“본 강의자료는 연세대학교 학생들을 위해 수업목적으로 제작ㆍ게시된 것이므로

Elasticity
and
수업목적 외 용도로 사용할 수 없으며, 다른 사람들과 공유할 수 없습니다. 위반에
따른 법적 책임은 행위자 본인에게 있습니다.”

its Application
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ⓒ 2009 South-Western, a part of Cengage Learning, all rights reserved

1

A scenario… Elasticity
You design websites for local businesses.  Basic idea:
You charge $200 per website, Elasticity measures how much one variable
and currently sell 12 websites per month. responds to changes in another variable.
 One type of elasticity measures how much
Your costs are rising demand for your websites will fall if you raise
(including the opportunity cost of your time), your price.
so you consider raising the price to $250.
 Definition:
The law of demand says that you won’t sell as Elasticity is a numerical measure of the
many websites if you raise your price. responsiveness of Qd or Qs to one of its
How many fewer websites? How much will your determinants.
revenue fall, or might it increase?
2 ELASTICITY AND ITS APPLICATION 3
 Price Elasticity of Demand Price Elasticity of Demand
Price elasticity Percentage change in Qd Price elasticity Percentage change in Qd
= =
of demand Percentage change in P of demand Percentage change in P
P
 Price elasticity of demand measures how Example:
much Qd responds to a change in P. P rises
Price elasticity by 10%
P2

 Loosely speaking, it measures the price- of demand P1

equals
sensitivity of buyers’ demand. D
15% Q
= 1.5 Q2 Q1
10%
Q falls
by 15%
ELASTICITY AND ITS APPLICATION 4 ELASTICITY AND ITS APPLICATION 5

Price Elasticity of Demand Calculating Percentage Changes

Price elasticity Percentage change in Qd Standard method
= of computing the
of demand Percentage change in P
Demand for percentage (%) change:
P your websites
Along a D curve, P and Q end value – start value
P x 100%
move in opposite directions, P2 start value
which would make price B
P1 $250
elasticity negative. A Going from A to B,
D $200 the % change in P equals
We will drop the minus sign
and report all price D
Q ($250–$200)/$200 = 25%
elasticities as Q2 Q1 Q
positive numbers. 8 12

ELASTICITY AND ITS APPLICATION 6 ELASTICITY AND ITS APPLICATION 7

 Calculating Percentage Changes Calculating Percentage Changes
Problem:  So, we instead use the midpoint method:
The standard method gives
different answers depending end value – start value
Demand for x 100%
your websites on where you start. midpoint
P
From A to B,  The midpoint is the number halfway between
B P rises 25%, Q falls 33%, the start & end values, the average of those
$250
A elasticity = 33/25 = 1.33 values.
$200
From B to A,  It doesn’t matter which value you use as the
D
P falls 20%, Q rises 50%, “start” and which as the “end” – you get the
Q elasticity = 50/20 = 2.50 same answer either way!
8 12

ELASTICITY AND ITS APPLICATION 8 ELASTICITY AND ITS APPLICATION 9

Calculating Percentage Changes ACTIVE LEARNING 1

 Using the midpoint method, the % change Calculate an elasticity
in P equals Use the following
$250 – $200 information to
x 100% = 22.2% calculate the
$225
price elasticity
 The % change in Q equals of demand
12 – 8 for hotel rooms:
x 100% = 40.0%
10 if P = $70, Qd = 5000
 The price elasticity of demand equals if P = $90, Qd = 3000
40/22.2 = 1.8

ELASTICITY AND ITS APPLICATION 10 11

 ACTIVE LEARNING 1 What determines price elasticity?
Answers To learn the determinants of price elasticity,
Use midpoint method to calculate we look at a series of examples.
% change in Qd Each compares two common goods.
(5000 – 3000)/4000 = 50% In each example:

% change in P
 Suppose the prices of both goods rise by 20%.
 The good for which Qd falls the most (in percent)
($90 – $70)/$80 = 25% has the highest price elasticity of demand.
The price elasticity of demand equals Which good is it? Why?
 What lesson does the example teach us about the
50%
= 2.0 determinants of the price elasticity of demand?
25%
12 ELASTICITY AND ITS APPLICATION 13

EXAMPLE 1: EXAMPLE 2:
Breakfast cereal vs. Sunscreen “Blue Jeans” vs. “Clothing”
 The prices of both of these goods rise by 20%.  The prices of both goods rise by 20%.
For which good does Qd drop the most? Why? For which good does Qd drop the most? Why?
 Breakfast cereal has close substitutes  For a narrowly defined good such as
(e.g., pancakes, Eggo waffles, leftover pizza), blue jeans, there are many substitutes
so buyers can easily switch if the price rises. (khakis, shorts, Speedos).

 Sunscreen has no close substitutes,  There are fewer substitutes available for
broadly defined goods.
so consumers would probably not
(There aren’t too many substitutes for clothing,
buy much less if its price rises.
other than living in a nudist colony.)
 Lesson: Price elasticity is higher when close  Lesson: Price elasticity is higher for narrowly
substitutes are available. defined goods than broadly defined ones.
ELASTICITY AND ITS APPLICATION 14 ELASTICITY AND ITS APPLICATION 15
EXAMPLE 3: EXAMPLE 4:
Insulin vs. Caribbean Cruises Gasoline in the Short Run vs. Gasoline
 The prices of both of these goods rise by 20%. in the Long Run
For which good does Qd drop the most? Why?  The price of gasoline rises 20%. Does Qd drop
 To millions of diabetics, insulin is a necessity. more in the short run or the long run? Why?
A rise in its price would cause little or no  There’s not much people can do in the
decrease in demand. short run, other than ride the bus or carpool.
 A cruise is a luxury. If the price rises,  In the long run, people can buy smaller cars
some people will forego it. or live closer to where they work.
 Lesson: Price elasticity is higher for luxuries  Lesson: Price elasticity is higher in the
than for necessities. long run than the short run.

ELASTICITY AND ITS APPLICATION 16 ELASTICITY AND ITS APPLICATION 17

The Determinants of Price Elasticity: The Variety of Demand Curves

A Summary
 The price elasticity of demand is closely related
The price elasticity of demand depends on: to the slope of the demand curve.
 the extent to which close substitutes are  Rule of thumb:
available The flatter the curve, the bigger the elasticity.
 whether the good is a necessity or a luxury The steeper the curve, the smaller the elasticity.
 how broadly or narrowly the good is defined  Five different classifications of D curves.…
 the time horizon – elasticity is higher in the
long run than the short run

ELASTICITY AND ITS APPLICATION 18 ELASTICITY AND ITS APPLICATION 19

“Perfectly inelastic demand” (one extreme case) “Inelastic demand”
Price elasticity % change in Q 0% Price elasticity % change in Q < 10%
= = =0 = = <1
of demand % change in P 10% of demand % change in P 10%

D curve: P
D D curve: P
vertical relatively steep
P1 P1
Consumers’ Consumers’
price sensitivity: P2 price sensitivity: P2
none relatively low D
P falls Q P falls Q
Elasticity: by 10% Q1 Elasticity: by 10% Q1 Q2
0 Q changes
<1
Q rises less
by 0% than 10%
ELASTICITY AND ITS APPLICATION 20 ELASTICITY AND ITS APPLICATION 21

“Unit elastic demand” “Elastic demand”

Price elasticity % change in Q 10% Price elasticity % change in Q > 10%
= = =1 = = >1
of demand % change in P 10% of demand % change in P 10%

D curve: P D curve: P
intermediate slope relatively flat
P1 P1
Consumers’ Consumers’
price sensitivity: P2 price sensitivity: P2 D
intermediate D relatively high
P falls Q P falls Q
Elasticity: by 10% Q1 Q2 Elasticity: by 10% Q1 Q2
1 >1
Q rises by 10% Q rises more
than 10%
ELASTICITY AND ITS APPLICATION 22 ELASTICITY AND ITS APPLICATION 23
“Perfectly elastic demand” (the other extreme) Elasticity of a Linear Demand Curve
Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0% P The slope
200% of a linear
$30 E = = 5.0
D curve: P 40% demand
horizontal curve is
67%
P2 = P1 D 20 E = = 1.0 constant,
Consumers’ 67%
price sensitivity: but its
40%
extreme 10 E = = 0.2 elasticity
200%
is not.
P changes Q
Elasticity: by 0% Q1 Q2 $0 Q
infinity 0 20 40 60
Q changes
by any %
ELASTICITY AND ITS APPLICATION 24 ELASTICITY AND ITS APPLICATION 25

Price Elasticity and Total Revenue Price Elasticity and Total Revenue
 Continuing our scenario, if you raise your price
Price elasticity Percentage change in Q
from $200 to $250, would your revenue rise or fall? =
of demand Percentage change in P
Revenue = P x Q
 A price increase has two effects on revenue: Revenue = P x Q
 Higher P means more revenue on each unit  If demand is elastic, then
you sell.
price elast. of demand > 1
 But you sell fewer units (lower Q),
% change in Q > % change in P
due to Law of Demand.
 Which of these two effects is bigger?  The fall in revenue from lower Q is greater
It depends on the price elasticity of demand. than the increase in revenue from higher P,
so revenue falls.
ELASTICITY AND ITS APPLICATION 26 ELASTICITY AND ITS APPLICATION 27
 Price Elasticity and Total Revenue Price Elasticity and Total Revenue
Elastic demand increased Price elasticity Percentage change in Q
(elasticity = 1.8) revenue due =
P lost of demand Percentage change in P
to higher P
If P = $200, revenue
due to Revenue = P x Q
Q = 12 and
$250 lower Q
 If demand is inelastic, then
revenue = $2400. price elast. of demand < 1
$200 % change in Q < % change in P
If P = $250, D
Q = 8 and  The fall in revenue from lower Q is smaller
revenue = $2000. than the increase in revenue from higher P,
When D is elastic, Q so revenue rises.
8 12
a price increase  In our example, suppose that Q only falls to 10
causes revenue to fall. (instead of 8) when you raise your price to $250.
ELASTICITY AND ITS APPLICATION 28 ELASTICITY AND ITS APPLICATION 29

Price Elasticity and Total Revenue ACTIVE LEARNING 2

Now, demand is Elasticity and expenditure/revenue
increased
inelastic:
revenue due A. Pharmacies raise the price of insulin by 10%.
elasticity = 0.82 P to higher P lost
revenue Does total expenditure on insulin rise or fall?
If P = $200,
due to
Q = 12 and B. As a result of a fare war, the price of a luxury
$250 lower Q
revenue = $2400. cruise falls 20%.
If P = $250, $200 Does luxury cruise companies’ total revenue
Q = 10 and D rise or fall?
revenue = $2500.
When D is inelastic, Q
a price increase 10 12
causes revenue to rise.
ELASTICITY AND ITS APPLICATION 30 31
 ACTIVE LEARNING 2 ACTIVE LEARNING 2
Answers Answers
A. Pharmacies raise the price of insulin by 10%. B. As a result of a fare war, the price of a luxury
Does total expenditure on insulin rise or fall? cruise falls 20%.
Does luxury cruise companies’ total revenue
Expenditure = P x Q
rise or fall?
Since demand is inelastic, Q will fall less
Revenue = P x Q
than 10%, so expenditure rises.
The fall in P reduces revenue,
but Q increases, which increases revenue.
Which effect is bigger?
Since demand is elastic, Q will increase more
than 20%, so revenue rises.
32 33

Price Elasticity of Supply Price Elasticity of Supply

Price elasticity Percentage change in Qs Price elasticity Percentage change in Qs
= =
of supply Percentage change in P of supply Percentage change in P

 Price elasticity of supply measures how much Example:

P
S
Qs responds to a change in P. P rises
Price P2
by 8%
 Loosely speaking, it measures sellers’ elasticity P1
price-sensitivity. of supply
 Again, use the midpoint method to compute the equals
Q
percentage changes. 16% Q1 Q2
= 2.0
8% Q rises
by 16%
ELASTICITY AND ITS APPLICATION 34 ELASTICITY AND ITS APPLICATION 35
 The Variety of Supply Curves “Perfectly inelastic” (one extreme)
Price elasticity % change in Q 0%
 The slope of the supply curve is closely related to = = =0
of supply % change in P 10%
price elasticity of supply.
 Rule of thumb: S curve: P
S
The flatter the curve, the bigger the elasticity. vertical
The steeper the curve, the smaller the elasticity. P2
Sellers’
 Five different classifications.… price sensitivity: P1
none
P rises Q
Elasticity: by 10% Q1
0
Q changes
by 0%
ELASTICITY AND ITS APPLICATION 36 ELASTICITY AND ITS APPLICATION 37

“Inelastic” “Unit elastic”

Price elasticity % change in Q < 10% Price elasticity % change in Q 10%
= = <1 = = =1
of supply % change in P 10% of supply % change in P 10%

S curve: P S curve: P
S S
relatively steep intermediate slope
P2 P2
Sellers’ Sellers’
price sensitivity: P1 price sensitivity: P1
relatively low intermediate
P rises Q P rises Q
Elasticity: by 10% Q1 Q2 Elasticity: by 10% Q1 Q2
<1 =1
Q rises less Q rises
than 10% by 10%
ELASTICITY AND ITS APPLICATION 38 ELASTICITY AND ITS APPLICATION 39
“Elastic” “Perfectly elastic” (the other extreme)
Price elasticity % change in Q > 10% Price elasticity % change in Q any %
= = >1 = = = infinity
of supply % change in P 10% of supply % change in P 0%

S curve: P S curve: P
relatively flat S horizontal
P2 P2 = P1 S
Sellers’ Sellers’
price sensitivity: P1 price sensitivity:
relatively high extreme
P rises Q P changes Q
Elasticity: by 10% Q1 Q2 Elasticity: by 0% Q1 Q2
>1 infinity
Q rises more Q changes
than 10% by any %
ELASTICITY AND ITS APPLICATION 40 ELASTICITY AND ITS APPLICATION 41

The Determinants of Supply Elasticity ACTIVE LEARNING 3

 The more easily sellers can change the quantity Elasticity and changes in equilibrium
they produce, the greater the price elasticity of  The supply of beachfront property is inelastic.
supply. The supply of new cars is elastic.
 Example: Supply of beachfront property is  Suppose population growth causes
harder to vary and thus less elastic than demand for both goods to double
supply of new cars. (at each price, Qd doubles).
 For many goods, price elasticity of supply  For which product will P change the most?
is greater in the long run than in the short run,
because firms can build new factories,  For which product will Q change the most?
or new firms may be able to enter the market.

ELASTICITY AND ITS APPLICATION 42 43

 ACTIVE LEARNING 3 ACTIVE LEARNING 3
Answers Answers
Beachfront property New cars
When supply (inelastic supply): When supply (elastic supply):
is inelastic, P is elastic, P
an increase in an increase in
demand has a D1 D2 S demand has a D1 D2
bigger impact bigger impact S
on price than P2 B on quantity
on quantity. than on price. B
P2
A
P1 A P1

Q Q
Q1 Q2 Q1 Q2
44 45

How the Price Elasticity of Supply Can Vary APPLICATION: Does Drug Interdiction Increase
or Decrease Drug-Related Crime?
P Supply often  One side effect of illegal drug use is crime:
S
becomes Users often turn to crime to finance their habit.
elasticity
$15 <1 less elastic  We examine two policies designed to reduce
as Q rises, illegal drug use and see what effects they have
12 due to on drug-related crime.
elasticity capacity
>1 limits.
 For simplicity, we assume the total dollar value
4 of drug-related crime equals total expenditure
$3 on drugs.
Q
100 200
500 525
 Demand for illegal drugs is inelastic, due to
addiction issues.
ELASTICITY AND ITS APPLICATION 46 ELASTICITY AND ITS APPLICATION 47
 Policy 1: Interdiction Policy 2: Education
Interdiction new value of drug- new value of drug-
reduces Price of related crime Education Price of related crime
the supply Drugs S2 reduces the Drugs
D1
of drugs. S1 demand for D2 D1
drugs. S
Since demand P2
for drugs is P and Q fall.
inelastic, initial value initial value
P1 P1
P rises propor- of drug- Result: of drug-
tionally more related A decrease in P2 related
than Q falls. crime total spending crime

Result: an increase in on drugs, and

Q2 Q1 Quantity in drug-related Q2 Q1 Quantity
total spending on drugs, of Drugs of Drugs
and in drug-related crime crime.

ELASTICITY AND ITS APPLICATION 48 ELASTICITY AND ITS APPLICATION 49