Elasticity of demand - Essay Example

The economic law of supply and demand influences a lot the movement of product and services in the marketplace. Business analyst and economist are interested in how responsive the demand is to some change in price or income a concept known as elasticity. The precise metric utilize in the industry is the price elasticity of demand which is the percentage change in quantity divided by the percentage change in price (Varian, 2003). The price elasticity of demand behaves differently depending on the market structure a firm operates in.

This paper analyzes the behavior of price elasticity under monopolistic competition, oligopoly, and monopoly to determine the differences in price elasticity among the economic structures. Under monopolistic competition the price elasticity is high. One of the reasons this occurs is because there are many firms competing in the marketplace. Firms can enter easily into this market structure because there are no barriers of entry. An example of a firm operating under monopolistic competition is the fast food giant McDonalds.

It is clear for customer that the prices between fast food chains change a lot based on the price moves made by others. When McDonalds introduced its one dollar value menu, competitors in the industry such as Burger King and Wendy’s followed with an economical menu of their own. The intense competition in under this market structure raises the price elasticity of demand for its players. In an oligopoly market structure the price elasticity of demand is medium. An oligopoly market is one in which there are a limited number of firms participating in the marketplace.

Since there is competition the price elasticity of demand is affected by others. There are barriers of entry which limit the number of participants. The price elasticity of demand is lower in monopoly than in monopolistic competition since it now in the best interest of the participants for price wars to occur. Many fluctuations in price among participant in the market can be very damaging to the entire market structure. An example of an oligopoly is the airline industry. Airlines can not go in full price wars since their activities are interconnected as far as sharing resources from airports and the firm know the aggregate demand for flying is somewhat stable, thus a price war will only lower the total profits of all the participants in the market structure.

The economic profits of firms participating in an oligopoly depend on the other players which lower the price elasticity of demand. A third market structure is a monopoly market structure. In this market structure there is only one firm participating in the marketplace. The lack of competitors under this market structure results in non existent price elasticity of demand. The price determination for the monopolist is set by the firm itself at the point in which profits are maximized independent of the customer’s reactions.

Being a sole provider give the monopolist power. Economic profits under monopoly are achieved when marginal cost equals marginal revenues (Hirschey, 2006). An example of a monopoly is a public utility company such as the local electricity provider. When electricity prices go up there is no where to turn for the customers since there is only one service provider which is reason which there is no price elasticity of demand under monopoly. The price elasticity of demand varies depending on which market structure a firm operates in.

The three market structures discussed in this paper were monopoly, oligopoly and monopolistic structure. Out of the three structures monopolistic competition has the highest price elasticity of demand because this structure has the highest level of competition. A monopoly market structure has no price elasticity of demand due to the fact that there is one participant in the marketplace which gives this the ability to set its own price levels based on the equation MR=MC. An oligopoly has a medium price elasticity of demand due to a limited number of participants in the marketplace.

The price movement in oligopoly intensifies if a price war occurs between the players in the industry.ReferencesHirschey, M. (2007). Economics for Managers (India Edition). Australia: Thompson South-Western.Varian, H, (2003). Intermediate Microeconomics: A Modern Approach (6th ed.). New York: W.W. Norton & Company. References