Elasticity and its Application 5 Elasticity and its Application Economics P R I N C I P L E S O F N. Gregory Mankiw The elasticity chapter in most principles textbooks is fairly technical, and is not always students’ favorite. This PowerPoint chapter contains several special features designed to engage and motivate students to learn this important material. First, we consider a scenario in which students face a business decision – whether to raise the price of a service they sell. This scenario is used to illustrate the effects of raising price on number of units sold and on revenue, which students immediately recognize as critical to the business decision. Second, instead of merely listing the determinants of elasticity, students are asked to think about some concrete examples and deduce from each one a lesson about the determinants of elasticity. Third, instead of putting the applications at the end of the chapter (as in the textbook), this PowerPoint includes one of them immediately after the section on price elasticity of demand. This helps break up what would otherwise be a long stretch of theory. Please be assured that this PowerPoint presentation is, nonetheless, very consistent with the textbook’s approach. Premium PowerPoint Slides by Ron Cronovich

In this chapter, look for the answers to these questions: What is elasticity? What kinds of issues can elasticity help us understand? 탄력성이란? 탄력성은 어떤 문제를 이해하는 데 도움이 되는가? What is the price elasticity of demand?수요의 가격탄력성은? How is it related to the demand curve?수요곡선과는 어떤 관계? How is it related to revenue & expenditure?수입, 지출과는 어떤 관계? What is the price elasticity of supply?공급의 가격탄력성은? How is it related to the supply curve?공급곡선과는 어떤 관계? What are the income and cross-price elasticities of demand? 수요의 소득탄력성과 교차탄력성은? 1

You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. 당신은 지역 기업체를 위해 웹사이트를 디자인한다. 웹사이트당 200달러를 받으며 한 달에 12개의 웹사이트를 판매한다. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to $250. 비용(당신의 시간의 기회비용을 포함하여)이 증대하여 당신은 가격을 250달러로 올리는 것을 고려 중이다. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase? 수요의 법칙은 만약 당신이 가격을 올리면 예전에 팔던 만큼은 웹사이트를 팔지 못할 것이라는 것을 말해준다. 판매는 얼마나 줄 것이며 당신의 수입은 얼마나 감소하거나 증가할 것인가? A scenario… We will follow this scenario throughout the first section of this chapter (the section on price elasticity of demand) to illustrate and motivate several important concepts, such as the impact of price changes on sales and revenue. 2 2

Elasticity Basic idea: 기본적인 아이디어 Elasticity measures how much one variable responds to changes in another variable. 탄력성은 한 변수가 다른 한 변수의 변화에 얼마나 많이 반응하는가를 측정한다. One type of elasticity measures how much demand for your websites will fall if you raise your price. (예컨대)탄력성의 한 유형은 만약 당신이 가격을 올리면 당신의 웹사이트에 대한 수요가 얼마나 감소할 것인가를 측정한다. Definition: 정의 Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants. 탄력성은 수요량과 공급량이 그 결정변수의 변화에 대해 반응하는 정도를 수치로 측정한 것이다. Here, Qd and Qs are short for quantity demanded and quantity supplied, as in the PowerPoint for Chapter 4. ELASTICITY AND ITS APPLICATION 3

Price Elasticity of Demand수요의 가격탄력성 Price elasticity of demand = Percentage change in Qd수요량의 변화율 Percentage change in P가격의 변화율 Price elasticity of demand measures how much Qd responds to a change in P. 수요의 가격탄력성은 가격의 변화에 수요량이 얼마나 많이 반응하는가를 측정 Loosely speaking, it measures the price-sensitivity of buyers’ demand. 말하자면 그것은 구매자 수요의 가격 민감도를 측정한다. ELASTICITY AND ITS APPLICATION 4

Price Elasticity of Demand Price elasticity of demand = Percentage change in Qd Percentage change in P P Q Example: D P rises by 10% Price elasticity of demand equals P2 Q2 P1 Q1 15% 10% = 1.5 Q falls by 15% ELASTICITY AND ITS APPLICATION 5

Price Elasticity of Demand Price elasticity of demand = Percentage change in Qd Percentage change in P P Q Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. 수요곡선에서 P와 Q는 반대방향으로 움직이므로 가격탄력성은 음수가 된다. We will drop the minus sign and report all price elasticities as positive numbers. 음수 부호를 없애고 모든 가격탄력성을 양수로 표현한다. D P2 Q2 P1 Q1 It might be worth explaining to your students that “P and Q move in opposite directions” means that the percentage change in Q and the percentage change in P will have opposite signs, thus implying a negative price elasticity. To be consistent with the text, the last statement in the green box says that we will report all price elasticities as positive numbers. It might be slightly more accurate to say that we will report all elasticities as non-negative numbers: we want to allow for the (admittedly rare) case of zero elasticity. ELASTICITY AND ITS APPLICATION 6

Calculating Percentage Changes변화율의 계산 Standard method of computing the percentage (%) change: 변화율 계산의 표준적 방법 Demand for your websites end value – start value start value x 100% P Q $250 8 B D Going from A to B, the % change in P equals $200 12 A ($250–$200)/$200 = 25% ELASTICITY AND ITS APPLICATION 7

Calculating Percentage Changes Problem: The standard method gives different answers depending on where you start. 표준적 방법은 어디에서 출발하느냐에 따라 답이 달라진다. Demand for your websites P Q From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50 $250 8 B D $200 12 A ELASTICITY AND ITS APPLICATION 8

Calculating Percentage Changes So, we instead use the midpoint method: 대신 중간점 계산법을 사용 end value – start value midpoint x 100% The midpoint is the number halfway between the start & end values, the average of those values. 중간점이란 출발점과 도착점 값의 중간 값으로 두 값의 평균이다. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way! 중간 값 계산법을 사용하면 어떤 점을 출발점으로 하든 동일한 답을 얻게 된다. ELASTICITY AND ITS APPLICATION 9

Calculating Percentage Changes Using the midpoint method, the % change in P equals $250 – $200 $225 x 100% = 22.2% The % change in Q equals 12 – 8 10 x 100% = 40.0% These calculations are based on the example shown a few slides back: points A and B on the website demand curve. The price elasticity of demand equals 40/22.2 = 1.8 ELASTICITY AND ITS APPLICATION 10

A C T I V E L E A R N I N G 1 Calculate an elasticity Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Qd = 5000 if P = $90, Qd = 3000 11

A C T I V E L E A R N I N G 1 Answers Use midpoint method to calculate % change in Qd (5000 – 3000)/4000 = 50% % change in P ($90 – $70)/$80 = 25% The price elasticity of demand equals 50% 25% = 2.0 12

What determines price elasticity?탄력성의 결정요인 To learn the determinants of price elasticity, we look at a series of examples. Each compares two common goods. 탄력성의 결정요인들을 알아보기 위해, 우리는 일련의 예들을 살펴 볼 것이다. 각 예는 두 개의 보통 재화를 비교한다. In each example: 각 예에서 Suppose the prices of both goods rise by 20%. 두 재화의 가격이 20%씩 상승했다고 가정 The good for which Qd falls the most (in percent) has the highest price elasticity of demand. Which good is it? Why? 수요량이 (비율상) 많이 감소한 재화의 탄력성이 크다. 어떤 재화의 탄력성이 크며, 왜인가? What lesson does the example teach us about the determinants of the price elasticity of demand? 예는 수요의 가격탄력성의 결정요인에 대해 무엇을 가르쳐주는가? In essence, the textbook says “Here are the determinants of elasticity. The first one is availability of close substitutes. Here’s an example….” That’s great for a textbook. For teaching, I’ve found a different approach to be far more effective: having students deduce the general lessons from specific examples they can figure out using common sense. This is the approach on the next few slides. Also, see notes on the next slide for a good suggestion. ELASTICITY AND ITS APPLICATION 13

EXAMPLE 1: Breakfast cereal vs. Sunscreen 아침식사용 시리얼과 자외선차단제 The prices of both of these goods rise by 20%. For which good does Qd drop the most? Why? Breakfast cereal has close substitutes 시리얼은 대체재가 많다. (e.g., pancakes, Eggo waffles, leftover pizza), so buyers can easily switch if the price rises. Sunscreen has no close substitutes, so consumers would probably not buy much less if its price rises. 자외선 차단제는 밀접한 대체재가 없어서 소비자들은 가격이 올라도 구매량을 많이 줄일 수 없을 것이다. Lesson: Price elasticity is higher when close substitutes are available.가격탄력성은 밀접한 대체재를 찾을 수 있을 경우 더 크다. Suggestion: For each of these examples, display the slide title (which lists the two goods) and the first two lines of text (which ask which good experiences the biggest drop in demand in response to a 20% price increase). Give your students a quiet minute to formulate their answers. Then, ask for volunteers. ELASTICITY AND ITS APPLICATION 14

EXAMPLE 2: “Blue Jeans” vs. “Clothing”청바지와 옷 The prices of both goods rise by 20%. For which good does Qd drop the most? Why? For a narrowly defined good such as blue jeans, there are many substitutes (khakis, shorts, Speedos). 청바지처럼 좁게 정의된 재화에는 많은 대체재가 존재 There are fewer substitutes available for broadly defined goods. 넓게 정의된 재화에는 대체재가 거의 없다. (There aren’t too many substitutes for clothing, other than living in a nudist colony.옷을 대체할 수 있는 것은 나체촌에 살지 않는 한 찾기 힘들다) Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones. 가격탄력성은 넓게 정의된 재화보다는 좁게 정의된 재화에서 더 크다. You might need to clarify the nature of this thought experiment. Here, we look at two alternate scenarios. In the first, the price of blue jeans (and no other clothing) rises by 20%, and we observe the percentage decrease in quantity of blue jeans demanded. In the second scenario, the price of all clothing rises by 20%, and we observe the percentage decrease in demand for all clothing. ELASTICITY AND ITS APPLICATION 15

EXAMPLE 3: Insulin vs. Caribbean Cruises 인슐린과 카리브해의 크루즈 The prices of both of these goods rise by 20%. For which good does Qd drop the most? Why? To millions of diabetics, insulin is a necessity. A rise in its price would cause little or no decrease in demand. 수백만의 당뇨환자에게 인슐린은 필수재다. 인슐린 가격의 상승은 수요를 거의 감소시키지 못한다. A cruise is a luxury. If the price rises, some people will forego it. 크루즈는 사치재이다. 가격이 오르면 일부는 그것을 단념한다. Lesson: Price elasticity is higher for luxuries than for necessities. 가격탄력성은 필수재보다는 사치재에서 더 크다. ELASTICITY AND ITS APPLICATION 16

EXAMPLE 4: Gasoline in the Short Run vs EXAMPLE 4: Gasoline in the Short Run vs. Gasoline in the Long Run 단기에서의 휘발유와 장기에서의 휘발유 The price of gasoline rises 20%. Does Qd drop more in the short run or the long run? Why? There’s not much people can do in the short run, other than ride the bus or carpool. 단기에서는 버스를 타거나 카풀을 하는 것 이외에 대처할 수 있는 방법이 없다. In the long run, people can buy smaller cars or live closer to where they work. 장기에는 사람들은 더 작은 차를 사거나 직장에서 더 가까운 곳으로 이사를 할 수 있다. Lesson: Price elasticity is higher in the long run than the short run. 가격탄력성은 단기보다 장기에 더 크다. ELASTICITY AND ITS APPLICATION 17

The Determinants of Price Elasticity: A Summary The price elasticity of demand depends on: the extent to which close substitutes are available whether the good is a necessity or a luxury how broadly or narrowly the good is defined the time horizon – elasticity is higher in the long run than the short run This slide is a convenience for your students, and replicates a similar table from the text. If you’re pressed for time, it is probably safe to omit this slide from your presentation. ELASTICITY AND ITS APPLICATION 18

The Variety of Demand Curves다양한 수요곡선 The price elasticity of demand is closely related to the slope of the demand curve. 수요의 가격탄력성은 수요곡선의 기울기와 밀접한 관계가 있다. Rule of thumb: 대략 말하자면 The flatter the curve, the bigger the elasticity. The steeper the curve, the smaller the elasticity. 수요곡선이 평평할수록 탄력성이 크며, 가파를수록 탄력성이 작다. Five different classifications of D curves.… Economists classify demand curves according to their elasticity. The next 5 slides present the five different classifications, from least to most elastic. ELASTICITY AND ITS APPLICATION 19

“Perfectly inelastic demand” (one extreme case) Price elasticity of demand = % change in Q % change in P 0% = 0 10% D curve: P Q D vertical Q1 P1 Consumers’ price sensitivity: P2 none If Q doesn’t change, then the percentage change in Q equals zero, and thus elasticity equals zero. It is hard to think of a good for which the price elasticity of demand is literally zero. Take insulin, for example. A sufficiently large price increase would probably reduce demand for insulin a little, particularly among people with very low incomes and no health insurance. However, if elasticity is very close to zero, then the demand curve is almost vertical. In such cases, the convenience of modeling demand as perfectly inelastic probably outweighs the cost of being slightly inaccurate. P falls by 10% Elasticity: 완전비탄력적 수요 Q changes by 0% ELASTICITY AND ITS APPLICATION 20

“Inelastic demand”비탄력적 수요 Price elasticity of demand = % change in Q % change in P < 10% < 1 10% D D curve: P Q relatively steep Q1 P1 Consumers’ price sensitivity: P2 Q2 relatively low An example: Student demand for textbooks that their professors have required for their courses. Here, it’s a little more clear that elasticity would be small, but not zero. At a high enough price, some students will not buy their books, but instead will share with a friend, or try to find them in the library, or just take copious notes in class. Another example: Gasoline in the short run. P falls by 10% Elasticity: < 1 Q rises less than 10% ELASTICITY AND ITS APPLICATION 21

“Unit elastic demand”단위탄력적 수요 Price elasticity of demand = % change in Q % change in P 10% = 1 10% D D curve: P Q intermediate slope Q1 P1 Consumers’ price sensitivity: P2 Q2 intermediate This is the intermediate case: the demand curve is neither relatively steep nor relatively flat. Buyers are neither relatively price-sensitive nor relatively insensitive to price. (This is also the case where price changes have no effect on revenue.) P falls by 10% Elasticity: 1 Q rises by 10% ELASTICITY AND ITS APPLICATION 22

“Elastic demand” 탄력적 수요 Price elasticity of demand = % change in Q % change in P > 10% > 1 10% D D curve: P Q relatively flat Q1 P1 Consumers’ price sensitivity: P2 Q2 relatively high A good example here would be breakfast cereal, or nearly anything with readily available substitutes. An elastic demand curve is flatter than a unit elastic demand curve (which itself is flatter than an inelastic demand curve). P falls by 10% Elasticity: > 1 Q rises more than 10% ELASTICITY AND ITS APPLICATION 23

“Perfectly elastic demand” (the other extreme) Price elasticity of demand = % change in Q % change in P any % = infinity 0% D curve: P Q horizontal P2 = P1 D Consumers’ price sensitivity: Q1 Q2 “Extreme price sensitivity” means the tiniest price increase causes demand to fall to zero. “Q changes by any %” – when the D curve is horizontal, quantity cannot be determined from price. Consumers might demand Q1 units one month, Q2 units another month, and some other quantity later. Q can change by any amount, but P always “changes by 0%” (i.e., doesn’t change). If perfectly inelastic is one extreme, this case (perfectly elastic) is the other. Here’s a good real-world example of a perfectly elastic demand curve, which foreshadows an upcoming chapter on firms in competitive markets. Suppose you run a small family farm in Iowa. Your main crop is wheat. The demand curve in this market is downward-sloping, and the market demand and supply curves determine the price of wheat. Suppose that price is $5/bushel. Now consider the demand curve facing you, the individual wheat farmer. If you charge a price of $5, you can sell as much or as little as you want. If you charge a price even just a little higher than $5, demand for YOUR wheat will fall to zero: Buyers would not be willing to pay you more than $5 when they could get the same wheat elsewhere for $5. Similarly, if you drop your price below $5, then demand for YOUR wheat will become enormous (not literally infinite, but “almost infinite”): if other wheat farmers are charging $5 and you charge less, then EVERY buyer will want to buy wheat from you. Why is the demand curve facing an individual producer perfectly elastic? Recall that elasticity is greater when lots of close substitutes are available. In this case, you are selling a product that has many perfect substitutes: the wheat sold by every other farmer is a perfect substitute for the wheat you sell. extreme P changes by 0% Elasticity: infinity Q changes by any % ELASTICITY AND ITS APPLICATION 24

Elasticity of a Linear Demand Curve 직선인 수요곡선의 탄력성 P Q $30 20 10 $0 40 60 The slope of a linear demand curve is constant, but its elasticity is not. 200% 40% = 5.0 E = 67% = 1.0 E = 40% 200% = 0.2 E = The material on this slide is not used anywhere else in the textbook. Therefore, if you are pressed for time and looking for things to cut, you might consider cutting this slide. (Note that this is my personal recommendation and is not necessarily the official position of Greg Mankiw or Cengage/South-Western.) Due to space limitations, this slide uses “E” as an abbreviation for elasticity, or more specifically, the price elasticity of demand, and the slide omits the analysis of revenue along the demand curve. Calculations of percentage changes use the midpoint method. (This is why the increase from Q=0 to Q=20 is 200% rather than infinity.) As you move down a linear demand curve, the slope (the ratio of the absolute change in P to that in Q) remains constant: From the point (0, $30) to the point (20, $20), the “rise” equals -$10, the “run” equals +20, so the slope equals -1/2 or -0.5. From the point (40, $10) to the point (60, $0), the “rise” again equals -$10, the “run” equals +20, and the slope again equals -0.5. However, the percentage changes in these variables do not remain constant, as shown by the different colored elasticity calculations that appear on the slide. The lesson here is that elasticity falls as you move downward & rightward along a linear demand curve. ELASTICITY AND ITS APPLICATION 25

Price Elasticity and Total Revenue탄력성과 총수입 Continuing our scenario, if you raise your price from $200 to $250, would your revenue rise or fall?우리의 시나리오를 계속해 보자. 가격을 200달러에서 250달러로 올렸더니 당신의 수입이 증가했나 혹은 감소했나? Revenue = P x Q A price increase has two effects on revenue: 가격인상은 수입에 두 가지 효과를 미친다. Higher P means more revenue on each unit you sell. 높아진 가격은 판매 단위당 수입이 증가한 것을 의미 But you sell fewer units (lower Q), due to Law of Demand. 그러나 수요의 법칙때문에 당신은 더 적은 단위만을 판매하게 된다. Which of these two effects is bigger? 두 효과 중 어떤 것이 큰가? It depends on the price elasticity of demand. 탄력성이 좌우 We return to our scenario. It’s not hard for students to imagine being in this position – running their own business and trying to decide whether to raise the price. To most of your students, it should be clear that making the best possible decision would require information about the likely effects of the price increase on revenue. That is why elasticity is so helpful, as we will now see…. ELASTICITY AND ITS APPLICATION 26

Price Elasticity and Total Revenue Price elasticity of demand = Percentage change in Q Percentage change in P Revenue = P x Q If demand is elastic, then 수요가 탄력적이라면 price elast. of demand > 1 % change in Q > % change in P The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls. 판매량 감소로 인한 수입의 감소가 가격인상으로 인한 수입의 증가보다 크다. ELASTICITY AND ITS APPLICATION 27

Price Elasticity and Total Revenue Elastic demand (elasticity = 1.8) increased revenue due to higher P P Q lost revenue due to lower Q $200 12 If P = $200, Q = 12 and revenue = $2400. D $250 8 If P = $250, Q = 8 and revenue = $2000. In the “Normal” view (edit mode), the labels over the graph look cluttered, like they’re on top of each other. This is not a mistake – in “Slide Show” mode (presentation mode), all will be fine – try it! Point out to students that the area (outlined in blue) representing lost revenue due to lower Q is larger than the area (outlined in yellow) representing increased revenue due to higher P. Hence, the net effect is a fall in revenue. When D is elastic, a price increase causes revenue to fall. ELASTICITY AND ITS APPLICATION 28

Price Elasticity and Total Revenue Price elasticity of demand = Percentage change in Q Percentage change in P Revenue = P x Q If demand is inelastic, then price elast. of demand < 1 수요가 비탄력적이면 수요의 가격탄력성이 1보다 작다. % change in Q < % change in P The fall in revenue from lower Q is smaller than the increase in revenue from higher P, so revenue rises. 줄어든 판매량으로 인한 수입의 감소가 인상된 가격으로 인한 수입의 증가보다 작아서 수입은 증가한다. In our example, suppose that Q only falls to 10 (instead of 8) when you raise your price to $250. ELASTICITY AND ITS APPLICATION 29

Price Elasticity and Total Revenue Now, demand is inelastic: elasticity = 0.82 increased revenue due to higher P P Q lost revenue due to lower Q $200 12 If P = $200, Q = 12 and revenue = $2400. D $250 10 If P = $250, Q = 10 and revenue = $2500. Again, the slide appears cluttered in “Normal” view (edit mode), but everything is fine when displayed in “Slide Show” mode (presentation mode). Point out to students that the area representing lost revenue due to lower Q is smaller than the area representing increased revenue due to higher P. Hence, the net effect is an increase in revenue. The knife-edge case, not shown here but perhaps worth mentioning in class, is unit-elastic demand. In that case, an increase in price leaves revenue unchanged: the increase in revenue from higher P exactly offsets the lost revenue due to lower Q. When D is inelastic, a price increase causes revenue to rise. ELASTICITY AND ITS APPLICATION 30

A C T I V E L E A R N I N G 2 Elasticity and expenditure/revenue A. Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall?약국들이 인슐린의 가격을 10% 인상했다. 인슐린에 대한 총지출은 증가했나, 감소했나? B. As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall? 요금전쟁의 결과 호화 유람선의 가격이 20% 하락했다. 호화 유람선회사들의 총수입은 증가했나 혹은 감소했나? These problems, perhaps similar to those you might ask on an exam, are complex in that they test several skills at once: students must determine whether demand for each good is elastic or inelastic, and they must determine the impact of a price change on revenue/expenditure. So far, we’ve been talking about how elasticity determines the effects of an increase in P on revenue. Part (b) asks your students to determine the effects of a decrease in P. 31

A C T I V E L E A R N I N G 2 Answers A. Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall? Expenditure = P x Q Since demand is inelastic, Q will fall less than 10%, so expenditure rises. 32

A C T I V E L E A R N I N G 2 Answers B. As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall? Revenue = P x Q 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. The first part of the explanation discusses the opposing effects on revenue; its purpose is to clarify the effects of a price decrease on revenue, as we have previously only discussed the effects of a price increase. 33

APPLICATION: Does Drug Interdiction Increase or Decrease Drug-Related Crime? 마약수송차단과 마약관련 범죄의 증감 One side effect of illegal drug use is crime: Users often turn to crime to finance their habit. 마약 불법사용의 부수효과 중 하나는 범죄이다. 사용자들은 종종 돈을 마련하기 위해 범죄를 저지른다. We examine two policies designed to reduce illegal drug use and see what effects they have on drug-related crime. 우리는 마약 불법사용을 줄이기 위해 고안된 두 가지 정책을 검토하고 이 정책들이 마약관련 범죄에 미치는 영향을 살펴볼 것. For simplicity, we assume the total dollar value of drug-related crime equals total expenditure on drugs. 단순화를 위하여 마약관련 범죄의 총액이 마약에 대한 지출총액과 같다고 가정하자. Demand for illegal drugs is inelastic, due to addiction issues. 마약수요는 중독성 때문에 비탄력적이다. In the textbook, this application appears near the end of the chapter, and you can easily move these slides to the end if you wish to teach things in the same order as the book. However, I encourage you to consider teaching this application right here - immediately after the section on price elasticity of demand. It is safe to do so, as this application only requires knowledge of price elasticity of demand. Also, putting the application here breaks up what would otherwise be a very long section of theory with a real-world example that most students find very interesting. Knowing elasticity helps us understand what might otherwise be a counter-intuitive result (that drug interdiction increases drug-related crime rather than reducing it). ELASTICITY AND ITS APPLICATION 34

Policy 1: Interdiction Interdiction reduces the supply of drugs. 수송차단은 공급을 감소시킴 new value of drug-related crime Price of Drugs Quantity of Drugs S2 D1 S1 Since demand for drugs is inelastic, 수요가 비탄력적이어서 P rises propor-tionally more than Q falls. 가격의 상승폭이 더 크다. P2 Q2 initial value of drug-related crime P1 Q1 By the time all elements have appeared on the screen, the slide will look kind of busy. I think this is okay, because the elements appear on the screen one by one, so students have time to absorb each one before the next one appears. However, if you’d rather strip the slide down a bit, here’s a suggestion: in “Normal” view (which one uses to edit slides), you can delete the boxes that represent the initial and new values of drug-related crime, and the accompanying captions. Then, when presenting this slide in class, simply point out (with your mouse cursor, a laser pointer, or even your arms and hands) the areas that represent the initial and new values of drug-related crime. Result: an increase in total spending on drugs, and in drug-related crime 마약에 대한 총지출과 마약범죄 증가 ELASTICITY AND ITS APPLICATION 35

Policy 2: Education P and Q fall. new value of drug-related crime new value of drug-related crime Education reduces the demand for drugs. 교육은 수요를 감소시킴 Price of Drugs Quantity of Drugs D2 D1 S P and Q fall. initial value of drug-related crime P1 Q1 Result: A decrease in total spending on drugs, and in drug-related crime. 마약에 대한 지출과 범죄를 모두 감소시킴 P2 Q2 ELASTICITY AND ITS APPLICATION 36

Price Elasticity of Supply Price elasticity of supply = Percentage change in Qs Percentage change in P Price elasticity of supply measures how much Qs responds to a change in P. 공급의 가격탄력성은 가격의 변화에 공급량이 얼마나 반응하는지를 측정 Loosely speaking, it measures sellers’ price-sensitivity. 말하자면 그것은 판매자의 가격민감도를 측정 Again, use the midpoint method to compute the percentage changes. 여기서도 중간점 계산법을 사용 Most everything in the “price elasticity of supply” section corresponds to analogous concepts from the “price elasticity of demand” section. So, it is probably safe to move through this section more quickly. ELASTICITY AND ITS APPLICATION 37

Price Elasticity of Supply Price elasticity of supply = Percentage change in Qs Percentage change in P P Q Example: S P rises by 8% Price elasticity of supply equals P2 Q2 Q1 P1 16% 8% = 2.0 Q rises by 16% ELASTICITY AND ITS APPLICATION 38

The Variety of Supply Curves The slope of the supply curve is closely related to price elasticity of supply. 공급곡선의 기울기와 공급의 가격탄력성은 밀접히 관련 Rule of thumb: 대략 말하자면 The flatter the curve, the bigger the elasticity. The steeper the curve, the smaller the elasticity. 공급곡선이 평평할수록 탄력성이 크고 가파를수록 탄력성이 작다. Five different classifications.… 5가지 유형 Economists classify supply curves according to their elasticity. The next 5 slides present the different classifications, from least to most elastic. ELASTICITY AND ITS APPLICATION 39

“Perfectly inelastic”완전비탄력적 (one extreme) Price elasticity of supply = % change in Q % change in P 0% = 0 10% S curve: P Q S vertical P2 Sellers’ price sensitivity: P1 none P rises by 10% Elasticity: Q1 Q changes by 0% ELASTICITY AND ITS APPLICATION 40

Price elasticity of supply “Inelastic”비탄력적 Price elasticity of supply = % change in Q % change in P < 10% S < 1 10% S curve: P Q relatively steep P2 Sellers’ price sensitivity: Q2 P1 relatively low P rises by 10% Elasticity: Q1 < 1 Q rises less than 10% ELASTICITY AND ITS APPLICATION 41

Price elasticity of supply “Unit elastic”단위탄력적 Price elasticity of supply = % change in Q % change in P 10% = 1 10% S curve: P Q S intermediate slope P2 Sellers’ price sensitivity: Q2 P1 intermediate P rises by 10% Elasticity: Q1 = 1 Q rises by 10% ELASTICITY AND ITS APPLICATION 42

Price elasticity of supply Price elasticity of supply = % change in Q % change in P > 10% > 1 10% S S curve: P Q relatively flat P2 Sellers’ price sensitivity: Q2 P1 relatively high P rises by 10% Elasticity: Q1 > 1 Q rises more than 10% ELASTICITY AND ITS APPLICATION 43

“Perfectly elastic” 완전탄력적 (the other extreme) Price elasticity of supply = % change in Q % change in P any % = infinity 0% S curve: P Q horizontal P2 = P1 S Sellers’ price sensitivity: Q1 Q2 extreme P changes by 0% Elasticity: infinity Q changes by any % ELASTICITY AND ITS APPLICATION 44

The Determinants of Supply Elasticity 공급탄력성의 결정요소 The more easily sellers can change the quantity they produce, the greater the price elasticity of supply. 판매자가 자신의 생산량을 변화시키는 것이 쉬울수록 공급의 가격탄력성은 크다. Example: Supply of beachfront property is harder to vary and thus less elastic than supply of new cars. 해변가의 부동산공급은 신차의 공급보다 그 양을 변화시키기 어려우며 따라서 덜 탄력적이다. For many goods, price elasticity of supply is greater in the long run than in the short run, because firms can build new factories, or new firms may be able to enter the market. 많은 재화에 있어 공급의 가격탄력성은 단기에서보다 장기에서 더 크다. 왜냐하면 기업들이 새로운 공장을 짓거나 새 기업들이 시장에 진입할 수 있기 때문이다. This section is not perfectly analogous to the section on the determinants of the price elasticity of demand, but it’s similar enough that you can probably cover it more quickly and with much less hand-holding. ELASTICITY AND ITS APPLICATION 45

A C T I V E L E A R N I N G 3 Elasticity and changes in equilibrium The supply of beachfront property is inelastic. The supply of new cars is elastic. 해변의 건물 공급은 비탄력적이고 새 차의 공급은 탄력적이다. Suppose population growth causes demand for both goods to double (at each price, Qd doubles). 인구증가로 두 재화 모두의 수요가 두 배로 증가하였다(즉 각 가격에서 수요량이 두 배가 되었다). For which product will P change the most? 어떤 재화의 가격이 더 많이 변화하였나? For which product will Q change the most? 어떤 재화의 생산이 더 많이 변화하였나? This is one of the “Problems and Applications” at the end of the chapter. 46

A C T I V E L E A R N I N G 3 Answers Beachfront property (inelastic supply): When supply is inelastic, an increase in demand has a bigger impact on price than on quantity. 공급이 비탄력적이면, 수요의 증가는 거래량보다는 가격에 큰 영향을 미친다. P Q S D1 D2 B Q2 P2 In this slide and the next, the initial price and quantity and the two demand curves are the same. The only difference is the elasticity of supply and slope of the supply curve. [The D curve shifts to the right, but not in a parallel fashion: at each price, quantity demanded is twice as high, so the new D curve will be flatter than the initial one.] In the text box containing the verbal explanation, “bigger impact” is shorthand for “bigger percentage impact” or “bigger proportional impact.” Q1 P1 A 47

A C T I V E L E A R N I N G 3 Answers New cars (elastic supply): When supply is elastic, an increase in demand has a bigger impact on quantity than on price. 공급이 탄력적이면, 수요의 증가는 가격보다 거래량에 더 큰 영향을 미친다. P Q D1 D2 S Q2 P2 B Q1 P1 A 48

How the Price Elasticity of Supply Can Vary Supply often becomes less elastic as Q rises, due to capacity limits. 공급은 생산능력의 한계때문에 종종 공급량이 증가할수록 비탄력적으로 된다. P Q S elasticity < 1 $15 525 12 500 This graph replicates the one in Figure 6. Note: The graph here is not quite drawn to scale. When the price rises from $3 to $4 (a 29% increase, using the midpoint method), quantity rises from 100 to 120 (or 67%). Because 67% > 29%, price elasticity of supply is greater than one. When the price rises from $12 to $15 (22%), quantity rises from 500 to 525 (about 5%), so price elasticity of supply is less than one. The way I like to explain this is as follows: When output is very low, it is relatively easy for firms to increase output. They may have excess capacity, or they are not requiring full effort from their workers. Increasing output is not difficult, so it doesn’t take much of an increase in price to induce an increase in production. When output is very high, it is relatively expensive for firms to increase output further: there’s little or no excess capacity, they are already running their factories and machines at a high level of intensity. To increase output further, they might have to pay their workers overtime, and their machines experience more wear and tear and therefore require more repairs. So, at high levels of output, it takes a much larger price increase to make firms willing to increase output further. Eventually, firms bump up against their capacity constraints, and simply cannot increase output in response to further price increases. Of course, all of this applies to the short run. In the long run, firms can build more factories, and (depending on the market structure) new firms can enter the market. Real-world example: In the peak summer driving season, gasoline demand is highest. Many refineries are producing near capacity, so the supply curve is steep. In other months, when demand is lower, refineries have more excess capacity, and the supply curve is not as steep. elasticity > 1 4 200 $3 100 ELASTICITY AND ITS APPLICATION 49

Other Elasticities 다른 탄력성들 Income elasticity of demand: measures the response of Qd to a change in consumer income 수요의 소득탄력성은 소비자의 소득이 변화할 때 수요량의 반응을 측정한다. Income elasticity of demand = Percent change in Qd Percent change in income Recall from Chapter 4: An increase in income causes an increase in demand for a normal good. 소득의 증가는 정상재에 대한 수요를 증대시킨다. Hence, for normal goods, income elasticity > 0. 그러므로 정상재의 소득탄력성은 0보다 크다. For inferior goods, income elasticity < 0. 열등재의 소득탄력성은 0보다 작다. This topic and the next one (cross-price elasticity) do not appear anywhere else in the book. Instructors who are pressed for time may consider cutting these topics. (This is merely my suggestion, not the official position of Greg Mankiw or Cengage/South-Western.) ELASTICITY AND ITS APPLICATION 50

Other Elasticities % change in Qd for good 1 Cross-price elasticity of demand: 수요의 교차탄력성 measures the response of demand for one good to changes in the price of another good 다른 한 재화 가격의 변화에 대한 한 재화의 수요의 반응을 측정 Cross-price elast. of demand = % change in Qd for good 1 % change in price of good 2 For substitutes, cross-price elasticity > 0 (e.g., an increase in price of beef causes an increase in demand for chicken) 대체재일때 교차탄력성은 0보다 크다. For complements, cross-price elasticity < 0 (e.g., an increase in price of computers causes decrease in demand for software) 보완재일 때 교차탄력성은 0보다 작다. ELASTICITY AND ITS APPLICATION 51

Cross-Price Elasticities in the News “As Gas Costs Soar, Buyers Flock to Small Cars” -New York Times, 5/2/2008 “Gas Prices Drive Students to Online Courses” -Chronicle of Higher Education, 7/8/2008 “Gas prices knock bicycle sales, repairs into higher gear” -Associated Press, 5/11/2008 “Camel demand soars in India” (as a substitute for “gas-guzzling tractors”) -Financial Times, 5/2/2008 “High gas prices drive farmer to switch to mules” -Associated Press, 5/21/2008 I found all of these at Greg Mankiw’s blog, at http://gregmankiw.blogspot.com. Most were posted during May 2008; the one about online courses is from July 2008. He adds new ones periodically as he finds them. If you’d like to see the actual articles, start at Mankiw’s blog and search on “cross-price elasticity”. You’ll get a list of all of his posts on this topic, with links to the articles. (If any of the links are broken, try Googling the article’s title/headline.) ELASTICITY AND ITS APPLICATION

CHAPTER SUMMARY Elasticity measures the responsiveness of Qd or Qs to one of its determinants. Price elasticity of demand equals percentage change in Qd divided by percentage change in P. When it’s less than one, demand is “inelastic.” When greater than one, demand is “elastic.” When demand is inelastic, total revenue rises when price rises. When demand is elastic, total revenue falls when price rises. 53

CHAPTER SUMMARY Demand is less elastic in the short run, for necessities, for broadly defined goods, or for goods with few close substitutes. Price elasticity of supply equals percentage change in Qs divided by percentage change in P. When it’s less than one, supply is “inelastic.” When greater than one, supply is “elastic.” Price elasticity of supply is greater in the long run than in the short run. 54

CHAPTER SUMMARY The income elasticity of demand measures how much quantity demanded responds to changes in buyers’ incomes. The cross-price elasticity of demand measures how much demand for one good responds to changes in the price of another good. 55