Price Equilibrium

Our next level of study that comprehends our understanding of demand as well as supply curves, is an equilibrium of price. The demand curve represents the actions, at any price level, of the consumers. The supply curve represents the actions, at any price level, of the producers. To find out what the price level will actually be, we need to see what happens when we combine the demand and supply curves.

As the market price decreases, the quantity demanded will increase and the quantity supplied will decrease until the quantity demanded equals the quantity supplied, at which point the surplus is eliminated and a market equilibrium is established.

In the supply and demand model, the equilibrium price and quantity in a market is located at the intersection of the market supply and market demand curves. Note that the equilibrium price is generally referred to as P* and the market quantity is generally referred to as Q*.

If the price in a market is lower than P*, the quantity demanded by consumers will be larger than the quantity supplied by producers. A shortage will therefore result, and the size of the shortage is given by the quantity demanded at that price minus the quantity supplied at that price. Producers will notice this shortage, and the next time they have the opportunity to make production decisions they will increase their output quantity and set a higher price for their products. As long as a shortage remains, producers will continue to adjust in this way, bringing the market to the equilibrium price and quantity at the intersection of supply and demand.

Conversely, consider a situation where the price in a market is higher than the equilibrium price. If the price is higher than P*, the quantity supplied in that market will be higher than the quantity demanded at the prevailing price, and a surplus will result. (This time, the size of the surplus is given by the quantity supplied minus the quantity demanded.) When a surplus occurs, firms either accumulate inventory (which costs money to store and hold) or they have to discard their extra output. This is clearly not optimal from a profit perspective, so firms will respond by cutting prices and production quantities when they have the opportunity to do so. This behavior will continue as long as a surplus remains, again bringing the market back to the intersection of supply and demand.

Since any price below the equilibrium price P* results in upward pressure on prices and any price above the equilibrium price P* results in downward pressure on prices, it should not be surprising that the only sustainable price in a market is the P* at the intersection of supply and demand. This price is sustainable because, at P*, the quantity demanded by consumers is equal to the quantity supplied by producers, so everyone who wants to buy the good at the prevailing market price can do so and there is none of the good left over.

In general, the condition for equilibrium in a market is that the quantity supplied is equal to the quantity demanded. This equilibrium identity determines the market price P*, since quantity supplied and quantity demanded are both functions of price.

Functionality of supply and demand intersects with price level. Hope, you have understood the different aspects of law of demand, supply and price.

The Theory of Supply

Just like with demand, where it only became effective if it was backed up with the ability to pay, supply is defined as the willingness and ability of producers to supply goods and services onto a market at a given price in a given period of time. In theory, at higher prices a larger quantity will generally be supplied than at lower prices, ceteris paribus, and at lower prices a smaller quantity will generally be supplied than at higher prices, ceteris paribus.

The determinants of supply

• Prices of other factors of production.
• Technology.
•  Indirect taxes and subsidies.
• Labour productivity.
•  Price expectations
•  Entry and exit of firms to and from an industry. 

 Movements along a supply curve

A movement along a supply curve only occurs when the price changes, ceteris paribus. In other words, the price changes but the other non-price determinants remain constant. The diagram below shows that a price rise will cause an extension up the supply curve, whilst a price fall will cause a contraction back down the supply curve.

Demand curve and its movements

The determinants of demand

It is fairly obvious so far that the price of a good is a pretty strong determinant of its demand, but there are many other things that will affect demand too.

·        Real income.

·        The price of other goods.

·        Tastes and preferences.  Changing preferences will affect your demand for product regardless of its price.

·        Expectations of future prices.

·        Advertising.

·        Population.

·        Interest rates and credit conditions.

Movements along a demand curve

It is very important that you understand the difference shifts of and movements along demand curves. Examiners often test your understanding of this point in multiple-choice questions.

A movement along a demand curve only occurs when there is a change in the price of the good in question. Some textbooks call these movements extensions and contractions. In the diagram below (note that it is a straight-line sketch), when the price falls (from P2 to P1) there is a rise in demand (from Q2 to Q1), ceteris paribus.  When the price rises (from P₁ to P2) there is a fall in demand (from Q₁ to Q2), ceteris paribus. The movement along the curve is from point B to point C.

ECONOMIC CONCEPTS AND DEMAND CURVE

1.  Utility- Utility, in its broadest usage, is the general capability that things have of ministering to human well being. It expresses only a general or average impression that we have in reference to the relation of a class of goods to human wants.

2.  Goods- What are goods? Goods consist of all those things, the objective for the user which have a beneficial relation to human wants. They fall into several classes. We may first distinguish between free and economic goods. Free goods are things that exist in superfluity, that is, in quantities sufficient not only to gratify, but to satisfy all the wants that may depend on them. Economic goods are things so limited in quantity that all of the wants to which they could minister are not satisfied.

3.  Value- Value, in the narrow personal sense, may be defined as the importance attributed to a good by a man. The vagueness and inexactness of the word "utility," or the word "good," disappears when we reach the word "value." Value is in the closest relation with wants, and in this narrow sense depends on the individual's estimate. From the meeting and comparison of the estimates of individuals, raise market values or prices, which are the central object of study in economics.

Demand

What is demand? Demand is the relationship between the quantity of a good or service consumers will purchase and the price charged for that good.

The Economic glossary  defines demand as "the want or desire to possess a good or service with the necessary goods, services, or financial instruments necessary to make a legal transaction for those goods or services." Demand represents the entire relationship between quantity desired of a good and all possible prices charged for that good. The specific quantity desired for a good at a given price is known as the quantity demanded. Typically a time period is also given when describing quantity demanded.

Demand - Examples of Quantity Demanded:

When the price of an orange is 65 Rs the quantity demanded is 300 oranges a week.

If the local Starbucks lowers their price of a tall coffee from $1.75 to $1.65, the quantity demanded will rise from 45 coffees an hour to 48 coffees an hour.

 Demand Curves:

A demand curve is simply a demand schedule presented in graphical form. The standard presentation of a demand curve has price given on the Y-axis and quantity demanded on the X-axis.

     The Law of Demand:

The law of demand states that, the quantity demanded for a good rises as the price falls. In other words, the quantity demanded and price are inversely related. Demand curves are drawn as 'downward sloping' due to this inverse relationship between price and quantity demanded.

     Price Elasticity of Demand:

The price elasticity of demand represents how sensitive quantity demanded is to changes in price. Further information is given in the article Price Elasticity of Demand.

     

The demand curve graphically shows how many units of a good or service will be bought at each price. It plots the relationship between quantity and price that's been calculated on the demand schedule. That's a table that shows exactly how many units of a good or service will be purchased at various prices. 
As you can see in the chart, the price is on the vertical (y) axis and the quantity is on the horizontal (x) axis. This chart plots the conventional relationship between price and quantity -- the lower the price, the higher the quantity. As the price decreases from p0 to p1, the quantity increases from q0 to q1.

Elastic Demand

Elastic demand means that consumers are really sensitive to price changes. If the
price goes down just a little, they'll buy a lot more. If prices rise just a bit, they'll stop buying as much and wait for prices to return to normal. This relationship between price and the quantity bought is guided by the Law of Demand. If a good or service has elastic demand, that means that consumers will do a lot of comparison shopping. It also means they aren't desperate to have it, they don't need it every day, or there are a lot of other similar choices. 

     

Inelastic demand
Inelastic demand means that the quantity demanded by buyers doesn't change as much as the price does. This usually occurs with goods or services that people need every day. They've got to buy it, even if the price goes up. Similarly, they won't buy much more, even if the price drops. This relationship between price and the quantity bought is guided by the Law of Demand.

INTRODUCTION

Hello friends, welcome to “Economic Friendly”, a blog that will enlighten and inspire one and all with the knowledge of economies and its far-reaching effects.

I am not a preacher, or a teacher. But  I am aspiring B.e.d student who wants to complete the degree course in economics. In pursuit of completing the course, I feel, it's my moral duty to make the economics an interesting subject to study. So why, don’t we work together as a team and evolve ourselves. I, promise, that I will try my best to make the subject as interesting and intriguing as possible.

Scope of Economics

Economics studies man’s life and work, not the whole of it, but only one aspect of it. Economics only tells us how a man utilizes his limited resources for the satisfaction of his unlimited wants. A man has limited amount of money and time, but his wants are unlimited.

Let’s understand what is an economic activity.

Economic Activity: It we look around, we see the farmer tilling his field, a worker is working in the factory, a businessman is looking after his business activities, a Doctor attending the patients, a teacher teaching his students and so on. They are all engaged in what is called “Economic Activity”. They earn money and purchase goods. Neither money nor goods is an end in itself. They are needed for the satisfaction of human wants and to promote human welfare.

To fulfill the wants a man is taking efforts. Efforts lead to satisfaction. Thus wants- Efforts-Satisfaction sums up the subject matter of economics.

Economics is a social Science: In primitive society, the connection between wants, efforts and satisfaction was close and direct. But in a modern Society things are not so simple and straight. Here man produces what he does not consume and consumes what he does not produce. When he produces more, he has to sell the excess quantity. Similarly, he has to buy a product which is not produced by him. Thus the process of buying and selling which is called as Exchange comes in between wants efforts and satisfaction.

Thus we can say that the subject-matter of Economics can be further broken down into

Consumption- the satisfaction of wants.

Production- i.e. producing things, making an effort to satisfy our wants

Exchange- its mechanism, money, credit, banking etc.

Distribution – sharing of all that is produced in the country. In addition, Economics also studies “Public Finance”

Micro-Economic – When economics is studied at individual level i.e. consumer’s behavior, producer’s behavior, and price theory etc it is a matter of micro-economics. Macro Economics – When we study how income and employment is generated and how the level of country’s income and employment is determined, at aggregated level, it is a matter of macro-economics. Thus national income, output, employment, general price level economic growth etc. are the subject matter of macro Economics.

c) Economics, a Science or an Art? Broadly different subjects can be classified as science subjects and Arts subjects, Science subjects groups includes physics, Chemistry, Biology etc while Arts group includes History, civics, sociology Languages etc. Whether Economics is a science or an art? Let us first understand what is terms ‘science’ and ‘arts’ really means.

A science is a systematized body of knowledge. A branch of knowledge becomes systematized when relevant facts hove been collected and analyzed in a manner that we can trace the effects back to their and project cases forward to their effects. In other words laws have been discovered, explaining facts, it becomes a science, In Economics also many laws and principles have been discovered and hence it is treated as a science. An art lays down formulae to guide people who want to achieve a certain aim. In this angle also Economics guides the people to achieve aims, e.g. aims like removal poverty, more production etc. Thus Economics is also an art. In short Economics is both science as well as art also.

d) Economics whether positive or normative science: A positive science explains ''why" and "wherefore" of things. i.e. causes and effects and normative science on the other hand rightness or wrongness of the things. In view of this, Economics is both a positive and normative science. It not only tells us why certain things happen, it also says whether it is right or wrong the thing to happen. For example, in the world few people are very rich while the masses are very poor. Economics should and can explain not only the causes of this unequal distribution of wealth, but it should also say whether this is good or bad. It might well say that wealth ought to be fairly distributed. Further, it should suggest the methods of doing it.