Question

a) Explain why the demand curve facing a perfectly competitive firm is assumed to be perfectly elastic (i.e., horizontal at the going market price).

b) The manufacturer of high-quality flatbed scanners is trying to decide what price to set for its product. The costs of production and the demand for the product are assumed to be as follows: TC = 500,000 + 0.85Q + 0.015Q 2 Q = 14,166 - 16.6P Determine the short-run profit-maximizing price.

c) Explain why the demand curve facing a monopolist is less elastic than one facing a firm that operates in a monopolistically competitive market (all other factors held constant).

Answer 1

a) Perfect Competition is a form of market structure in which there is free entry and exit of firms and firms are selling homogeneous and identical products in the market. Firms under this form of market are price takers rather than price makers. Industry determines the equilibrium price from the demand and supply curve intersection. Sellers can sell any unit of commodity at that price and firms does not have any price control over the commodity. If one seller try to charge higher price then it will lose all his customers because all firms are selling similar products in every respect like color, shape, brand, etc.

Demand curve of the firm is perfectly elastic (Ed = Infinity). It means that the firm can sell any amount of the commodity at the prevailing price. Firm's demand curve is indicated by a horizontal straight line parallel to X-axis. This shows that the firm is accept the price determined by the forces of market demand and market supply, it can sell whatever amount it wishes to sell at this price.

b) MC = 0.85 + 0.03Q

TR = PQ = (14166 - Q)/16.6 x Q

MR = (14166 - 2Q)/16.6

Equilibrium is where MR = MC

(14166 - 2Q)/16.6 = 0.85 + 0.03Q

14166 - 2Q = 14.11 + 0.498Q

14151.89 = 2.498Q

Q = 5665.29 units

P = (14166 - Q)/16.6 = $ 512.09

c) Demand curve of monopolistic is less elastic because there is no other firm in the market from where consumer can purchase goods. So, demand of goods sold by monopoly firm has less elastic demand.

Under monopolistic competition, there are large number of firms and leads to higher competition which makes demand of good more elastic.