Alright, here’s a question on Perfect Competition that really got me started in understanding the concepts better. This question is awesome to do because it introduces the concepts of demand elasticity, summation of the demand curves, and the scenario of 2 types of customers in a particular industry. So here goes:
1. All Rounders treat Books and Parties as complement goods (To be all rounded, we gotta study hard and play harder!). Stressed People treat them as gross substitutes (Don’t talk about studies when we’re clubbing!). Books are sold in a perfectly competitive market where the demand of the All Rounders has an elasticity greater than unity and that of the Stressed People is less than unity. Assume that the All Rounders constitute a much smaller group of consumers than the Stressed People.
a. Draw the initial equilibrium in the market.
b. Analyse the short-run effects of an increase in the price of Parties on: equilibrium price and quantity of Books, on the spending on Books of each group of consumers and on the output and profit of the firm.
c. What will happen to all these elements in the long run?
I hope you have fun with this question! Attempt it first!