 台 電 之 夏 日 電 價 ( 柯 伯 昇 ) 台 電 自 民 國 七 十 八 年 起, 實 施 所 謂 的 夏 日 電 價 主 要 目 的 在 於 引 導 用 戶 抑 制 夏 季 尖 峰 用 電 負 載, 以 減 緩 發 供 電 設 備 投 資, 抑 低 發 電 成 本, 進 而 維 持 低 廉 電 價 水 準 其 最 終 目 的 無 非 就 是 希 望 以 價 制 量 以 解 決 國 內 季 節 性 供 電 短 缺 的 問 題 推 論 : 一 般 營 業 處 所 在 正 常 上 班 的 時 間, 不 太 可 能 會 因 電 價 的 上 升 而 減 少 冷 氣 空 調 的 使 用, 所 以 夏 日 電 價 對 於 營 業 用 電 之 價 格 需 求 彈 性 應 該 是 很 小 至 於 一 般 家 庭 冷 氣 空 調 的 使 用, 試 想 一 個 消 費 者 既 然 願 意 購 買 冷 氣 空 調, 還 會 在 乎 每 度 平 均 約 上 漲 二 成 的 電 費 嗎? 電 力 的 價 格 需 求 彈 性 並 不 大, 所 以 台 電 的 夏 日 電 價 措 施 欲 藉 由 以 價 制 量 來 抑 低 夏 日 尖 峰 用 電 的 負 載, 其 效 果 不 彰, 是 可 預 見 的 結 果 19 Elasticity of Demand and Supply Price Elasticity of Demand Determinants of the Price Elasticity of Demand Price Elasticity of Supply Other Elasticity Measures 2003 South-Western/Thomson Learning 20 10
Determinants Why price elasticities of demand vary for different goods Three basic determinants Availability of substitutes Proportion of the consumer s budget spent on the good A matter of time 21 Availability of Substitutes The greater the availability of substitutes The closer the substitutes, The greater the good s price elasticity of demand The number and similarity of substitutes depend on how we define the good The more broadly we define a good, the fewer the substitutes and the less elastic the demand 22 11
Example of Availability of Substitutes Shoes is less elastic than running shoes Substitutes for running shoes: tennis shoes.. Running shoes is less elastic than Nike running shoes. Much ads. is aimed at the uniqueness of a product No substitutes. Why? 23 Proportion of Consumer s Budget If spending on some goods represents a large share of the consumer s budget, Change in the price of such a good has a substantial impact on the purchase power 考 慮 房 子 vs. 衛 生 紙 Generally, the more important the item is as a share of the consumer s budget, The greater will be the income effect of a change in price The more price elastic will be the demand for the item 24 12
A Matter of Time The process of finding substitutes takes time The longer the adjustment period, The greater the consumers ability to find substitute The more responsive the change in quantity demanded is to a given change in price See next slide 25 Demand Becomes More Elastic over Time D w = the demand curve one week after the price change D m = one month after D y, = one year after. Suppose the price now increases to $1.25. The more time for consumers to respond to price increase, the greater the reduction in quantity demanded. $1.25 1.00 Price per unit 0 50 75 95 A 100 D y D w D m Quantity per period At A, the flatter the demand curve, the more price elastic the demand. 26 13
大 陸 新 聞 羅 奇 : 面 對 高 油 價 中 國 應 節 能 和 尋 找 可 替 代 能 源 對 於 可 替 代 能 源, 中 國 現 在 已 經 轉 向 了 核 發 電, 並 且 在 過 去 幾 年 已 有 了 相 應 的 計 劃 或 專 案 對 於 石 油 價 格 與 全 球 經 濟 增 長 的 關 係, 羅 奇 認 為, 如 果 今 後 幾 個 月 石 油 價 格 仍 然 維 持 目 前 每 桶 50 美 元 不 變, 將 足 以 導 致 2005 年 之 後 全 球 經 濟 的 嚴 重 衰 退 27 Elasticity Estimates consumers have little time to adjust the short run Consumers can more fully adjust to a price change the long run. Next slide provides some short-run and long-run price elasticity estimates for selected products 28 14
Selected Price Elasticities of Demand Product Short Run Long Run Cigarettes (among adults) 0.4 Electricity (residential) 0.1 1.9 Air travel 0.1 2.4 Medical care and hospitalization 0.3 0.9 Gasoline 0.4 1.5 Milk 0.4 Fish (cod) 0.5 Wine 0.7 1.2 Movies 0.9 3.7 Natural gas (residential) 1.4 2.1 Automobiles 1.9 2.2 29 Elasticity of Demand and Supply Price Elasticity of Demand Determinants of the Price Elasticity of Demand Price Elasticity of Supply Other Elasticity Measures 2003 South-Western/Thomson Learning 30 15
Price Elasticity of Supply The price elasticity of supply measures how responsive producers are to a price change Price elasticity of supply = percent change in quantity supplied Percentage change in price Higher price usually increased quantity supplied, Percent change in price and the percent change in quantity supplied move in the same direction the price elasticity of supply is usually a positive number Next slide depicts a typical upward-sloping supply curve 31 Figure of Price Elasticity of Supply S If the price increases from p to p', the quantity supplied increases from q to q' p' p The price elasticity of E s, is E s = q (q + q)/2 p (p + p)/ 2 Price per unit Where q is the change in quantity supplied and p is the change in price. 0 q q' Quantity per period 32 16
Categories of Supply Elasticity The terminology for supply elasticity is the same as for demand elasticity If supply elasticity is less than 1.0, supply is inelastic If it equals 1.0, supply is unit elastic If it exceeds 1.0, supply is elastic 33 Constant-Elasticity Supply Curves Perfectly elastic Perfectly inelastic Unit elastic S' Price per unit p E = S S Price per unit E = S 0 Price perunit $10 5 E = S 1 S" 0 Quantity per period 0 Quantity per period Q 0 10 20 Quantity per period Producers will supply none of the good at a price below p. The supply curve is horizontal. There is no change in the quantity supplied regardless of the price. The supply curve is perfectly vertical. Any supply curve that is a straight line from the origin is a unit-elastic supply curve. 34 17
In Class Exercise Why any supply curve that is a straight line from the origin must be a unit-elastic supply curve? Unit elastic Price per unit $10 5 E = S 1 S" 0 10 20 Quantity per period 35 Determinants The elasticity of supply indicates how responsive producers are to a change in price Their responsiveness depends on how easy it is to alter output when price changes If the marginal cost rises sharply higher price will elicit little increase in supplied If the marginal cost rises slowly the lure of a higher price will prompt a large increase in output 36 18
Length of Time Like Demand, supply also becomes more elastic over time as producers adjust to price changes The longer the time period under consideration, the more able producers are to adjust to changes in relative prices See next slide 37 Supply Becomes More Elastic over Time S w is the supply curve when the period of adjustment is a week. Price $1.00 $1.25 Quantity 100 110 S w S m Sy S m is the supply curve when the adjustment period is one month. Here the firms have a greater ability to vary output Price $1.00 $1.25 Quantity 100 140 $1.25 1.00 Price per unit 0 100 140 200 110 Quantity per period Supply is even more elastic when the adjustment period is a year as shown by S y 38 19
新 聞 : 石 油 價 格 由 於 全 球 原 油 供 給 彈 性 ( 註 : 考 慮 伊 拉 克, 墨 西 哥 灣 ) 降 低, 短 期 因 素 對 原 油 價 格 波 動 的 影 響 將 會 增 加, 加 上 全 球 主 要 區 域 ( 中 國 日 本 歐 洲 ) 戰 備 儲 油 提 升, 又 使 原 油 供 需 吃 緊, 因 此 預 期 原 油 將 維 持 高 檔 然 而 從 長 期 而 言, 在 足 夠 可 的 調 整 時 間 情 況, 由 於 新 的 能 源 開 發, 使 得 能 源 替 代 性 以. 及 消 費 偏 好 與 習 慣 的 改 變, 因 而 需 求 彈 性 相 對 提 高, 從 而 價 格 波 動 變 小 39 Elasticity of Demand and Supply Price Elasticity of Demand Determinants of the Price Elasticity of Demand Price Elasticity of Supply Other Elasticity Measures 2003 South-Western/Thomson Learning 40 20
Income Elasticity of Demand The income elasticity of demand measures the percent change in demand divided by the percent change in income Categories of Income Elasticity of Demand Goods with income elasticities less than zero are called inferior goods demand declines when income increases 41 分 析 : 小 孩 是 劣 等 財 嗎? ( 莊 奕 琦 ) 台 灣 人 的 生 育 率 像 自 由 落 體 在 很 短 時 間 內 急 速 下 降, 現 已 在 全 世 界 敬 陪 末 座 民 國 四 十 年, 台 灣 每 位 婦 女 生 7.04 個 小 孩 ; 到 民 國 七 十 該 是 四 十 年 次 婦 女 生 育 的 時 候, 她 們 卻 只 生 2.46 個 到 了 去 年, 生 育 率 更 跌 至 只 有 1.18 個, 連 續 幾 年 創 歷 史 新 低, 更 和 世 界 婦 女 生 育 值 的 2.8 個 差 一 截 隨 著 經 濟 發 展, 不 盡 然 如 馬 爾 薩 斯 所 言, 小 孩 的 個 數 會 增 加, 因 為 當 工 資 普 遍 增 加 時, 婦 女 撫 育 小 孩 的 機 會 成 本 也 增 加, 同 時 教 育 小 孩 的 費 用 亦 提 高 ( 因 在 經 濟 發 展 進 步 的 時 代, 小 孩 反 而 必 須 具 備 更 專 業 的 技 能, 接 受 更 多 的 教 育 ), 凡 此 種 種 均 使 小 孩 的 相 對 價 格 大 幅 上 漲, 其 結 果 反 而 造 成 擁 有 小 孩 的 數 量 減 少 這 正 是 經 濟 因 素 的 力 量 促 使 婦 女 生 育 率 隨 經 濟 發 展 而 普 遍 下 降 的 主 要 原 因 當 然, 如 果 小 孩 的 價 格 持 續 上 漲, 導 致 消 費 者 主 觀 交 換 率 小 於 小 孩 相 對 價 格 ( 即 市 場 客 觀 交 換 率 ), 可 能 會 造 成 最 適 小 孩 個 數 為 零 亦 即 生 小 孩 換 言 之, 不 生 小 孩 也 可 以 是 消 費 者 理 性 的 選 擇, 不 是 不 愛 擁 有 小 孩, 而 是 小 孩 實 在 是 一 種 負 擔 不 起 的 昂 貴 奢 侈 財! 42 21
Categories of Income Elasticity of Demand Normal goods have income elasticities greater than zero demand increases when income increases Normal goods with income elasticities greater than zero but less than 1 are called income inelastic goods demand increases not as much as income does Goods with income elasticity greater than 1 are called income elastic demand increases more than does income does 43 Selected Income Elasticities of Demand Income Income Product Elasticity Product Elasticity Private education 2.46 Physicians services 0.75 Automobiles 2.45 Coca-Cola 0.68 Wine 2.45 Beef 0.62 Owner-occupied housing 1.49 Food 0.51 Furniture 1.48 Coffee 0.51 Dental service 1.42 Cigarettes 0.50 Restaurant meals 1.40 Gasoline and oil 0.48 Shoes 1.10 Rental housing 0.43 Chicken 1.06 Beer 0.27 Spirits ( hard liquor) 1.02 Pork 0.18 Clothing 0.92 Flour 0.36 Both income elasticity of food and the demand of food in inelastic. This results in problems in agriculture markets. 44 22
The Demand for Grain is Price is Inelastic As the market revenues falls, the total revenue falls. Price per bushel $5 4 3 2 1 D 0 5 10 11 Billions of bushels per year 45 The Effect of Increases in Supply and Demand on Farm Revenue Price per bushel $8 4 S S' Supply increases (S S ) Technical advances. Demand increases (D D Income increases. Total effect: Drop in market price and total revenue. D D' 0 5 10 14 Billions of bushels per year 46 23
Cross-Price Elasticity of Demand Since firms often produce an entire line of products, it has a special interest in how a change in the price of one product will affect the demand for another The responsiveness of the demand for one good to changes in the price of another good is called the cross-price elasticity of demand Defined as the percent change in the demand of one good divided by the percent change in the price of another good 47 Substitutes and Complements If an increase in the price of one good leads to an increase in the demand for another good, their cross-price elasticity is positive the two goods are substitutes If an increase in the price of one good leads to a decrease in the demand for another, their cross-price elasticity is negative the two goods are complements Otherwise, two goods are unrelated. (Jump to Appendix 5) 48 24
課 堂 報 告 請 說 明 何 謂 Price Elasticity of Demand, 並 說 明 考 慮 Elasticity 之 下, 價 格 變 動 對 Total revenue 的 影 響 請 說 明 何 謂 demand is inelastic, 請 舉 例 說 明 有 哪 些 商 品 的 quantity demand 逼 近 perfectly inelastic 請 說 明 adjustment period 的 長 度 如 何 影 響 Price Elasticity of Demand 請 說 明 為 什 麼 Price Elasticity of Supply 的 值 通 常 為 正 數 請 定 義 何 謂 cross elasticity of demand, 請 說 明 為 何 substitutes 和 complements 的 elasticity 分 別 為 正 和 負 49 Homework 2. Explain the relationship between the price elasticity of demand and total revenue 10. Compute price elasticity and total revenue 11. Compute the income elasticity of demand 50 25