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Arc Elasticity

The document discusses different methods for measuring price elasticity of demand. It explains that the geometric method is only applicable for infinitesimal price changes, while the arc elasticity formula should be used for appreciable price changes. The arc elasticity formula calculates elasticity based on the average price and quantity between the initial and new price/quantity points, providing a better approximation than using a single point measurement. It also notes that the arc elasticity addresses limitations of using a single base point when calculating percentage changes between two points on a demand curve.

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133 views2 pages

Arc Elasticity

The document discusses different methods for measuring price elasticity of demand. It explains that the geometric method is only applicable for infinitesimal price changes, while the arc elasticity formula should be used for appreciable price changes. The arc elasticity formula calculates elasticity based on the average price and quantity between the initial and new price/quantity points, providing a better approximation than using a single point measurement. It also notes that the arc elasticity addresses limitations of using a single base point when calculating percentage changes between two points on a demand curve.

Uploaded by

Sujatha Mohan
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© Attribution Non-Commercial (BY-NC)
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Figure 2.9

Since the slope of a demand curve is dP/ dQ, the term dP/dQ in the expressionfor eo is the reciprocal of the slope. For both demand curves, since P/Q is the same,the elasticitiescan be compared by comparing dQ/dp. As D, is steeperthan Dr, dQ/dP for D, is less than that for Dr. (Rememberthat dQ/dP measuresthe reciprocal of the slope). Hence D, (the steepercurve) is lesselastic than D,. . : V. I Elasticity _Arc The geometrical method of measurementof price elasticity of demand is applicable only for infinitesimal changesin price. If price changesappreciably then we use the arc elasticity of demand. Arc elasticity is calculated with the help of the following formula: AQ (P,+P,)/2 _Le.(p,+pr)/2 eP_ AP (Q, +Q,)/2 AP'(e, +e,)/2 Whete Pand Q, are initial price and quanti$,PrandQ, are new price and quantity and AP and AQ are the changesin price and quantity respectively. The arc elasticity is a measure of average elasticity, that is, the elasticity at the midpoint of the chord that connectsthe two points (A and B) on the demand curve defined by the initial and new price levels.The measureof arc elasticityis an approximation of the true elasticity of the sectionAB of the demand curve. The more convex to the origin the demand curve is, the poorer the linear approximation attained by the arc elasticity formula.

Caurion It would be observedthat the only difference between this formula and the point elasticity formula is in the use of the average quantities and average prices. A basic limitation of the point elasticity formula relates to the use of the base.If in Figure 2.10we have to measureelasticity of demand between the points A and B by the percentagemethod, it is difficult to say which one of those will make a better base. The choice will be entirely arbitrary. The problem can be : solved by using average prices and average quantities.

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LIBM Institate of Business Management

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