ECON1001 · Introductory Microeconomics
Elasticity & Perfect Competition
Week 6 measures responsiveness and applies the toolkit to the benchmark market structure. Elasticity is a unit-free %Δ/%Δ ratio; price elasticity of demand varies along a linear demand curve (elastic at the top, unit elastic at the midpoint, inelastic at the bottom) and ties directly to total revenue. Cross-price and income elasticities classify goods as substitutes/complements and normal/inferior. The chapter also sets out the four-way market-structure taxonomy and the perfect-competition rules: shut down if P < AVCmin in the short run, and free entry/exit driving P = ATCmin with zero economic profit in the long run.
What this chapter covers
- 01Elasticity as unit-free %Δ/%Δ; point vs midpoint (arc) methods
- 02Price elasticity of demand and its categories from 0 to −∞
- 03Why elasticity varies along a linear demand curve
- 04Elasticity and total revenue; TR maximised at unit elasticity
- 05Cross-price elasticity (substitutes vs complements) and income elasticity (normal vs inferior vs luxury)
- 06Elasticity of supply
- 07Market-structure taxonomy: competition, monopolistic competition, oligopoly, monopoly
- 08Perfect competition: short-run shutdown rule and long-run zero-profit entry/exit
Point elasticity and the link to revenue
- 3 marks · PED at P = 15At P = 15: Q = 120 − 60 = 60. Slope dQ/dP = −4. PED = (dQ/dP)(P/Q) = (−4)(15/60) = −1.
- 2 marks · PED at P = 20At P = 20: Q = 120 − 80 = 40. PED = (−4)(20/40) = −2.
- 2 marks · classify and recall the TR rulePED = −1 is unit elastic; PED = −2 is elastic. Total revenue is maximised where demand is unit elastic (the midpoint of a linear demand).
- 1 mark · revenue conclusionTherefore TR is at its maximum at P = 15. At P = 20 demand is elastic, so a price cut would raise revenue — revenue is not yet at its peak.
Key terms
- Price elasticity of demand (PED)
- The percentage change in quantity demanded divided by the percentage change in price, computed as (dQ/dP)(P/Q); usually negative, and its magnitude classifies demand as elastic, unit elastic or inelastic.
- Midpoint (arc) elasticity
- An elasticity computed using the averages of the two endpoint prices and quantities, giving the same value whether price rises or falls.
- Cross-price elasticity
- The responsiveness of one good's quantity to another good's price; positive for substitutes, negative for complements, zero for independent goods.
- Income elasticity
- The responsiveness of quantity demanded to income; negative for inferior goods, between 0 and 1 for normal necessities, and above 1 for luxuries.
- Shutdown rule
- In the short run a competitive firm produces where P = MC only if price covers minimum average variable cost; if P < AVC_min it shuts down and produces nothing.
- Long-run zero-profit condition
- Free entry and exit in perfect competition drive price to minimum average total cost, leaving every firm with zero economic profit.
Elasticity & Perfect Competition FAQ
Why does elasticity change along a straight-line demand curve?
The slope dQ/dP is constant, but elasticity also depends on the P/Q ratio. High up the curve P is large and Q small, so demand is elastic; low down P is small and Q large, so it is inelastic; the midpoint is exactly unit elastic.
When should a competitive firm shut down in the short run?
When the price falls below minimum average variable cost. Above that, producing at P = MC at least covers all variable cost and part of fixed cost, so the firm loses less by operating; below it, the firm loses less by producing nothing.
Why is long-run economic profit zero in perfect competition?
Positive profit attracts entry, which shifts market supply right and pushes price down; losses cause exit, raising price. The process only stops when price equals minimum average total cost, leaving zero economic profit.
Exam move
Drill the point formula PED = (dQ/dP)(P/Q) and the midpoint method until both are automatic, and immediately translate any elasticity value into its revenue consequence. Keep the four-structure taxonomy on one card (number of firms, product type, entry barriers, pricing power) because it frames every later chapter. For perfect competition, practise the two regimes separately: the short-run shutdown comparison against AVC_min, and the long-run convergence to P = ATC_min with zero profit.
