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Economics

Elasticity

Dept. of Economics @ NCKU


Weng, Ming-Hung
Last-minute ticket (*)
Of which the last-
minute ticket is
relatively more
expensive compared
to its regular level?
Why?
1. Airplane
2. Broadway show
Raising fare vs. revenue
THSR raised its price in 2013
How can THSR be sure if its revenue will go up or
down as suggested by the law of demand?

Cigarette tax for long-term care expenses?


The government is considering to raise cigarette
tax to cover the possible long-term care expenses.
How does the government calculate the possible
tax revenue?
Outlines
Price elasticity of demand
Determinants of price elasticity of demand
Elasticity vs revenue
Other elasticity measures
Tax incidence and elasticity
Elasticities (*)
Suppose the price has increased by both
$100 in market A and market B from $400.
Quantities are down by 1,000 units in
market A and 100 units in market B .
Which market has experienced a bigger
change?
1. A
2. B = =
= =
Elasticities (*)
Suppose the price has increased by both $100
in market A and market B from $400.
Quantities are down by 1,000 units in market
A from 10,000 and down by 100 units in
market B from 200 units. Which market has
experienced a bigger change?
1. A
= ; :
2. B
= ; :
Elasticities
Elasticity
A measure of sensitivity in relative changes
between variables
%, % both matter

Three measures for elasticity of demand:


1. Price elasticity of demand
2. Cross-price elasticity of demand
3. Income elasticity of demand
Price Elasticities of demand
Price elasticities of demand
How sensitively does the quantity demanded of a
good respond to changes in its own price?
%change in quantity demanded
=
%change in own price
If a 5% increase in price caused 10% decrease in
quantity demanded, the price elasticity will be
%
= 2.
%
1% increase in prices causes 2% drop in quantity
Price Elasticities
If price decreased by 20% and as a result the
quantity demanded rose by 15%
=
1. -1.33
2. -0.75
3. 1.33
4. 0.75
Elasticities
Suppose the price has increased by both
$100 in market A and market B from $400.
Quantities are down by 1,000 units in
market A from 10,000 and down by 100
units in market B from 200 units.
=
1. -4
2. -2
3. -0.5
4. -0.25
Elasticities
Suppose the price has increased by both $100 in
market A and market B from $400. Quantities are
down by 1,000 units in market A from 10,000 and
down by 100 units in market B from 200 units.
% %
= = while = = .
% %
Great magnitude of elasticity, , implies greater
relative change in quantity demanded for the
same % change in price, or smaller relative price
change from the same % change in quantity.
Price Elasticities
is usually referred to when seeing positive
price elasticity
> 1: elastic demand (relative change in
Q is bigger than that in P)
< 1: inelastic demand
= 1: unit elastic demand
= : perfectly elastic demand
= 0: perfectly inelastic demand
Elasticity of cigarette
A research report on cigarette consumption
(1971-2000) in Taiwan claimed if the price of
cigarettes increased by 1%, its consumption
would reduce by 0.8%. Accordingly the
demand for cigarette is considered
1. Elastic
2. Inelastic
3. Unit elastic
Determinants of elasticity (*)

*Which good is
less elastic?

Exhibit 5.13 Examples of Various Price Elasticities

2015 Pearson Education, Ltd.


Determinants of elasticity

Determinants of elasticity: (the more elastic, if)


Number and closeness of substitutes
Budget share spent on the good
Time horizon available to adjust to price changes
Price Elasticities
Determinants of elasticity: (the more elastic, )
Number and closeness of substitutes
Budget share spent on the good
Time horizon available to adjust to price changes

The price elasticity measured within a _____ is


more elastic
1. month
2. year
3. decade
Price Elasticities
Which category of oil is more elastic? (In which
case would you be more able to adjust if its
price goes up?)

1. Olive oil
2. Vegetable oil (including olive oil + other
vegie oil.)
3. Cooking oil (including vegie oil and other
kinds of cooking oil.)
Cigarette elasticity
A research report on cigarette consumption
(1971-2000) in Taiwan claimed that the price
elasticity coefficients for domestic and
imported cigarettes were 0.644 and 0.822
respectively. Why?
Elasticities
%change in quantity demanded
=
%change in own price

Great magnitude of elasticity, , implies


greater relative change in quantity demanded
for the same % change in price, or smaller
relative price change from the same %
change in quantity.
Last-minute ticket
Why are last-minute
airplane tickets so
expensive?

While last-minute
Broadway show tickets
are so cheap?
2015 Pearson Education, Ltd.
Elasticities versus revenue/spending (*)
If the price of olive oil goes down due to lower
exchange rate of Euros against NTD, will we
spend more or less on olive oil?
1. More
2. Less
3. Not sure
Elasticities versus revenue/spending
Spending=pricequantity consumed %
Spending = =
%
If (Similarly for increase in price)
the dominating force?(greater relative change)
if elastic; (ex: 20% price drop causes 30% quantity
jump)
if inelastic; (ex: 20% price drop causes 4% quantity
increase)
Elasticities versus revenue/spending
If demand for gasoline is inelastic, during
the price hike of gasoline, we spend
_________ on gasoline
1. More
2. Less
3. Not sure
Fare for THSR
THSR raised its price in 2013. If its revenue
increases by 8% afterwards, its demand is
considered
1. elastic.
2. unitary elastic.
3. inelastic.
4. neither elastic nor inelastic.
Cigarette tax for long-term care
expenses?
Tax revenue from cigarette tax?
Annual consumption 1.8 billion packs, average
price is $80, = . .
$20 increase is 25% in price,
Reduction in consumption will be 20%=25x0.8
after tax consumption will be 1.8 0.8 =
1.44 billion packs, contributing 28.8 billion NT.
Can so much revenue be collected?
Cross-Price Elasticity
Cross-Price Elasticities
How sensitively does the quantity
demanded of good A respond to the good
Bs price changes? (along with a change in
quantity demanded for good B in a reverse
way)

%change in quantity demanded of A


=
%change in price of B
Cross-Price Elasticities
> 0: substitutes
causing (along with )
(price elasticity 0 as Q goes to its substitutes)

< 0: complements
causing (along with )
(Goods always consumed together, moving in the
same direction)

~0: unrelated
Cross-Price Elasticity
Which pair of commodities are closer substitutes?
1. A. 2. B. 3. C. 4. D. 5. E

2015 Pearson Education, Ltd.


Cross-Price Elasticity
Which pair of commodities are closer complements?
1. A. 2. B. 3. C. 4. D. 5. E

2015 Pearson Education, Ltd.


Income Elasticity
Income elasticities
How sensitively does the quantity
demanded respond to the changes in the
consumers income?

%change in quantity demanded


=
%change in
Income Elasticity
%change in quantity demanded
=
%change in

0: normal goods
> 1: luxury goods (getting bigger share when
income goes up)
< 1: necessity goods (getting smaller share
when income goes up)

< 0: inferior goods


Income Elasticity
Which commodity is an inferior good?
1. A. 2. B. 3. C.

2015 Pearson Education, Ltd.


price elasticity of supply
How responsive producers are to changes in
the market price
Elasticity of supply will be greater (if the firm
can make more change when) :
The more inventory the firm has
The more easily the firm can hire workers
The longer the time horizon
price elasticity of supply
Tax incidence and elasticity
Tax incidence and elasticity
If supply is perfectly
elastic as the long
run supply of
+ + competitive market,
tax (subsidy)
incidence is fully
borne (enjoyed) by
consumers


Tax incidence and elasticity
If supply is perfectly

inelastic, tax
(subsidy) incidence is
fully borne (enjoyed)
by sellers.


Tax incidence and elasticity
+ Tax incidence
depends on relative
+ elasticity of S/D. The
(demand) side that is
relatively more
elastic bears less tax
burden.

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