Economics Perfect Competition Questions Long
Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good or service to a change in its price. In the context of perfect competition, where there are many buyers and sellers in the market, price elasticity of demand plays a crucial role in determining the equilibrium price and quantity.
In perfect competition, all firms produce identical products, and there is free entry and exit of firms in the market. This means that consumers have many alternatives to choose from, and they can easily switch between different sellers based on price differences. As a result, the demand curve facing an individual firm in perfect competition is perfectly elastic, meaning that the firm can sell any quantity at the prevailing market price.
The price elasticity of demand in perfect competition is infinite or perfectly elastic because any increase in price by an individual firm will cause consumers to switch to other firms offering the same product at a lower price. Conversely, any decrease in price by an individual firm will attract more consumers, but the firm cannot charge a higher price than the prevailing market price.
The concept of price elasticity of demand in perfect competition has several implications. Firstly, it ensures that no individual firm has the power to influence the market price. Each firm is a price taker and must accept the prevailing market price determined by the forces of supply and demand. This leads to allocative efficiency, as resources are allocated to their most valued uses.
Secondly, price elasticity of demand in perfect competition determines the slope of the demand curve facing an individual firm. Since the demand curve is perfectly elastic, it is horizontal at the market price. This implies that the firm can sell any quantity at the market price, but it cannot charge a higher price for any given quantity.
Lastly, price elasticity of demand in perfect competition determines the income elasticity of demand. Since the demand curve is perfectly elastic, any increase in consumers' income will not lead to an increase in the quantity demanded of the product. Therefore, the income elasticity of demand is zero in perfect competition.
In conclusion, the concept of price elasticity of demand in perfect competition highlights the responsiveness of quantity demanded to changes in price. In this market structure, the demand curve facing an individual firm is perfectly elastic, ensuring that the firm is a price taker and cannot influence the market price. This leads to allocative efficiency and determines the slope of the demand curve facing the firm. Additionally, the income elasticity of demand is zero in perfect competition.