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Chapter 6: Problem 3

What is the midpoint formula for calculating price elasticity of demand? How else can you calculate the price elasticity of demand? What is the advantage of using the midpoint formula?

Short Answer

Expert verified
The midpoint formula for price elasticity of demand is \[ \frac{\left(Q2 - Q1\right)/ \left[\left(Q2 + Q1\right) / 2\right]}{\left(P2 - P1\right)/ \left[\left(P2 + P1\right) / 2\right]} \]. Other methods include the total outlay method and the point elasticity method. The advantage of the midpoint formula is that it avoids bias in the calculations due to the choice of direction in the percentage change calculation, providing a more consistent and uniform measure.

Step by step solution

01

Introduce Midpoint Formula for Price Elasticity

The standard formula to calculate the price elasticity of demand using the midpoint approach is given by: \[ \text{Price Elasticity of Demand} = \frac{\text{Percentage change in Quantity Demanded}}{\text{Percentage change in Price}} \] In terms of the midpoint formula, this is expressed as: \[\frac{\left(Q2 - Q1\right)/ \left[\left(Q2 + Q1\right) / 2\right]}{\left(P2 - P1\right)/ \left[\left(P2 + P1\right) / 2\right]}\] Where Q1 and Q2 represent the initial and new quantity demanded, and P1 and P2 represent the initial price and new price.
02

Alternative Methods for Calculating Price Elasticity of Demand

Other than the midpoint method, price elasticity of demand can also be calculated using the total outlay method and the point elasticity method. In the total outlay method, the price-quantity variation is observed to derive elasticity. In the point elasticity method, the derivative of the demand function gives the elasticity at any given point on the demand curve.
03

Advantages of the Midpoint Formula

The major advantage of using the midpoint formula to calculate the price elasticity of demand lies in its inherent fairness. It calculates the percentage changes in price and quantity demanded in relation to an average or midpoint, instead of only the initial points. This way, it avoids the end-point problem of getting different elasticity values, dependent on whether price increases or decreases. This takes care of any bias due to the choice of direction in the percentage change calculation, providing a more consistent and uniform measure of elasticity.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Midpoint Formula
Understanding how demand changes in response to price variations is crucial in economics, and the midpoint formula offers a precise way to quantify this relationship. The midpoint formula is designed to calculate the price elasticity of demand, which measures how much the quantity demanded of a good responds to a change in its price. Calculated by dividing the percentage change in quantity demanded by the percentage change in price, the formula normalizes these changes by their average or midpoint values, using the following equation:
\[\frac{\left(Q2 - Q1\right)/ \left[\left(Q2 + Q1\right) / 2\right]}{\left(P2 - P1\right)/ \left[\left(P2 + P1\right) / 2\right]}\]
Here, \(Q1\) and \(Q2\) are the initial and new quantities demanded, while \(P1\) and \(P2\) are the initial and new prices. The midpoint approach ensures fairness and consistency, which is especially valuable when examining goods with significant price or demand shifts.
Calculating Price Elasticity
Price elasticity of demand is a concept that requires careful calculation as its value helps businesses and economists understand market dynamics. Although the midpoint formula is common, there are other robust methods to delve into elasticity. These include:
  • The Total Outlay Method: This involves observing how the expenditure on a good changes with its price. If total spending increases as price decreases, the demand is considered elastic.
  • The Point Elasticity Method: It uses the derivative of the demand function to determine elasticity precisely at a specific point on the demand curve.
Each method offers different insights and can be used based on the demands of the scenario. Knowing them enhances one's ability to analyze varying economic situations.
Economic Concepts
Economic concepts like the price elasticity of demand are foundational in understanding market forces. It's a measure of responsiveness—quantifying how quantity demanded for a product or service changes in response to price fluctuations. An elastic demand means consumers are sensitive to price changes, while inelastic demand indicates that price changes have little effect on the quantity demanded.
Using the midpoint formula to calculate this elasticity provides a balanced approach by centering the calculations on an average of the initial and new values, thus evaluating the proportional changes consistently regardless of direction—price rise or fall. This concept is vital for creating pricing strategies, forecasting revenue, and understanding consumer behavior, proving its worth across multiple dimensions of economics.

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Most popular questions from this chapter

When lettuce prices doubled, from about \(\$ 1.50\) per head to about \(\$ 3.00,\) the reaction of one consumer was quoted in a newspaper article: "I will not buy [lettuce] when it's \(\$ 3\) a head," she said, adding that other green vegetables can fill in for lettuce. "If bread were \(\$ 5\) a loaf we'd still have to buy it. But lettuce is not that important in our family." a. For this consumer's household, which product has the higher price elasticity of demand: bread or lettuce? Briefly explain. b. Is the cross-price elasticity of demand between lettuce and other green vegetables positive or negative for this consumer? Briefly explain.

What are the key determinants of the price elasticity of demand for a product? Which determinant is the most important?

When San Francisco and other cities in California adopted soda taxes, an opinion column in the New York Times observed, "Often, the taxes don't even pinch the budgets of low-income families, because they respond by drinking less soda." What does the columnist mean when he writes that soda taxes don't "pinch the budgets" of low-income families? Shouldn't an increase in the price of soda resulting from a tax always increase the amount that families have to spend to buy soda? Briefly explain.

The publisher of a magazine gives her staff the following information: $$ \begin{array}{l|l} \hline \text { Current price } & \$ 2 \text { per issue } \\ \hline \text { Current sales } & 150,000 \text { copies per month } \\ \hline \text { Current total costs } & \$ 450,000 \text { per month } \\ \hline \end{array} $$ The publisher tells the staff, “Our costs are currently \(\$ 150,000\) more than our revenues each month. I propose to eliminate this problem by raising the price of the magazine to \(\$ 3\) per issue. This will result in our revenue being exactly equal to our cost." Do you agree with the publisher's analysis? Explain. (Hint: Remember that a firm's revenue is calculated by multiplying the price of the product by the quantity sold.)

A study of the consumption of beverages in Mexico found that "overall, for soft drinks a \(10 \%\) price increase decreases the quantity consumed by \(10.6 \%\)." Given this information, calculate the price elasticity of demand for soda in Mexico. Is demand price elastic or price inelastic? Briefly explain. Source: M. A. Colchero, et al. "Price Elasticity of the Demand for Sugar Sweetened Beverages and Soft Drinks in Mexico," Economics and Human Biology," Vol. 19, December 2015, pp. \(129-137\).
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