Perfectly Elastic Demand
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Definition of Perfectly Elastic Demand:
A perfectly elastic demand
is a demand where any price increase would cause the quantity demanded to fall to zero, and reducing the price of a good or service will not increase sales.
A perfectly elastic demand curve is horizontal at the market price. It is important to distinguish between the market demand and a producer's demand. The market demand is the sum of individual demands. The market demand curve slopes downward. An individual producer's demand curve usually has a different slope. A buyer may need a specific good or service, but may not care which business provides it. A business's demand depends on the number of competitors it has, and if it can differentiate its product. If many producers offer identical products, then a buyer would make a decision based solely on price.
Businesses with a perfectly elastic demand curve operate in perfectly competitive markets. These companies are normally small and produce a good or service that is identical to other producers. No single company impacts the market price for the good or service it sells. Their customers are only motivated by price. These companies are “price takers”, meaning they must accept the market price, or choose not to sell their product. Any company that tries to raise its price will see their sales fall to zero because there are too many competitors offering the same product at a lower price. Conversely a company could lower its price, but would not do so because it could sell all it can offer at the market price.
To illustrate, assume Farmer Jones is a wheat farmer. He produces 200,000 bushels of wheat. The market price of wheat is determined on the Chicago Board of Trade, where buyers and sellers come together in the same way the price of a stock is determined on the New York Stock Exchange. The market supply and demand curves determine the price is $8.00 per bushel. This is illustrated on Graph 1. Graph 2 is Farmer Jones's supply and demand curve. Farmer Jones must accept $8.00 or less for his wheat. If he tries to sell it for $8.25, buyers would purchase from his competitors, so above $8.00 the quantity demanded would be zero. The good news is that Farmer Jones can sell his 200,000 bushels at $8.00, so there would be no incentive for him to reduce his price. (If Farmer Jones increased his supply, his supply curve on Graph 2 would shift to the right and there would be no change in the equilibrium price.)
Dig Deeper With These Free Lessons:
Price Elasticity of Demand - How Much of a Price Change Would You Tolerate
Supply and Demand - Consumers and Sellers Reach Agreement
Market Structures Part I - Perfect Competition and Monopoly