Which of the following statements about the relationship between price elasticity of demand and type of firm is/are correct? 1. Perfectly elastic demand is associated with a competitive firm. 2. Perfectly inelastic demand is associated with a monopolistically competitive firm. Select the answer using the code given below.

Correct — A, 1 only. Statement 1 states the standard result for a firm in perfect competition. Such a firm is one seller among very many, selling a homogeneous product at the ruling market price; if it raised its price even slightly it would lose every buyer, and it has no reason to lower it because it can already sell all it wants at the market price. Its own demand curve is therefore a horizontal line at that price — perfectly elastic. Statement 2 fails. A monopolistically competitive firm sells a differentiated product, so it does have some pricing power, but the availability of close substitutes makes its demand curve downward-sloping and relatively elastic, not perfectly inelastic. Perfectly inelastic demand — a vertical demand curve, quantity unchanged whatever the price — is a textbook limiting case for goods with no substitutes at all, not a market structure result.

• (b)2 only — Keeps only statement 2, which is the wrong one. Monopolistic competition is associated with elastic, downward-sloping firm demand, not a vertical demand curve.
• (c)Both 1 and 2 — Accepts both. That would require the same theory to give a perfectly competitive firm a horizontal demand curve and a monopolistically competitive one a vertical curve, which no market-structure model does.
• (d)Neither 1 nor 2 — Rejects both, but the horizontal demand curve of a price-taking firm in perfect competition is one of the most standard results in microeconomics.

Market structures are classified by the number of sellers, the nature of the product and the freedom of entry, and each classification implies a shape for the individual firm's demand curve. Under perfect competition the firm is a price taker facing a horizontal, perfectly elastic demand curve; the market demand curve still slopes downward. Under monopolistic competition each firm has a differentiated product, so it faces a downward-sloping but highly elastic demand curve, and under monopoly the firm faces the market demand curve itself, which is much less elastic.

The reliable way through this item is to separate the firm's demand curve from the market's. Students often carry a single mental picture of a downward-sloping demand curve and apply it to every firm, which makes statement 1 look wrong; the point is that the horizontal line belongs to the individual price-taking firm, not to the industry. Statement 2 fails on a different ground: perfect inelasticity is a property of a good with no substitutes, whereas monopolistic competition is defined by having many close ones. Attaching a perfectly inelastic curve to the market structure with the most substitutes is the strongest signal that the statement was written to be false.

• A perfectly competitive firm is a price taker and faces a perfectly elastic, horizontal demand curve.
• The market demand curve under perfect competition still slopes downward; only the individual firm's does not.
• Monopolistic competition means many sellers with differentiated products and a downward-sloping, relatively elastic firm demand curve.
• Perfectly inelastic demand is a vertical demand curve, associated with goods having no substitutes.
• A monopolist faces the entire market demand curve and therefore the least elastic demand of all structures.

• Applying the market's downward-sloping demand curve to the individual competitive firm.
• Treating perfectly inelastic demand as a market-structure property rather than a property of the good.
• Equating monopolistic competition with monopoly because the names look alike.

Asked as a two-statement code item pairing market structures with demand elasticities — one pairing is the textbook result and the other is the opposite extreme.

• practice — not a real PYQ

  A firm that can sell any quantity at the ruling market price but nothing at all above it faces

  • (a)perfectly inelastic demand
  • (b)perfectly elastic demand
  • (c)unitary elastic demand
  • (d)inelastic demand

  Answer(b) perfectly elastic demand — the horizontal demand curve of a price-taking firm.

• practice — not a real PYQ

  Which market structure combines many sellers with differentiated products?

  • (a)Perfect competition
  • (b)Monopoly
  • (c)Monopolistic competition
  • (d)Duopoly

  Answer(c) Monopolistic competition — many sellers, but each product is distinguishable from the rest.