Point Method in Economics

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The "point method" in economics is a method for measuring the level of consumer response to changes in the price of goods or services. Economists call the measure of response the "price elasticity of demand." Elasticity is an important element in understanding basic microeconomics, which studies the actions of consumers and firms.

Theories/Speculation

  • When prices change, the level of demand for goods and services often changes as well. For example, a sharp increase in the price of beef may reduce the demand for beef as consumers substitute with less-expensive meat, such as chicken or pork. Economists use the term "elasticity of demand" to measure how much the quantity demanded responds to changes in price. If the quantity demanded shows a substantial response to a change in price, demand is elastic. Demand is inelastic if the quantity demanded shows little or no response to a change in price. The point method provides a way of calculating percent changes in price and quantity demanded.

Point Method Procedure

  • The point method computes percent changes in price and quantity of demand by dividing the change by the average of the initial and final quantity and price levels. For example, if the price of a $4 good rises to $6, the increase is $2 and the midpoint is $5 (the average of $4 and $6). Dividing the increase ($2) by the midpoint ($5) represents a 40 percent increase. If the quantity demanded at $4 is 100 units and 60 units at $6, the change is 40 units and the midpoint is 80 (average of 100 and 60). Dividing 40 by 80 results in a 50 percent decrease in quantity demanded.

Calculating Elasticity

  • To calculate elasticity of demand, divide the percent change in price by the percent change in quantity, calculating the percent changes with the point method described in the previous section. If the price rises 40 percent and the quantity demanded falls 50 percent, dividing 40 by 50 results in an elasticity of demand equal to 1.25. An elasticity of 1 or more indicates elastic demand, while an elasticity less than 1 indicates inelastic demand.

Expert Insight

  • Harvard economics professor Greg Mankiw, author of "Principles of Economics" and a former White House adviser, calls the point method a preferable approach to calculating elasticity of demand because the method provides the same answer regardless of the direction of price change. In the example shown in the previous section, a price increase from $4 to $6 is a 50 percent hike, while a price drop from $6 to $4 represents a 33 percent decrease. This would result in different elasticities, depending on whether the price rises or falls. Mankiw calls the point method, or "midpoint method," preferable because it generates consistent results regardless of the direction of change.

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References

  • "Principles of Economics, 3rd ed."; N. Gregory Mankiw; 2004
  • Photo Credit Hemera Technologies/AbleStock.com/Getty Images
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