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Calculating Point Elasticity of Demand

The document explains the calculation of point and arc elasticity of demand and supply, providing formulas and interpretations for each. It shows that point elasticity of demand is -2, indicating elastic demand, while arc elasticity of demand and supply are both approximately -1.22, suggesting sensitivity to price changes. Additionally, it outlines key differences between point and arc elasticity and includes multiple-choice questions to test understanding of economic concepts.

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Noralyn Empalmado
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4 views

Calculating Point Elasticity of Demand

The document explains the calculation of point and arc elasticity of demand and supply, providing formulas and interpretations for each. It shows that point elasticity of demand is -2, indicating elastic demand, while arc elasticity of demand and supply are both approximately -1.22, suggesting sensitivity to price changes. Additionally, it outlines key differences between point and arc elasticity and includes multiple-choice questions to test understanding of economic concepts.

Uploaded by

Noralyn Empalmado
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Calculating Point Elasticity of Demand: The formula

for point elasticity of demand is:


Understanding the Problem: We are given the following information:

 Percentage change in price = 1%


 Percentage change in quantity demanded = -2%

Point Elasticity of Demand = (% change in quantity demanded) / (% change in


price)

Substituting the given values:

Point Elasticity of Demand = (-2%) / (1%)

Simplifying:

Point Elasticity of Demand = -2

Therefore, the point elasticity of demand is -2.

Interpretation: A negative point elasticity of demand means that as the price increases, the
quantity demanded decreases. In this case, a 1% increase in price leads to a 2% decrease in
quantity demanded. This suggests that the demand for the product is relatively elastic, meaning
that consumers are sensitive to price changes.

Calculating Arc Elasticity of Demand


Given:

 Initial price (P1) = $10


 Final price (P2) = $12
 Initial quantity demanded (Q1) = 100 units
 Final quantity demanded (Q2) = 80 units

Formula for Arc Elasticity of Demand:

 Arc Elasticity = [(Q2 - Q1) / ((Q1 + Q2) / 2)] / [(P2 - P1) / ((P1 + P2) / 2)]

Calculation:

1. Calculate the percentage change in quantity:


o (Q2 - Q1) / ((Q1 + Q2) / 2) = (80 - 100) / ((100 + 80) / 2) = -20 / 90 = -0.2222
2. Calculate the percentage change in price:
o (P2 - P1) / ((P1 + P2) / 2) = (12 - 10) / ((10 + 12) / 2) = 2 / 11 = 0.1818
3. Calculate the arc elasticity:
o Arc Elasticity = -0.2222 / 0.1818 ≈ -1.22

Interpretation:

 The arc elasticity of demand is approximately -1.22. This indicates that a 1% increase in
price leads to a 1.22% decrease in quantity demanded.
 Since the absolute value of the elasticity is greater than 1, the demand is considered
elastic. This means that consumers are relatively sensitive to price changes.

Calculating Arc Elasticity of Supply


Understanding the Problem: We are given the following information:

 Initial price (P1) = $10


 Final price (P2) = $12
 Initial quantity supplied (Q1) = 100 units
 Final quantity supplied (Q2) = 80 units

Calculating Arc Elasticity of Supply: The formula for arc elasticity of supply is:

Arc Elasticity of Supply = [(Q2 - Q1) / ((Q1 + Q2) / 2)] / [(P2 - P1) / ((P1 +
P2) / 2)]

Substituting the given values:

Arc Elasticity of Supply = [(80 - 100) / ((100 + 80) / 2)] / [(12 - 10) / ((10
+ 12) / 2)]

Simplifying:

Arc Elasticity of Supply = [-20 / 90] / [2 / 11]

Further simplifying:

Arc Elasticity of Supply = -220 / 180

Therefore, the arc elasticity of supply is approximately -1.22.

Interpretation: A negative arc elasticity of supply means that as the price increases, the quantity
supplied decreases. In this case, a 20% increase in price leads to a 22% decrease in quantity
supplied. This suggests that the supplier is less willing or able to increase production as the price
increases.

Key Differences

 Point elasticity is more accurate when dealing with small changes in price and quantity.
 Arc elasticity is more accurate when dealing with large changes in price and quantity.
 Point elasticity is calculated at a specific point on the curve, while arc elasticity is
calculated between two points on the curve.

Price Elasticity Values


Inelastic Demand

 Value: 0
 Definition: Consumers are unwilling or unable to change their consumption habits in
response to price changes.
 Example: Essential goods like insulin or life-saving medications.

Inelastic Demand

 Value: Between 0 and -1


 Definition: Consumers are relatively insensitive to price changes.
 Example: Gasoline, cigarettes, and other addictive goods.

Unit Elastic Demand

 Value: -1
 Definition: Consumers are proportionally sensitive to price changes.
 Example: Many consumer goods, such as clothing or electronics.

Elastic Demand

 Value: Between -1 and -∞


 Definition: Consumers are highly sensitive to price changes.
 Example: Luxury goods like caviar or designer handbags.

Perfectly Elastic Demand

 Value: -∞
 Definition: Consumers are willing to buy any quantity at a specific price but none at any
other.
 Example: A perfectly competitive market with many identical sellers.

Note: A negative value for price elasticity of demand indicates an inverse relationship between
price and quantity demanded (as price increases, quantity demanded decreases).
Multiple Choice Questions

1. What is the law of demand?


o A. As price increases, quantity demanded increases.
o B. As price increases, quantity demanded decreases.
o C. As price decreases, quantity demanded increases.
o D. As price decreases, quantity demanded decreases.
2. Which of the following is a determinant of demand?
o A. Consumer income
o B. Price of related goods
o C. Technology
o D. Tastes and preferences
3. What happens to the equilibrium price when demand increases and supply
decreases?
o A. Increases
o B. Decreases
o C. Remains the same
o D. Cannot be determined
4. What is a price ceiling?
o A. A minimum price set by the government
o B. A maximum price set by the government
o C. A price set by the market
o D. A price set by consumers
5. What is the term for the extra value that consumers receive from a good or service
compared to what they actually pay?
o A. Producer surplus
o B. Consumer surplus
o C. Market surplus
o D. Total surplus
6. If the cross-price elasticity of demand between two goods is negative, what does that
mean?
o A. The goods are substitutes.
o B. The goods are complements.
o C. The goods are unrelated.
o D. The goods are inferior.
7. What is the term for the quantity of a good or service that producers are willing and
able to sell at a given price?
o A. Demand
o B. Supply
o C. Equilibrium
o D. Surplus
8. What happens to the equilibrium price when the price of a complementary good
increases?
o A. Increases
o B. Decreases
o C. Remains the same
o D. Cannot be determined
9. What is the term for the situation where the quantity demanded of a good or service
is equal to the quantity supplied?
o A. Equilibrium
o B. Surplus
o C. Shortage
o D. Disequilibrium
10. What is the term for a tax imposed on the production, sale, or consumption of a
specific good or service?

 A. Income tax
 B. Property tax
 C. Sales tax
 D. Excise tax

Quiz Answers

1. B. As price increases, quantity demanded decreases.


2. A. Consumer income
3. A. Increases
4. B. A maximum price set by the government
5. B. Consumer surplus
6. B. The goods are complements.
7. B. Supply
8. A. Increases
9. A. Equilibrium
10. D. Excise tax

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