Midpoint Computing Elasticity

Question: Describe about the Midpoint Computing Elasticity. Answer: 1. Midpoint method of computing elasticity of demand is based on the initial and final values of the two variables namely price and quantity demanded. Since it is based on the initial and final values, hence it could be used for computation only when information about the two points on the demand curve is known. The mathematical representation for computation of the elasticity of demand using the mid-point method is shown below (Krugman Wells, 2013). In the above formula, B1 and B2 are the initial and final quantities demanded respectively. Further, A1 and A2 are the initial and final price per unit quantity respectively. Even though midpoint method is a common method of computing elasticity of demand, there are other methods such as arc method and point elasticity method which can also be used to compute the elasticity of demand. Arc elasticity of demand computation mechanism is used when the demand equation is not given. However, the point elasticity method can be used when the exact demand curve is known (Pindyck Rubinfeld, 2011). The main advantage of the mid-point approach to compute elasticity of demand is that irrespective of the points taken into consideration, the elasticity value remains the same which is unlike the other methods especially the point elasticity where the value is susceptible to be different at various points (Mankiw, 2014). 2. The key determinants of the price elasticity of demand of a given product are the following (Nicholson Snyder, 2011). Close substitute availability If there are close substitutes available for the given product, the price elasticity of demand tends to be higher as with the increase in price, the consumers could shift to cheaper substitutes thus significantly lowering the consumption. However, in case of lower availability of substitutes, even in the event of price rise there would not be much substitutes and hence elasticity would be lower. Nature of goods The elasticity tends to be typically lower for staple or basic foods unlike luxury goods whose elasticity tends to be much higher. This is because basic goods such as rice, wheat tend to be pivotal unlike luxury goods such as high end cars and gadgets whose purchase could be postponed to later times. Extent of budget dedicated to the given product It has been observed that for products which tend to form a higher portion of the budget tend to more price elastic in comparison to whose which contribute a relatively less significant or insignificant portion of the overall budget. Out of the above determinants, the most significant determinant of price elasticity of demand is availability of close substitutes as it is the most fundamental determinant of elasticity of the given product. The other determinants play a rather secondary role with regards to elasticity determination (Mankiw, 2014). 3. For estimation of the underlying price elasticity of demand of CDs, the formula to be used is shown below (Krugman Wells, 2013). Price elasticity of demand (PED) = % change in quantity demanded of CD/% change in price of CD Initial price of CD = $ 21 Final price of CD = $ 15 % change in price of CD = ((15-21)/21)*100 = -28.57% Increase in quantity of CD demanded = 30% Hence, PED = 30/-28.57 = -1.05 As the PED of CDs is greater than 1, it implies that demand for CDs is elastic and hence the price should be decreased as it would lead to an increase in the overall revenue. This is because with the decrease in price, the percentage increase in quantity demanded would be greater than the percentage decrease in price. The result of this would be higher revenue for the company as the revenue is the product of price and quantity demanded (Pindyck Rubinfeld, 2011). 4. For estimation of the underlying price elasticity of demand of 33 songs, the formula to be used is shown below (Samuelson Marks, 2003). Price elasticity of demand (PED) = % change in quantity demanded of 33 songs/% change in price of 33 songs Initial price per download = $ 0.99 Final price per download = $ 1.29 Percentage change in price of 33 songs = [(1.29-0.99)/0.99]*100 = 30.3% Percentage change in quantity demanded of 33 songs = -35% Hence, PED = -35/30.3 = 1.155 5. Percentage change in price of chocolate sauce = -5% Percentage change in quantity demanded of chocolate sauce = 10% Hence, price elasticity of demand of chocolate sauce = 10/-5 = -2 Cross price elasticity of ice cream with respect to price of chocolate sauce =% change in demand of ice cream/% change in price of chocolate sauce Percentage change in price of chocolate sauce = -5% Percentage change in quantity demanded of ice cream = 15% Hence, cross price elasticity = 15/-5 = -3 As the cross price elasticity of ice cream with regards to chocolate sauce is negative, it implies that ice cream and chocolate sauce are complements (Nicholson Snyder, 2011). References Krugman, P Wells, G 2013, Microeconomics, 3rd eds., Worth Publishers, London Mankiw, G 2014, Microeconomics, 6th eds., Worth Publishers, London Nicholson, W Snyder, C 2011, Fundamentals of Microeconomics, 11th eds., Cengage Learning, New York Pindyck, R Rubinfeld, D 2011, Microeconomics, 5th eds., Prentice-Hall Publications, London Samuelson, W Marks, S 2003, Managerial Economics, 4th eds., Wiley Publications, New York