Price is determined Between The Two Limits Set By Demand and Supply.
The equilibrium price is set where market demand is equal to market supply. In other words, there is no pressure on the price to either increase or decrease, which refers to a position of price change.
Question: If for a given price there is excess supply, how will the equilibrium be reached? Use diagram.
Case A: Price Less Than Equilibrium Level or Situation of Excess Demand (Shortage of Supply) (M.D. > M.S)
Suppose the price is OP1 (Rs.30 ), there will be excess demand for ‘AB’ units (170-150 = 20 units).
Question: If, for a given price, there is excess demand, how will the equilibrium be reached ? Use diagram.
Case B: Price More Than Equilibrium Level or Situation Of Excess Supply (Shortage of Demand) (M.D. > M.S)
Suppose the price is OP2 (Rs.30 ), there will be excess demand of ‘CD’ units (170-150 = 20 units ).
Numerical Solution
At equilibrium level
Qd = Qs
i.e. 200 - P = 120 +P
200 - 120 = P + P
80 = 2P
P = Rs 40
Putting the value of Price in Qd or Qs, we get, 200 - 40 or 120 + 40 = 160 units
Try Yourself
Question: “When the market is not in equilibrium, there will be a tendency of price to change” Justify.
Question: Which of these, demand or supply, is more important in the determination of price?
According to Marshall, both are equally helpful in the determination of price. He has given equal importance to both of them and has quoted that “as we need an 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 the price.”
But however, under exceptional situations, the importance may vary depending upon
(a) Time Period
(b) Type of Goods
An industry is said to be viable when for a minimum price that sellers can afford, there is demand in the market. Thus there is an equilibrium price, and graphically, demand and supply intersect at some common point.
An industry is said to be non-viable when for a minimum price that the seller can afford, there is no demand in the market. Graphically supply curve is above the demand curve, and both do not intersect i.e, no equilibrium price exists.
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
Change in Demand
Supply Unchanged or Supply Remaining Constant
Change in Supply
Demand Unchanged or Demand Remaining Constant
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
(B) Demand Is Perfectly Inelastic and Supply Changes
(C) Supply Is Perfectly Elastic and Demand Changes
(D) Supply Is Perfectly Inelastic and Demand Changes
Question: “Change in demand and supply may or may not affect Price”
Question: “Change in demand and supply may increase, may decrease, or may not affect Price”
The statement is true as a change in price depends upon proportion change in demand and proportion change in 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
1. When Proportionate Decrease In Demand Is More Than Proportionate Decrease In Supply:
Price will fall, and quantity will fall
2. When Proportionate Decrease In Demand Is Less Than Proportionate Decrease In Supply:
Price will rise, and quantity will fall
3. When Proportionate Decrease In Demand Is Equal To Than Proportion Decrease In Supply:
Price remains unchanged, and quantity will fall
Increase or decrease in quantity depends upon proportionate change in demand and supply.
(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
Example of Imbalance between Demand and Supply
Government Intervention in Markets: When the two sets of agents -buyers and sellers, fail to restore equilibrium in the commodity market, there is a need for the third agent, i.e government, to resolve the problem. The government may be in form of CG / SG, Central Authorities, Public Agencies, Public Bodies, Local Governments, etc.
Meaning: Price-control means that an upper limit (maximum price) has been imposed on the price of a good or service Producers of these commodities cannot charge a 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 that it becomes within the reach of the poorer sections of the society
Examples: The Government of India has imposed Price controls on a number of commodities, e.g., fertilizers, Petroleum products, LPG, life-saving drugs, essential commodities like sugar, wheat, rice, kerosene, etc.
Application of Price Control / Ceiling Price -
Rent Control: The Imbalance between demand for and supply of housing accommodation causes an increase in rents.
The government passed the ‘Rent Control Act, which imposes a maximum limit on rent, i.e., landlords 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 a price ceiling at Pc, which is lower the equilibrium price level.
At the lower price quantity demanded will expand to Pc A, but suppliers will be ready to supply only Pc B quantity of goods. As a result, there will be excess demand or shortage of this commodity (equal to quantity demanded minus quantity supplied ).
This is represented by the line segment “AB”.
Consequences of Price Controls or Price Ceiling
Meaning: Price support means a lower limit (minimum price) has been laid on the prices of some commodities. The 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 goods or services.
Example: The government of India fixes the minimum price of agricultural goods so that farmers are assured of some minimum income from their produce.
Application of Minimum Wage Legislation: Minimum wages to be paid to the labor in factories or industrial establishments so that employers may be prohibited from paying less than the minimum wage fixed by the government.
The government decides to interfere with the free operation of the market forces and imposes a price floor at PF which is higher than the equilibrium price level.
At the higher price quantity demanded will contract to PFC, but suppliers will be ready to supply more PFD quantity of goods.
As a result, there will be excess supply or shortage of the commodity. This is represented by the line segment “CD”.
Consequences of Price Support (Above Equilibrium Price)
Excess demand is a situation when the quantity demanded is more than the quantity supplied at the prevailing market price.
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1. What is equilibrium price? |
2. How is equilibrium price determined? |
3. What factors can shift the equilibrium price? |
4. What happens if the market price is above the equilibrium price? |
5. What happens if the market price is below the equilibrium price? |
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