Problems in using arc elasticity, Managerial Economics

The use of arc elasticity in economic analysis involves a good deal of chariness since it is capable of being misinterpreted. Arc elasticity coefficients vary between the same two finite points on a demand curve if direction of change in price is reversed. Arc elasticity for a decrease in price would be different from that for same increase in price between the same to points on a demand curve. For instance, the price elasticity between points J and K - moving from J to K - is equal to 1.11. This is the elasticity for decrease in price from 25$ to 10$. Though a reverse movement on the demand curve, which is from point K to J implies an increase in price from 10$ to 25$ that will give a different elasticity coefficient. In the case of movement from point K to J, P = 10, Δ P = 10 - 25 = - 15, Q = 50 and ΔQ = 50 - 30 = 20. Substituting these values in elasticity formula, we get

EP = (20/-15)(10/50) = 0.26

Measure of arc elasticity co-efficient in equation I for the reverse movement in price is obviously different from the one given in equation II. So, while measuring the arc elasticity, direction of price change must be carefully noted, otherwise it may yield misleading conclusions.

A method recommended to resolve this problem is to use average of lower and upper values of P and Q in fraction, P/Q, so that formula is

Ep = (δQ/δP). {(P1+P2)/2} / {(Q1+Q2)/2}

   = (Q1-Q2/P1-P2). {(P1+P2)/2} / {(Q1+Q2)/2}

Substituting the values from this illustration, we get

= (30-50/25-10). {(10+25)/2} / {(30+50)/2} = 0.58

This method has its own disadvantages as elasticity co-efficient calculated through this formula, refers to elasticity of demand at mid-point between points J and K (Fig. below). Elasticity co-efficient (0.58) isn't applicable for the whole range of price-quantity combinations at different points between J and K on the demand curve (Fig. below). It gives only mean of the elasticity between the two points. It is vital to note that elasticity between mid-point and the upper point J or lower point K will be different. So this method doesn't give one measure of elasticity.

672_Problems in Using Arc Elasticity.png

Figure: Measuring Arc Elasticity

Posted Date: 8/10/2013 1:32:33 AM | Location : United States

Related Discussions:- Problems in using arc elasticity, Assignment Help, Ask Question on Problems in using arc elasticity, Get Answer, Expert's Help, Problems in using arc elasticity Discussions

Write discussion on Problems in using arc elasticity
Your posts are moderated
Related Questions
Case study for consumer behavior using indifference curev

Q. Explain Supernormal Equilibrium? Supernormal Equilibrium: E is the point of stable equilibrium as MC = MR and MC cuts the MR from below.   Figure: Supernormal Equ

Shifts in demand curve Shifts in the demand curve are brought about by the changes in factors like taste, prices of other related commodities, income etc other than the price

Substitution Effect on law of demand When price of a commodity falls it becomes comparatively cheaper if price of all other related goods, particularly of substitutes, remain c

A profit-maximizing firm faces the following options for hiring workers: a) Assume the firm has limited space so that it can only hire one worker. Which type of employee sh

Using the discounting principle calculate the present value of an annuity of five years at Rs. 500 payments made at the end of each of the next five years at 10% interest. stion..

different types of markets and role in managerial economics

Apprehensions about the future price of law of demand When consumers anticipate a constant rise in the price of a long-lasting commodity, they buy more of it despite the price

Question: EITHER Nowadays, there is an urgency in Mauritius to introduce a rapid transit system in order to reduce traffic congestion and shift towards a more efficient mode

Problem: (a) Explain with the help of a diagram, the effect on a consumer's equilibrium, of an increase in the price of commodity X while the consumer's money income and price