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ExamineFigure1below:
Figure1
Elasticity
30 25 20 Price 15 10 5 0 0 20 40 60 Quantity 80 100 120 Elasticity
Startingpointelasticityismostbeneficialtothosepeoplewhoareconsideringachangeina currentsituationandwouldlikeawaytoanticipatetheresultsofaparticularchange.Theonereason whysometextbookauthorsdonotlikestartingpointelasticityisthatitisdependentonwhatyou chooseasyourstartingpoint.Noticeintheexampleaboveifwechoosethepoint(60,10)asour startingpointandmoveto(40,15)themeasureofelasticitychanges: |(4060)/60/(1510)/10)|=0.66. Therefore,oneapproachtoavoidthispotentialconfusionistointroducemidpointelasticity. MidpointElasticity: Someauthorsliketointroducethemidpointelasticityapproachtoavoidtheproblemofgetting differentmeasuresofelasticityifstudentsusethewrongdenominatorwhencalculatingpercentage changes.Furthermore,ifyouwantasimpledescriptionofconsumerbehavioroveraportionofa demandcurveratherthanatasinglepointonthedemandcurve,midpointelasticityisappropriate.The onlychangefromaboveistoredefinethepercentagechangestobeintermsoftheaveragepoint betweenthestartingpointandtheendpoint.Fromtheexampleabovewecanseethattheaverage quantityis:(Q1+Q2)/2=(40+60)/2=50.Theaveragepriceis:(P1+P2)/2=(15+10)/2=12.5.Theformula forthemidpointpriceelasticityofdemandis: |%QD/%P|=|(Q2Q1)/((Q1+Q2)/2)/(P2P1)/((P1+P2)/2)| Thetwoscanceltocleanuptheequationalittle:|(Q2Q1)/(Q1+Q2)/(P2P1)/(P1+P2)| Thenicethingabouttheformulaisthatitdoesnotmatterifyouconfusethestartingpointandtheend point.Themathematicalresultwillbethesame.Considerthepointsweusedabove,(40,15)and(60, 10): |(6040)/50/(1015)/12.5|=1 |(4060)/50/(1510)/12.5|=1 Itisworthmentioningthatthenewmeasureofelasticityisdifferentfromthetwoprevious measures.Noticethatitisnotsimplytheaverageofthetwo. ArcElasticity: Arcelasticityissimplyavariantofthemidpointelasticitybutisconvenientifyouareworking withanonlinearfunctionandyouhavenotyettakencalculus(gotakecalculusifyouhavethechance itimpressesallofthepeoplewhoareafraidofmathclasses). Initssimplestform,arcelasticityisexactlylikethemidpointmethod.Thedifferenceisthatthe demandcurveofinterestisactuallycurved.ThedemandcurveinFigure2isaconstantelasticity demandcurve.Itconvenientlygoesthroughthesametwopointswehavebeenexamining.Therefore, youcanseefairlyquicklythatifyouweretoevaluatethepercentchangequantitydemandedrelativeto 2
ExactPointElasticity: Oneofthewayseconomistsmakealivingisbycalculatingelasticities.Becauseunderstanding elasticityissoimportant,ownersoffirmsbothlargeandsmallarewillingtopayhandsomelyfor informationaboutthesensitivityofthedemandtheyface.Wheneconomistsconductempirical researchtheyexamineaproblematthemargin.Thatis,theylookatthesensitivityofdemandto changesinpricewithinaverysmallrangerelativetotheobservedpriceandquantity.Theexactpoint elasticityformulaprovidesameasureofpriceelasticityofdemandthatrelatestoonepointona(linear) demandcurve.Formymoney,itistheeasiestofallofthemeasuresofelasticitytorememberanditis themostuseful.But,itdoesrequireaslightlydeeperunderstandingofdemand.ReferbacktoFigure1. Noticethatataparticularprice(25)thequantitydemandedgoestozero.Refertothispointasa. Someeconomistscallaachokepricethepriceatwhichalldemandischokedoff.Atanygivenprice, P,thepointelasticityofdemandissimply: 1 |P/(Pa)| Quicklycheckthreepointsofinterest: AtP=15:|15/(1525)|=11/3 AtP=10:|10/(1025)|=2/3
1
Notethatthequantitydemandedisnotneededtocalculatetheexactpointelasticity.Thisisbecauseallofthe informationthatisnecessaryiscapturedintherelativepositionofthecurrentpriceandthechokeprice.
AtP=12.5:|12.5/(12.525)|=1 Noticethatwegetthesameanswersasthestartingpointmethodinthefirsttwocasesand,byusing themidpointprice,wegetthesameanswerasthemidpointmethodinthelastcase.Therearesome additionalnicethingsaboutusingtheexactpointelasticity.Forone,itremindsusthatasprice increases,elasticityincreasesandaspricedecreases,elasticitydecreases.Anotherniceaspectabout theexactpointelasticityisthatitisanalogoustousingmoreadvancedcalculusapproaches.Toseethis, consideranonlineardemandfunctionsuchastheoneinFigure2.Now,examineanarccreatedby squeezingtwopointseverclosertogether.Oncethosetwopointsbecomeonepoint,drawatangentto thearcatthatpoint.Thetangentrepresentsthestraightlinedemandfunctionatthatpoint.Theexact pointelasticitygivesyoutheelasticityatthatpoint.