What is Price Determination? - Class 12 Micro Economics - Commerce PDF Download

PRICE DETERMINATION

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.

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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

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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.

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

(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 AND NON-VIABLE INDUSTRY

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

EFFECT ON EQUILIBRIUM PRICE // MARKET PRICE AND QUANTITY

NUMERICAL SOLUTION

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

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

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 PROPORTIONATE
DECREASE IN SUPPLY :: PRICE remains UNCHANGED and QUANTITY will FALL

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

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Increase or decrease in quantity depends upon proportionate change in demand
 and supply

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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

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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 , so that 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.e landlords cannot charge a rent more than what is fixed by the government.
 

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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 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 being represented by the line segment “AB”

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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

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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 contract to PF C , 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 being represented by the line segment “CD”

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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.