06 Apr What is Perfectly Elastic Demand?
If there is perfectly elastic demand for a product, a small change in its price will result in a drastic difference in sales. A rise in the product’s price will lead to sales falling to near zero, while a decrease in its price will result in an infinite level of demand.
What does perfectly elastic demand mean?
It’s important to bear in mind that perfect elasticity of demand is a theoretical concept. If the demand for a certain product is expected to rise to an infinite level if its price falls by even a small amount, it is necessary that the market that the product is being sold in is perfectly competitive.
The conditions that must be satisfied for perfectly elastic demand to exist are:
- There should be a large number of producers who manufacture the product.
- No single producer should be able to influence the price of the product.
- There should also be a very large number of customers.
- Every producer should be selling a homogeneous product.
Every manufacturer is a “price-taker.” This implies that the manufacturer has to sell at the price that is prevalent in the market. Raising the price is simply not an option. If a manufacturer increases the selling price, sales would fall to zero.
Additionally, there is no incentive to drop prices, as it is possible to sell the entire volume of production at the prevailing market price.
Example of perfectly elastic demand
Paulo & Sons is a bakery located in New York City. The bread that Paulo & Sons bakes retails at $2 per loaf. If the price is increased to $2.25, there will be a very large fall in sales.
Conversely, there is no reason to drop the price below $2 because at that price the entire quantity of bread that is produced can be sold.
The demand for the bread that Paulo & Sons produces can be said to be perfectly elastic. If there is a rise in prices, customers can easily buy from an alternative source. There are a number of other bakeries that can increase production volumes in case one supplier raises prices.
If a small change in price results in a great change in sales, the product is said to be subject to perfectly elastic demand. This usually happens in highly competitive markets and applies to exactly similar products that are offered by multiple sellers.