Perfectly elastic demand refers to a situation where the quantity demanded of a good or service changes infinitely in response to even the slightest change in price. In other words, consumers are extremely sensitive to price changes, and the demand curve is perfectly horizontal.
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With perfectly elastic demand, the demand curve is a horizontal line, indicating that consumers will buy any quantity at the prevailing market price.
Perfectly elastic demand implies that consumers have a large number of close substitutes for the good, and they will immediately switch to the substitute if the price of the good increases even slightly.
In the context of a profit-maximizing monopoly, the presence of perfectly elastic demand means the monopolist has no pricing power and must accept the market price.
The monopolist with perfectly elastic demand will produce the quantity where the marginal cost curve intersects the horizontal demand curve, and the price will be determined by the market.
Perfectly elastic demand is an extreme case, and in reality, most demand curves have some degree of slope, reflecting the fact that consumers are not infinitely responsive to price changes.
Review Questions
Explain how a profit-maximizing monopolist would determine their output and price under conditions of perfectly elastic demand.
Under perfectly elastic demand, a profit-maximizing monopolist has no pricing power and must accept the market price. The monopolist will produce the quantity where their marginal cost curve intersects the horizontal demand curve, as this is the point that maximizes profit. The price will then be determined by the market, as the monopolist cannot influence it. This is in contrast to a monopolist facing a downward-sloping demand curve, who can charge a higher price by restricting output.
Analyze the implications of perfectly elastic demand for a monopolist's ability to earn economic profits.
With perfectly elastic demand, a monopolist has no ability to earn economic profits. Since the monopolist must accept the market price and cannot influence it, they are unable to charge a price above the competitive level. As a result, the monopolist's economic profit will be driven to zero, as they will produce the quantity where their marginal cost equals the market price. This means the monopolist earns only a normal profit, with no excess profits, in the long run.
Evaluate how the presence of close substitutes for a good can lead to perfectly elastic demand, and discuss the impact this has on a monopolist's pricing and output decisions.
The presence of close substitutes for a good is a key factor that can lead to perfectly elastic demand. If consumers have many readily available alternatives to the monopolist's product, they will immediately switch to the substitute if the monopolist tries to raise the price even slightly. This means the monopolist has no pricing power and must accept the market price. As a result, the monopolist will produce the quantity where their marginal cost curve intersects the horizontal demand curve, and they will be unable to earn economic profits in the long run. The monopolist's pricing and output decisions are thus heavily constrained by the presence of close substitutes that create perfectly elastic demand.
A graphical representation of the relationship between the price of a good or service and the quantity demanded of that good or service.
Elasticity of Demand: A measure of the responsiveness of the quantity demanded of a good or service to a change in its price, income, or the prices of related goods.