Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is the equation for arc elasticity of demand?

1. ((Change in supply) ÷ average supply) ÷ ((Change in demand) ÷ average demand)

2. ((Change in demand) ÷ average demand) ÷ ((Change in price) ÷ average price)

3. (Change in quantity sold) ÷ (Change in price)

4. ((Demand increase) ÷ total demand) ÷ ((Price increase) ÷ total price)

The correct answer is: ((Change in demand) ÷ average demand) ÷ ((Change in price) ÷ average price)

The arc elasticity of demand is a measure that captures the responsiveness of quantity demanded to changes in price over a specific interval, rather than at a single point. The formula involves the percentage change in quantity demanded divided by the percentage change in price, calculated using average values for both quantity and price. The correct choice reflects this approach accurately. It shows the percentage change in demand (which is the change in demand divided by the average demand) in relation to the percentage change in price (which is the change in price divided by the average price). This method enables analysts to assess how sensitive the quantity demanded is to price changes over a range, providing a more holistic view than a point elasticity measure, which focuses solely on a specific price point. Instead of focusing narrowly on a single change, using averages helps smooth out the data and gives a better picture of consumer behavior regarding demand changes in response to price fluctuations. This approach is particularly useful for policymakers and economists when analyzing demand under varying price situations over a given period, as it can reflect realistic market situations.