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 price by the interaction of the forces of demand and supply is what is referred to as a price system or price mechanism.
The determination of price by demand is a key concept in economics. The basic idea is that the price of a good or service is determined by the level of demand for it.
When demand for a good or service is high, the price tends to rise. This is because there are more people willing to pay a higher price to get the good or service they want, and the seller can charge more to make a profit. Conversely, when demand is low, the price tends to fall. In this case, the seller needs to lower the price to attract buyers and move their inventory.
There are several factors that can affect the level of demand for a good or service, including consumer preferences, income levels, the availability of substitutes, and overall economic conditions. For example, if consumers perceive a product to be of high quality or to have unique features that are not available elsewhere, demand for that product may be higher, and the seller can charge a higher price.
On the other hand, if there are many similar products available, consumers may have less incentive to pay a higher price for any one of them. Additionally, if consumers\’ income levels are low, they may be less likely to purchase a product at a high price, even if they desire it.
In general, sellers try to set the price of a good or service at a level that maximizes their profits while still attracting enough buyers to generate sales. This is known as the equilibrium price, and it is determined by the intersection of the supply and demand curves for that product. The higher the demand, the higher the equilibrium price, and vice versa.
Overall, the determination of price by demand is a fundamental concept in economics, and understanding it is key to making informed decisions about buying, selling, and investing in goods and services.
- 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 the elasticity of demand and supply with the use of curves and mathematical expressions.
- Explain and use the concept of elasticity to analyze the 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 p
The equilibrium price is the 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 the 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 on price determination
lets us take a look at the 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 the supply curve and demand are called the equilibrium point.
Shortage, surplus and equilibrium price
Price tends towards the level which equates and demand.
- The 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
graph.
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 a period of shortage in order to buy while the sellers reduce the price during a period of surplus in order to sell. This market interaction or activity leads to an 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 and how it affects price determination:
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
- The equilibrium price is the price at which the quantity demanded equates to the 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.
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