Page 504 - Krugmans Economics for AP Text Book_Neat

when economists talk about the price elasticity of demand, they usually drop the minus
sign and report the absolute value of the price elasticity of demand. In this case, for ex-
ample, economists would usually say “the price elasticity of demand is 0.2,” taking it for
granted that you understand they mean minus 0.2. We follow this convention here.
The larger the price elasticity of demand, the more responsive the quantity de-
manded is to the price. When the price elasticity of demand is large—when consumers
change their quantity demanded by a large percentage compared with the percent
change in the price—economists say that demand is highly elastic.
As we’ll see shortly, a price elasticity of 0.2 indicates a small response of quantity de-
manded to price. That is, the quantity demanded will fall by a relatively small amount
when price rises. This is what economists call inelastic demand. And inelastic demand
was exactly what Flunomics needed for its strategy to increase revenue by raising the
price of its flu vaccines.

An Alternative Way to Calculate Elasticities:
The Midpoint Method
We’ve seen that price elasticity of demand compares the percent change in quantity de-
manded with the percent change in price. When we look at some other elasticities, which
we will do shortly, we’ll see why it is important to focus on percent changes. But at this
point we need to discuss a technical issue that arises when you calculate percent
changes in variables and how economists deal with it.
The best way to understand the issue is with a real example. Suppose you were trying
to estimate the price elasticity of demand for gasoline by comparing gasoline prices
and consumption in different countries. Because of high taxes, gasoline usually costs
about three times as much per gallon in Europe as it does in the United States. So what
is the percent difference between American and European gas prices?
Well, it depends on which way you measure it. Because the price of gasoline in Eu-
rope is approximately three times higher than in the United States, it is 200 percent
higher. Because the price of gasoline in the United States is one-third as high as in Eu-
rope, it is 66.7 percent lower.
This is a nuisance: we’d like to have a percent measure of the difference in prices that
doesn’t depend on which way you measure it. A good way to avoid computing different
elasticities for rising and falling prices is to use the midpoint method (sometimes called
the arc method).
The midpoint method replaces the usual definition of the percent change in a vari-
Ian Britton/Freefoto.com able, X, with a slightly different definition: × 100

Change in X
(46-4) % change in X =
Average value of X
where the average value of X is defined as

Average value of X = Starting value of X + Final value of X
2
When calculating the price elasticity of demand using the midpoint method, both the
percent change in the price and the percent change in the quantity demanded are found
using average values in this way. To see how this method works, suppose you have the
following data for some good:

Price Quantity demanded
The midpoint method is a technique for
calculating the percent change. In this Situation A $0.90 1,100
approach, we calculate changes in a variable
Situation B $1.10 900
compared with the average, or midpoint, of
the initial and final values.
462 section 9 Behind the Demand Curve: Consumer Choice