Measurement of Price Elasticity

There are two approaches of computing elasticity. The choice between the two depends on the available data and intended use.

(a)    Arc elasticity: Arc elasticities are appropriate for analysing the effect of discrete, i.e. measurable, changes on price. For example, a price increase from Rs 2 to Rs 4 could be evaluated by computing the arc elasticity. In actual practice, most elasticity computations involve the arc method. Arc elasticity measures the incremental changes between two points on a demand curve. To avoid ambiguity in elasticity coefficients, arising due to choice of price and quantity, averages of the original and new quantity and price are used.

Ep = Q2- Q1 . P2+P1/ P2-P1 . Q2+Q1

where subscripts 1 and 2 refer to the original and to the new values respectively.

(b)    Point elasticity: It refers to measurement of elasticity on a point On a demand curve. Point elasticity helps in measuring elasticity where change in price and quantity is infinitesimally small. As marginal analysis works by evaluating small changes taken with respect to an initial decision, it is often useful to measure elasticity w.r.t. infinitesimally small changes in price. In this case we writ  elasticity as,

Ep = dQ/Q  /  dP/P                  

where dQ/dP is the derivative of quantity w.r.t. price at -a point on a demand curve and P and Q are the price and quantity at that point.  

To measure the point elasticity on a non-linear demand curve, we first draw a tangent through the point. For example, to measure point elasticity at point R or demand curve Dx, tangent AB is drawn through the point The slope of the demand curve and of the line is same at that point so that the elasticity of the demand curve at point R will be equal to that of the line at this point. The elasticity of the line at point R can be measured as follows

Ep = dQ.P / dP.Q

  The reciprocal of the slope of the straight line AB at point R is NB / RN. Therefore

dQ/dP = NB/RN

At point R price P = RN and quantity Q = ON. 

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