What is Perfectly Elastic Demand?
Definition: A perfectly elastic demand is an economic situation where there is a direct relation between the supply or demand and pricing. In this case, a slight change in price will often result in a significant change in demand. For instance, a small price increment might cause demand for products and services to drop to zero, while a small decline in price may cause demand to rise to infinity.
Understanding Perfectly Elastic Demand
In a perfectly elastic demand situation, the quantities of products and services supplied or demanded in the market is entirely dependent on the price. A slight change in price can increase demand to infinity or trigger a drop to zero. For this reason, the quantities of goods and services demanded in such a market is dependent on the price on offer.
The elasticity of demand, therefore, determines a great deal of the shape and slope of a perfectly elastic demand curve. The flatter the slope, the higher the elasticity of demand, which means a slight change in price, would have serious consequences on demand.
Perfectly Elastic Demand Curve
Similarly, in a perfectly elastic demand kind of setting, the demand curve always appears as a horizontal straight line.
In the chart above, it is clear that at price Po, demand is infinite. At this price point, it is clear that consumers are willing to buy as much quantity of the product as they wish. Conversely, a slight increase in price could result in a fall in demand to zero.
A perfectly elastic demand situation is more of a theoretical concept that rarely happens in real-life situations. However, it tends to occur in highly competitive market settings with homogeneity of products. In such cases, the demand for products depends greatly on prices offered as well as the prevailing market price for similar products.
Given that price is the main driver of demand in a perfectly elastic demand setting, companies are always cautious of the price they peg on their goods services. The fact that such a market setting faces strong competition means it is nearly impossible to raise the price and still stay competitive. The availability of alternatives means consumers can shift to other options with ease whenever a given marketer rises prices to their disliking.
Businesses with a perfectly elastic demand curve operate in highly competitive markets. Most of these businesses are usually small in nature and produce goods and services that are identical to one another. In this case, no business is able to affect the market price for the goods or services it sells. Likewise, price does not motivate consumers.
Perfectly Elastic Demand Example
A good example of a perfectly elastic demand is in the housing sector. Property owners are often times forced to maintain a given rent charge in a bid to attract and retain tenants. Given that the sector in most countries is filled with options, a slight increase in rental fees can cause tenants to move in search of cheaper alternatives.
Perfectly Elastic Demand vs. Perfectly Inelastic Demand
While the price is the main driver of demand in a perfectly elastic demand situation, the same cannot be said about a perfectly inelastic demand. In a perfectly inelastic demand situation, there is usually no change in demand with a change in price.
A closer look at the chart above, it is clear that demand remains the same even with an increase in price from P1 to P2. Similarly, demand remains the same, even with a decline in price from P3 to P2.
A perfectly inelastic situation arises in the purchase of life-saving products or services. Regardless of the price changes that come into play, such products would always elicit demand.
Summary
A perfectly elastic demand situation occurs when a firm can sell as much goods and services as it wants at a given price point. Similarly, consumers must be ready and willing to purchase large quantities of the products and services at the quoted price point. However, a slight change in price tends to have a serious impact on demand.