Chapter Notes - Price Determination Commerce Notes | EduRev

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Equilibrium Price ::  It refers to a price where market demand is equal to market supply In other words, there is no pressure on price to either increase or decrease and refers to position of no price change. it is also called MARKET PRICE EQUILIBRIUM QUANTITY :: It refers to quantity demanded and supplied at equilibrium price and this situation of zero excess demand and zero excess supply is called MARKET EQUILIBRIUM.

Under perfect competition equilibrium price is determined by intersection of market demand and market supply curve . This free inter-play of demand and supply is called PRICE MECHANISM OR MARKET MECHANISM

Price Determination
 Equality between Demand and Supply

Price is determined Between The Two Limits Set By Demand and Supply.
Equilibrium price is set at where market demand is equal to market supply. In other words there is no pressure on price to either increase or decrease and refers to position of on price change

Price  Q. demanded  Q. supplied        EFFECT        

  Q= 200 -P      Q8 = 120 +P

10      190                130       Excess demand,Price will Increase                   

20      180                140       Excess demand,Price will Increase

30      170                150       Excess demand,Price will Increase

40      160                160       Equilibrium Level, no  change in  Price

50      150                 170      Excess Supply , Price   will decrease

60      140                 180      Excess Supply , Price   will decrease

Chapter Notes - Price Determination Commerce Notes | EduRev

 Equilibrium price is  OP (Rs.40) and     Equilibrium quantity is OQ (160 units)

Adjustment Mechanism

(Case A) Price Less Than Equilibrium Level or Situation of Excess Demand {Shortage of Supply}[[ M.D.  > M. S ]] :: Suppose price is OP1 (Rs.30 ), there will be excess demand of ‘ AB’ units (170-150 = 20 units ).
Situation:: Excess demand that is a  situation when quantity demanded is more than quantity supplied at the prevailing market price.
Cause:: As the prevailing market price is less than equilibrium price or  equilibrium price is more than prevailing market price

→ Buyer will be willing to buy more at reduced price { acc. to LOD }

→Seller would be selling less at reduced price { acc. to LOS }

Thus a situation will arise when Market demand will be greater than Market supply , known as EXCESS DEMAND

Effect :: This will

(i) result in COMPETITION AMONG BUYER and some consumer will be unable to obtains the commodity

(ii) result in BLACK MARKETING as some consumer will be willing pay to high price

Mechanism :: Accordingly PRICE WILL START increasing upto the level where there is no excess demand i.e Q demanded is equal to Q supplied . This process is indicated by ARROW POINTING UPWARD

(Case B) Price More Than Equilibrium Level or Situation Of Excess Supply {Shortage of Demand} [[ M.D.  > M. S ]] :: Suppose price is OP2 (Rs.30 ), there will be excess demand of ‘CD’ units (170-150 = 20 units ).

Situation :: Excess supply that is a  situation when quantity supplied is more than quantity demanded at the prevailing market price.

Cause :: As the prevailing market price is more than equilibrium price or  equilibrium price is less than prevailing market price

→  Buyer will be willing to buy less at higher price { acc. to LOD }

→Seller would be selling more at higher price { acc. to LOS }

Thus a situation will arise when Market Supply will be greater than Market Demand  , known as EXCESS SUPPLY

Effect: (i) Thus COMPETITION AMONG SELLER will start and some firm will not be able to sell the desired quantity

(ii) This will result in Stock Accumulation or Stock Piling

Mechanism :: Accordingly PRICE WILL START Decreasing upto the level where there is no excess demand i.e Q demanded is equal to Q supplied . This process is indicated by ARROW POINTING DOWNWARD

Numerical Solution
At equilibrium level Qd = Qs   i.e. 200 - P = 120 +P 200 - 120 = P + P →80 = 2P P = Rs 40

Putting value of Price in Qd or Qs we get   , 200 - 40 or  120 + 40 = 160 units

(Q1) If for a given price there is excess supply, how will the equilibrium be reached?Use diagram

(Q2) IF for a given price there excess demand, how will the equilibrium be reached ? use diagram

(Q3) “ When the market is not in equilibrium there will be tendency of price to change” Justify

(Q4)  Which of these DEMAND OR SUPPLY IS MORE IMPORTANT in determination of price?

Acc. to MARSHALL  both are equally helpful in determination of price . He has given equal importance to both of them and has quoted that “as we need upper blade and lower blade to cut cloth, as we require left and right leg to walk, similarly we require both demand and supply to determine price”.

But however under exceptional situation the importance may vary depending upon                            

          (a) TIME PERIOD                  (b) TYPE OF GOOD

(i) In case of very short period, the supply of perishable good (milk, vegetable) is fixed (inelastic Therefore demand has more influence in determination of price

(ii) In case of long period, the supply of desirable good can be stored and hence supply of good elastic. Moreover the sellers has a reserve price below which they are not prepared to sell the commodity. Therefore in this case supply has more influence in determination of price

Viable Industry :: An industry is said to be viable when for minimum price which seller can afford there is demand in the market. Thus there is equilibrium price and graphically demand and supply intersect at some common point

Non- Viable Industry :: An industry is said to be non-viable when for minimum price which seller can afford there is no demand in the market. Graphically supply curve is above demand curve and both donot intersect i.e no equilibrium price exist.

Examples

(a) aircraft industry in India as COP is very high so govt. Purchases it from Germany or France where it is a viable produce

(b) Robotics industry, Computer Memory Chips


Examples
(a) aircraft industry in India as COP is very high so govt. Purchases it from Germany or France where it is a viable produce (b) Robotics industry, Computer Memory Chips

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

Effect on Equilibrium Price // Market Price and Quantity

Change in Demand

Supply Unchanged or Supply Remaining Constant

(Case 1) Increase in Demand

     (Rightward Shift)

Chapter Notes - Price Determination Commerce Notes | EduRev

Chain Reaction

(a) Demand Increases that is there is rightward shift of Demand curve from DD to D1D1

(b) At same price of OP there will be EXCESS DEMAND of “EF” units

(c) Excess demand will result in

→ COMPETITION AMONG BUYER
and some consumer will be unable to obtains the commodity

→BLACK MARKETING as some consumer will be willing pay to high price

(d) This will result in Rise in Price

(e) At HIGHER PRICE

→ There will be Contraction of demand from ‘F’ to ‘E1 { according to law of demand }

→There will be Extension of Supply from ‘E’ to ‘E1’ { according to law of supply  }

(f) This process will continue upto the level a new equilibrium at ‘E1’ is reached with zero Excess demand

RESULT :: (1) PRICE has Increased           (2) Quantity has Increased

(Case2) Decrease in Demand

     (Leftward Shift)

Chapter Notes - Price Determination Commerce Notes | EduRev

Chain Reaction

(a) Demand decreases that is there is leftward shift of Demand curve from DD to D2D2.

(b) At same price of OP there will be EXCESS SUPPLY of “FE” units

(c) Excess Supply demand will result in

→ COMPETITION AMONG SELLER
will start and some firm will not be able to sell the desired quantity  

→STOCK ACCUMULATION OR STOCK PILING

(d) This will result in Fall in Price

(e) At REDUCED PRICE

→There will be Extension of demand from ‘F’ to ‘E2 { according to law of demand } →There will be Contraction of Supply from ‘E’ to ‘E2’ { according to law of supply  }

(f) This process will continue upto the level a new e quilib rium a t ‘E2’ is reached with ze ro Excess supply

RESULT :: (1) PRICE has Decreased           (2) Quantity has Decreased

Change in Supply

Demand Unchanged or Demand Remaining Constant

(Case 3) Increase in Supply

     (Rightward Shift)

Chapter Notes - Price Determination Commerce Notes | EduRev

Chain Reaction

(a) Supply Increases that is there is rightward shift of Supply curve from SS to S1S1.

(b) At same price of OP there will be EXCESS supply of “EN” units

(c) Excess Supply will result in  

→COMPETITION AMONG SELLER
will start and some firm will not be able to sell the desired quantity

 →STOCK ACCUMULATION OR STOCK PILING
(d) This will result in Fall in Price

(e) At REDUCED PRICE

→There will be Extension of demand from ‘E’ to ‘E1 { according to law of demand } →There will be Contraction of Supply from ‘N’ to ‘E1’ { according to law of supply  }

(f) This process will continue upto the level a new equilibrium at ‘E1’ is reached with zero Excess supply

RESULT :: (1) PRICE has Decreased          (2) Quantity has Increased

 

(Case 4) Decrease in Supply

     (Leftward Shift)

Chapter Notes - Price Determination Commerce Notes | EduRev

Chain Reaction

(a) Supply decreases that is there is leftward shift of Supply curve from SS to S2S2.

(b) At same price of OP there will be EXCESS DEMAND of “NE” units

(c) Excess Supply demand will result in  

→COMPETITION AMONG BUYER
and some consumer will be unable to obtains the commodity →BLACK MARKETING as some consumer will be willing pay to high price

(d) This will result in RISE in Price

(e) At HIGHER PRICE

→There will be Contraction of demand from ‘E’ to ‘E2 { according to law of demand }

→ There will be Extension of Supply from ‘N’ to ‘E2’ { according to law of supply  }

(f) This process will continue upto the level a new e quilib rium a t ‘E2’ is reached with ze ro Excess Demand

RESULT :: (1) PRICE has Increased           (2) Quantity has Decreased

 

Numerical Solution

(Case 1) Increase in Demand       (Rightward Shift)

 Qd = 200 - P + 40

Qs = 120 +P

At equilibrium

Qd = Qs

200 - P + 40 = 120 +P

240 - P = 120 + P

120 = 2P

P = Rs 60 (increases)

Qd = Qs = 180 units (increases)

(Case2) Decrease in Demand       (Leftward Shift)

Qd = 200 - P - 40

Qs = 120 +P

At equilibrium Qd = Qs

200 - P - 40 = 120 +P

160 - P = 120 + P

40 = 2P

P = Rs 20 (decreases)

Qd = Qs = 140 units (decreases)

(Case 3) Increase in Supply     (Rightward Shift)

 Qd = 200 - P

Qs = 120 +P + 40

At equilibrium Qd = Qs

200 - P = 120 + P + 40

200 - P = 160 + P

40 = 2P

P = Rs 20 (decreases)

Qd = Qs = 180 units (increases)

(Case 4) Decrease in Supply      (Leftward Shift)

 Qd = 200 - P

Qs = 120 +P -40

At equilibrium Qd = Qs

200 - P = 120 + P - 40

200 - P = 80 + P

120 = 2P

P = Rs 60 (increases)

Qd = Qs = 140 units (decreases)

Exceptional or Miscellaneous Cases

(A) Demand Is Perfectly Elastic and Supply Changes

 

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

(B) Demand Is Perfectly Inelastic and Supply Changes

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

(C) Supply Is Perfectly Elastic and Demand Changes

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

(D) Supply Is Perfectly Inelastic and Demand Changes

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

Simultaneous Change in Demand and Supply

(Q) “ Change in demand and supply may or may not effect Price” 

(Q) “ Change in demand and supply may increase, may decrease or may not effect Price” 

The STATEMENT IS TRUE as change in price depends upon proportion change in demand and proportion change in supply

Simultaneous Increases in Demand and Supply :: This will result in increase in equilibrium quantity always and change in equilibrium price will depends upon whether demand increases more than, equal to,or  less than supply

(1) When Proportionate Increase In Demand Is More Than Proportionate
 Increase In Supply::

PRICE will RISE and QUANTITY will RISE

(2) When Proportionate Increase In Demand Is Less Than Proportionate
 Increase In Supply:: 

PRICE will FALL and QUANTITY will RISE

(3) When Proportionate Increase In Demand Is Equal To Than Proportionate
Increase In Supply::

 PRICE remains UNCHANGED and QUANTITY will RISE

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

Simultaneous Decreases in Demand and Supply :: This will result in decrease in equilibrium quantity always and change in equilibrium price will depend upon whether demand decreases more than, equal to,or  less than supply

(A) When Proportionate Decrease In Demand Is More Than Proportionate
 Decrease In Supply::

PRICE will FALL and QUANTITY will FALL

(B) When Proportionate Decrease In Demand Is Less Than Proportionate
 Decrease In Supply:

PRICE will RISE and QUANTITY will FALL

(C) When Proportionate Decrease In Demand Is Equal To Than Proportion-
Ate Decrease In Supply::

 PRICE remains UNCHANGED and QUANTITY will FALL

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

Demand and Supply Shifts In Opposite Direction

(A)Demand Increases and Supply Decreases:: This situation will result in EXCESS DEMAND ( same explanation ) and hence there will be INCREASE IN PRICE
 (B) Demand Decreases and Supply Increases :: 
This situation will result in EXCESS SUPPLY ( same explanation ) and hence there will be DECREASE IN PRICE

 Increase or decrease in quantity depends upon proportionate change in demandand supply

Chapter Notes - Price Determination Commerce Notes | EduRevChapter Notes - Price Determination Commerce Notes | EduRev

Glance

Situations                                   Effect on                                        Equilibrium

 

(1) Changes in Demand (Supply is unchanged)

(a) demand increases

(b) demand decreases

(2) Changes in Supply (Demand is same)

(a)    supply increases

(b)    supply decreases

(3) Simultaneous Changes in both Demand and Supply

→ IN SAME DIRECTION

(a)    Increase in demand > Increase in supply
(b)    Increase in demand < Increase in supply
(c)    Increase in demand = Increase in supply

(d)    Decrease in demand > Decrease in supply
(e)    Decrease in demand < Decrease in supply

(g) Decrease in demand = Decrease in supply

→ IN DIFFERENT /OPPOSITE DIRECTION

(a) Increase in demand and Decrease in supply

(a) Decrease in demand and Increase in supply

RISES

FALLS

RISES

FALLS

 

RISES

FALLS

SAME

FALLS

RISES

SAME

 

RISES

FALLS

RISES

FALLS

RISES

FALLS

 

FALLS

FALLS

FALLS

FALLS

FALLS

FALLS

 

DEPENDS

DEPENDS

 

VARIOUS {SIX} CASES WHERE EQUILIBRIUM PRICE REMAINS SAME

(a) Proportionate Increase in Demand    = Proportionate Increase in Supply

(b) Proportionate Decrease in Demand  = Proportionate decrease in Supply

(c) Demand increases and Supply is Perfectly elastic

(d) Demand decreases and Supply is Perfectly elastic

(e) Supply Increases and Demand is perfectly elastic

(f)  Supply Decreases and Demand is perfectly elastic

Application of Demand and Supply Analysis

Example of Imbalance between Demand and Supply

→In 1998 Indian economy suffered the ‘ onion crisis’. The price of onion increased from Rs 5 per kilogram to Rs 60 per kilogram in the retail market.

→In 1978, the was bumper crop of sugarcane in India and the price of sugarcanes crashed to Rs. 5 per quintal. Farm produces had to suffer huge losses. Same happens in 2001 in case of potato market . In these cases of excess supply, sellers stand to lose

Government Intervention in Markets :: When the two set of agents -buyers and sellers, fail to restore equilibrium in the commodity market, there is need of the third agent i.e  government to resolve the problem. Government may be in form of CG / SG , Central Authorities, Public Agencies, Public  Bodies, Local Government, etc.

Price Control // Ceiling Price or Maximum Price Legislation

Meaning:: Price-control means that a upper limit ( maximum price ) has been imposed on the price of a good or service Producers of these commodities cannot charge price higher than the ceiling price (i e the maximum price) fixed by the Government.   Govt. fixes this price below the equilibrium market price of a commodity , sothat it becomes within the reach of the poorer sections of the society

Examples

(a) The Government of India has imposed Price controls on a numbers of commodities e.g fertilizers, Petroleum products, LPG, life saving drugs , essential commodities like sugar , wheat , rice , kerosene etc.

(b) Application of Price Control // Ceiling Price - Rent Control :: The Imbalance  between demand for and supply of housing accommodation causes increase in rents.  

→The government passes ‘Rent Control Act’ which imposes maximum limit on rent i.elandlords cannot charge a rent more than what is fixed by the government.

In Fig  DD and SS are the original demand and supply curves respectively for a commodity. E is the equilibrium point, corresponding to which OQ quantity is being demanded and supplied at the price OP per unit. Suppose the Government decides to interfere with the free operation of the market forces and imposes price ceiling at Pc which is lower the equilibrium price level.

 At the lower price quantity demanded will expandto Pc A, but suppliers will be ready to supply only Pc B quantity of goods.  As a resul t, there will be excess demand orshortage of this commodity (equal to quantity demanded minus quantity supplied ) .

This is being represented by the line segment “AB”

 

Chapter Notes - Price Determination Commerce Notes | EduRev

Consequences of Price Controls or Price Ceiling

(1)Shortages or Excess Demand :: The quantity actually sold and bought in the market will reduce and as a result a large  portion of consumer’s demand will go unsatisfied .
This shortage is being  represented by the line segment “AB”

(2) Rationing :: To ensure availability of good to everyone , governments generally have price controls with distribution controls. The most effective form of distribution control is rationing. Rationing implies that a ceiling(maximum amount)  is imposed on the quantity which can be  bought and consumed by a consumer.
This is done by giving ration coupons to the consumer so that no individual can buy more than a certain amount of controlled good .

(3) Queue System  ::  The controlled goods are sold through ration shops which are also called fair price shops and these are  distributed on the basis of first-come first-served. This situation  results  in the formation of long  queues at the ration shop

(4)  Black Marketing :: Black marketing is a direct consequence of price controls. Black marketing implies a situation in which the controlled commodity is sold unlawfully at a price higher than the lawfully enforced ceiling price. This situation arises largely because of the fact that

(i) the number of potential consumers of the commodity is more than the available supplies of the commodity, and

(ii) there are consumers who are willing to pay more than the ceiling price

Floor Price or Price Support or Minimum Price Legislation

Meaning :: Price support means a lower limit  ( minimum price) has been laid on the prices of some commodities. Floor price is a legal limit on the minimum price that the supplier may charge for a particular good or service. It benefits the suppliers of good or service.

Example

(a) GOI fixes minimum price of agriculture goods so that farmers are assure of some minimum income from their produce.

(b) Application of Minimum Wage Legislation:: Minimum wages to be paid to the labour in factory or industrial establishment so that employers may be prohibited from paying less than the minimum wage fixed by the government

Government  decides to interfere with the free operation of the market forces and imposes price floor at PF which is higher than the equilibrium price level.

At the higher price quantity demanded will contractto PF C , but suppliers will be ready to supply more PFD quantity of goods.  

As a r esult , there wi ll be excess supply orshortage of the commodity  . This is being represented by the line segment “CD”

Chapter Notes - Price Determination Commerce Notes | EduRev

Consequences of Price Support (Above Equilibrium Price)

(1) Surpluses:: The quantity actually bought and supplied will reduce as  a direct consequence of price support and as a result, large proportion of producer’s stocks will remain unutilised. This surplus is shown by the line segment “CD”

(2) Buffer Stocks:: In order to maintain the support price, the Government would have to design some such programme like the government purchases the surplus stocks available with the produces and stock them for emergencies. The buffer stock operations benefit the producers as a group but it has negative impact on (a) Consumers who have to pay higher prices for the product (b) the people in general who have to pay taxes to support this programme.

(3) Subsidies :: To offset the loss to the consumers, the government may undertake to subsidies the product. By subsidy, we mean that the government purchases the product at the support price and sells the product to consumers below its cost of procurement. The difference between cost and price is borne but the government.

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