Question

What would the PP schedule in Krugman’s basic diagram look like if demand became more elastic as per capita consumption increased?

Answer 1

In the Krugman model, labor is the only factor of production where units of labor is a function of given levels of output produced by a firm. Second important characteristic of the model is that the market structure shows monopolistic competition. The Krugman model graphically shows the consumption of a typical good by a representative consumer as per capita consumption on x-axis whereas the vertical axis shows the ratio of the price of the good to the wage rate.

The PP curve shows the relationship between the price of the good to marginal cost. As consumption increase demand becomes less elastic. ZZ curve shows the phenomenon that economic profits are zero, in the long run, means the price is equal to average cost at all points in ZZ curve.

The PP curve will not be upward sloping in case demand being more elastic as per capita consumption increases. Because the original upward slopping PP curve shows that as per capita consumption increases, the price of the good increases along with it, the reason is that demand is assumed to be less elastic as consumption increases and thus profit maximizing price increases. The given practices in the question is a case of price discrimination also called dumping where markets are segmented and lower prices are charged at markets where demand is more elastic.