DETERMINATION OF PRICE BY DEMAND AND SUPPLY. In a perfectly competitive or free Market economy, prices are determined by the interaction of the forces of demand and supply. The determination of prices by the interaction of the forces of demand and supply is what is referred to as price system or price mechanism.
- Identify and explain the interaction between the forces of demand and supply in determining the market price.
- Explain the effect of changes in demand and supply on the equilibrium price and quantity.
- Explain elasticity of demand and supply with the use of curves and mathematical expressions.
- Explain and use the concept of elasticity to analyze price policy of firms maximum and minimum price control.
WHAT IS PRICE DETERMINATION
As explained from the laws of demand and supply, it is known that the higher the price the lower the quantity demanded while the lower the prices, the higher the quantity of commodity demanded. On the other hand, the higher the price, the higher the quantity supplied.
But there will be a price at which the quantity demanded equals the quantity supplied. This price is known as the equilibrium price.
Equilibrium price is that price at which the quantity demanded is equal to the quantity of commodities supplied. The point where the demand curve meets the supply curve is called equilibrium position or equilibrium point.
The quantity demanded and supplied equilibrium price is called equilibrium quantity. Under this condition, both producers (suppliers)and consumers (buyers) can be satisfied:
there will be no pressure on price. Market equilibrium can be explained better by a schedule
A typical example of Market demand and supply schedule
lets us take a look at demand and supply schedule for yam
|Price demanded||Quantity supplied||Quality|
|(N) 25 20 15 10 5||(kg) 20 40 60 80 100||(kg) 100 80 60 40 20|
From the table and the graph above. It is that at 6 15.00, 60 kg of yam was demanded and 60kg of yam was equally supplied. 6 1500 is the equilibrium price while 60kg equilibrium quantity and the point of intersection between supply curve and demand called equilibrium point.
Shortage, surplus and equilibrium price
Price tends towards the level which equates and demand.
- Price of goods is determined by the interaction of the forces of demand and supply.
- If the price is at a level where supply is less than demand, then there will be excess demand which may increase the r rice, e.g. the portions under the price of 6 15.00 in the
This situation represents shortages. When there is a problem of shortage, the seller may want to increase the price or buyers may want to buy more of the commodities.
- When the prevailing market price of a commodity is higher than the equilibrium price, then supply will definitely be higher than demand and the market will experience excess supply, resulting in a situation which represents surplus.
Under this situation, the seller will be interested to reduce the price to enable him to sell more goods.
Excess supply, which results to surplus, usually occurs in portions above 6 15.00.
- In summary, buyers raise the price during the period of shortage in order to buy while the sellers reduce the price during the period of surplus in order to sell. This market interaction or activity leads to equilibrium point where the sellers and buyers will be willing to supply and buy at a given price over a period of time.
Worked example of Supply and Demand Schedule :
the schedule below to answer the following questions:
- At what price and quantity does the market attain equilibrium and why?
|Price per unit (N)||Quantity demanded per week||Quantity supplied per week|
|5 6 7 8 9 10||500 400 300 250 150 50||60 150 300 400 500 600|
At what price does the market exhibit excess demand and by how many units?
- At what price does the market exhibit excess supply and by how many units?
- At what price will the supplier be willing to sell most? What quantity will he be willing to sell at that price?
Solution to price equilibrium
- Equilibrium price is the price at which quantity demanded equates quantity supplied. The equilibrium
price is 7. The equilibrium quantity is 300 units. Reason: Because at that price quantity demanded is equal to quantity supplied.
- Excess demand arises at prices 5 and 6
At 5 = 500 – 60 = 440 units
At 6 = 400 -150 = 250 units
- Excess supply at prices 8,9 and 10
Excess supply at 6 8 = 400 -250=150 units
69 = 500- 150 = 350
Units 6 10 = 600-50 = 550 units.
- The supplier will be willing to sell most at price 6 7. The quantity is 300 units.