Problems in using arc elasticity, Managerial Economics

Assignment Help:

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


Related Discussions:- Problems in using arc elasticity

Price discrimination, Let there be two consumers A and B, each buying at mo...

Let there be two consumers A and B, each buying at most two units of a good. A values having one unit at £10 and having two units at £12 whereas B values having one unit at £8 and

Porter’s Five Forces, bargaining power of customer for a cement company

bargaining power of customer for a cement company

Describe the forecasting method in managerial economics, Describe the Forec...

Describe the Forecasting method in managerial economics It is a technique or a method to predict many future aspects of a business or any other operation. For illustration, a r

Marginal cost, Marginal Cost This is the increase in total...

Marginal Cost This is the increase in total cost resulting from the production of an extra unit of output.  Thus, if TC n   is the total cost of producing n

Investment demand theory , In the national income analysis, investment ref...

In the national income analysis, investment refers to the value of than part of the aggregate output for any given time period which takes the form of construction of new structure

Costs for producing clealung, You own a pharmaceutical company that is spec...

You own a pharmaceutical company that is specialized in the manufacture of medicine for smokers. You newly patented an innovative drug called Clealung, which drastically reduces th

Limits on the process of bank deposit creation, Limits on the process of ba...

Limits on the process of bank deposit creation On the demand side , there may be a lack of demand for loans, or at least of borrowers who are sufficiently credit worthy .

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd