Question

1. What does it mean to have perfectly elastic demand? What does it mean to have perfectly inelastic demand? Graph each
2. What factors effect the magnitude of the price elasticity of demand?
3. What is meant by a proprietorship? What are its advantages and disadvantages?
4. What is meant by a corporation? What are its advantages and disadvantages?
5. What is meant by a partnership? What is its advantages and disadvantages?

Answer 1

When demand is perfectly elastic at a certain price demand is infinite. In such cases, if a firm increased the price slightly, demand would drop to 0. When demand is perfectly elastic, the demand curve is horizontal.

At price P', Demand is infinite. However, for any price above P', demand =0.

The value of price elasticity of demand (ep) is infinite. Theoretically, this concept is valid for homogenous products in perfectly competitive markets.

When demand is perfectly inelastic there is no change in quantity demanded even if there is a change in prices. In such cases, even if a firm increased the price greatly, demand will not change. When demand is perfectly inelastic, the demand curve is vertical.

Even if the firm changes prices from, P' to P'' demand will not change from Q'.

The value of price elasticity of demand (ep) is 0. Theoretically, this concept is valid for essential goods.

The following are a few factors that affect the magnitude of the price elasticity of demand.

1. Nature of commodity - Necessities like food items have inelastic demand, luxuries like AC have elastic demand.

2. Substitutes - Availability of substitutes increases the elasticity of demand. If McDonald's increases its price, Burger king will see increased demand.

3. Income - Rich people are less price-sensitive than poor people.

4. Level of prices - Costly items like a TV or Car are generally prone to price sensitivity than inexpensive items like salt or needle.

5. Time dimension - Demand is inelastic in the short-run as consumers can't change their habits or find substitutes, however, Demand is elastic in the long-run as a consumer will switch or stop consumption.

6. Habits - Demand is inelastic for habitual necessities like alcohol or cigarettes.