Eventually a price is found which enables an exchange to take place. A rational seller would take this a step further, and gather as much market information as possible in an attempt to set a price which achieves a given number of sales at the outset. For markets to work, an effective flow of information between buyer and seller is essential. This is efficient because there is neither an excess of supply and wasted output, nor a shortage — the market clears efficiently.
This is a central feature of the price mechanism, and one of its significant benefits. As can be seen, this market will be in equilibrium at a price of 60p per soft drink. At this price the demand for drinks by students equals the supply, and the market will clear.
At a price higher than equilibrium, demand will be less than , but supply will be more than and there will be an excess of supply in the short run. Graphically, we say that demand contracts inwards along the curve and supply extends outwards along the curve. Both of these changes are called movements along the demand or supply curve in response to a price change.
Demand contracts because at the higher price, the income effect and substitution effect combine to discourage demand, and demand extends at lower prices because the income and substitution effect combine to encourage demand.
Lower prices discourage supply because of the increased opportunity cost of supplying more. The opportunity cost of supply relates to the possible alternative of the factors of production. In the case of a college canteen which supplies cola, other drinks or other products become more or less attractive to supply whenever the price of cola changes.
Changes in demand and supply in response to changes in price are referred to as the signalling and incentive effects of price changes. If the market is working effectively, with information passing quickly between buyer and seller in this case, between students and a college canteen , the market will quickly readjust, and the excess demand and supply will be eliminated. In the case of excess supply, sellers will be left holding excess stocks, and price will adjust downwards and supply will be reduced.
In the case of excess demand, sellers will quickly run down their stocks, which will trigger a rise in price and increased supply. The more efficiently the market works, the quicker it will readjust to create a stable equilibrium price.
Graphically, changes in the underlying factors that affect demand and supply will cause shifts in the position of the demand or supply curve at every price.
Whenever this happens, the original equilibrium price will no longer equate demand with supply, and price will adjust to bring about a return to equilibrium. For example, if there is a particularly hot summer, students may prefer to drink more soft drinks at all prices, as indicated in the new demand schedule, QD 1. At the higher level of demand, keeping the price at 60p would lead to an excess of demand over supply, with demand at and supply at , with an excess of This will act as an incentive for the seller to raise price, to 70p.
Equilibrium will now be re-established at the higher price. An increase in demand shifts the demand curve to the right, and raises price and output. An increase in supply shifts the supply curve to the right, which reduces price and increases output. A decrease in supply shifts the supply curve to the left, which raises price but reduces output. In a competitive market, firms may enter or leave with little difficulty.
Firms may be attracted into a market for a number of reasons, but particularly because of the expectation of profit. In simple terms, goods which cannot be stored for some time are called the perishable goods. Fresh vegetables, milk etc. Supply of such goods at any given time is fixed.
If demand increases supply cannot be increased so quickly. Therefore, it is demand that plays a dominant role in the determination of price. In figure 5 quantities of perishable goods is measured on horizontal axis, price on vertical axis. SS is the supply curve. It signifies the fact that supply of perishable goods remains fixed. DD is the original demand curve which shows the equilibrium at paint E. Thus, OP is the equilibrium price.
Now, suppose, if in the very short period demand increases and assumes the form of D 2 D 2. The equilibrium will also shift to E 2. It depicts that with the increase in demand the price increases to OP 2. Durable goods are those which can be reproduced or those can be stored.
Like perishable goods, the supply of durable goods is not vertical throughout the length. Firms selling such goods have a minimum reserve price. They will not sell goods at less than the reserve price. These goods are like wheat, soap, oil etc. MPS is the market period supply curve where OQ 0 is the stock of the commodity. Q 1 O 0 stock will be held back.
If the demand is D 2 D 2 , the whole stock will be sold out at OP 0 price. But in case the demand is D 2 D 2 , the equilibrium will be at E 2 and the price will be OP 2 where the entire output is sold. At OR price i. But from R to Eo, as the price rises, the quantity supplied also rises. If the seller expects that a high price will prevail in the market in future, the reserve price will be higher and vice-versa.
If the seller is in urgent need of money, his reserve price will be lower. Thus, higher the liquidity preference, higher will be the reserved price and vice-versa. If the seller expects that in future the cost of production will fall, his reserve price will be lower and vice-versa. If the seller finds that the storage expenses are higher and the time for which the stocks have to be held are longer, his reserve price will be lower and vice-versa.
The durability of the commodity influences the reserve price. The more durable a commodity is, the higher will be the reserved price. The future demand of the commodity also influences the reserve price of the producer. If the producer expects a higher demand in future, his reserve price will also be higher. The figure 7 depicts the process of price determination in the short period.
DD is the demand curve of the industry.
The equilibrium price of a product or service is determined through extensive market research research. It can also vary over time. This equilibrium price occurs when the number of customers willing to pay a certain price meets the quantity suppliers are willing to make.
How can an equilibrium price be found. What happens if a firm sets the price of a product above the equilibrium level. What is price determined by. The interaction of demand and supply. If price is not at the equilibrium level initially, what will market forces do.
This lesson will explain what the market price is and also walk you through an example of determining the equilibrium price. Definition The equilibrium price is the market price where the quantity of goods supplied is equal to the quantity of goods demanded. The equilibrium price for dog treats is the point where the demand and supply curve intersect corresponds to a price of $ At this price, the quantity demanded (determined off of the demand curve) is boxes of treats per week, and the quantity supplied (determined from the supply curve) is boxes per week.
Thus, at the equilibrium price, wishes of both the buyers and sellers are satisfied and the market will be in a state of rest. At all other prices, the wishes of buyers and sellers would be inconsistent and are, thus, disequilibrium prices. They will not persist. If price is greater than the equilibrium price, supply would exceed demand. At equilibrium level of output OX, price is equal to its marginal cost and marginal cost curve cuts the MR curve from below. The firm enjoys normal profits. Now, suppose demand increases from DD to D 1 D 1 and the industry is in equilibrium at point E 1 which determines the price OP 1 The new price OP 1 is less than the new market price i.e., OH.