Is The Demand Curve For PC Firm Really Flat?
Practically every introductory microeconomics text describes the demand curve facing a perfectly competitive firm as being flat or horizontal. A horizontal demand curve is perfectly elastic. If there are n identical firms in the market then the elasticity of demand PED facing any one firm is
-
- PEDmi = nPEDm - (n - 1) PES
where PEDm is the market elasticity of demand, PES is the elasticity of supply of each of the other firms, and (n -1) is the number of other firms. This formula suggests two things. The demand curve is not perfectly elastic and if there are a large number of firms in the industry the elasticity of demand for any individual firm will be extremely high and the demand curve facing the firm will be nearly flat.
For example assume that there are 80 firms in the industry and that the demand elasticity for industry is -1.0 and the price elasticity of supply is 3. Then
- PEDmi = nPEDm - (n - 1) PES,
- PEDmi = (-1) - (80 - 1) 3,
- PEDmi = -1(80) - (79 x 3)
- PEDmi = -80 - 237 = - 317
That is the firm PED is 317 times as elastic as the market PED. If a firm raised its price "by one tenth of one percent demand would drop by nearly one third." if the firm raised its price by three tenths of one percent the quantity demanded would drop by nearly 100%. Three tenths of one percent marks the effective range of pricing power the firm has because any attempt to raise prices by a higher percentage will effectively reduce quantity demanded to zero.
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