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Markets exist for the vast majority of goods and services. Markets can be defined broadly or narrowly. For example there are the consumer goods, capital goods, commodities, financial and labor markets. Each of these broad categories can be broken down into more specific markets. For example within the financial market there are markets for foreign exchange and for long term loans, within the corn modifies market there are the markets for corn and copper and within the consumer goods market there are the markets for clothes and cars. Prices usually play an important role in these markets.
EQUILIBRIUM PRICE AND OUTPUT:-
In the absence of government intervention, price is determined by demand and supply. The equilibrium price is where demand and supply are equal. At this point there are no forces causing the price to change. The quantity which consumers want to buy will equal the quantity which producers want to sell at the current price.
At prices higher than the equilibrium price the quantity supplied will be greater than the quantity demanded and the excess supply would oblige sellers to lower their prices in order to dispose of their output. For example, if price is 40p supply would exceed demand by 110. This situation, illustrated in Figure 11.2, where supply exceeds demand and there is downward pressure on price is sometimes described as a buyers’ market.
At prices lower than the market price, e.g. 2Op, the quantity demanded will exceed the quantity supplied, giving rise to a condition known as a sellers’ market. This is illustrated in Figure I I .3.
The equilibrium or market price is 3Op, because at any other price there are market forces at work which tend to change the price.
CHANGES IN EQUILIBRIUM PRICE:-
As market prices are determined in free markets by the interaction of demand and supply, changes in market prices are due to changes in demand or supply, or both.
THE EFFECTS OF SHIFTS IN DEMAND:-
The effects of changes in demand may be stated in terms of economic predictions.
• In the short run, other things being equal, an increase in demand will raise the price and this, in turn, will cause an extension in supply.
• In the short run, other things being equal, a decrease in demand will lower the price and cause a contraction in supply.
Figure I I .4 illustrates the effects of an increase in demand. OD is the original demand curve so that the equilibrium price is P and quantity Q is demanded and supplied.
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Figure I I .5 shows a decrease in demand. The demand curve shifts to the Left (D ).There is a surplus at price P (equal to the horizontal distance between the demand curves). Suppliers will be obliged to lower prices to Pi in order to clear their stocks. This fall in price will cause a contraction in supply.
THE EFFECTS OF SHIFTS IN SUPPLY:-
The effects of changes in supply may also be summarized in the form of two economic predictions:
• in the short run, other things being equal, an increase in supply will lower the price and this in turn will cause an extension in demand:
• in the short run, other things being equal, a decrease in supply will arise the price and cause a contraction n demand.
Figure I I .6 demonstrates the effects of an increase in supply. The supply curve moves from 55 to S 5. The immediate effect is a surplus (shown by the dotted line) at the ruling price P. This surplus will force price downwards to P and the lower price will result in an extension in demand. The quantity demanded and supplied will be Q.
Figure I I .7 shows a decrease in supply. When supply falls from 55 to SiSi there will be excess demand at price P (equal to the horizontal distance between the supply curves).This will cause the price to rise to a new equilibrium price of PL this higher price results in a contraction in demand.
MOVEMENTS ALONG AND SHIFTS IN DEMAND AND SUPPLY:-
In analyzing changes in market prices it is important to consider what has caused the change in price. For example if there has been an increase in demand, higher demand will be associated with a higher price. Whereas if the cause of the price rise is a decrease in supply, lower demand will be associated with a higher price So it is very important to recognize the cause of the change in price and the order of events.
THE DISTINCTION BETWEEN P.RICE ELASTICITIES OF DEMAND LAND SUPPLY:-
As well as knowing the direction of changes in prices, it is also important to know the extent of such changes. Knowledge of price elasticity of demand and price elasticity of supply enable economists to calculate the extent to which changes in demand affect prices and the quantity supplied and the extent to which changes in supply affect prices and quantity demanded.
For example, if demand is elastic, an increase in supply will cause a relatively small fall in price and a greater percentage change in quantity demanded. In this case total revenue will rise. Figure I 1.8 shows the effect of an increase in supply when demand is elastic.
If demand is inelastic an increase in supply will cause a relatively large fall in price and a smaller percentage change in quantity demanded. In this case total revenue will fall. Figure I I .9 shows the effect of an increase in supply in a market where demand is inelastic.
If supply is elastic an increase in demand will cause a relatively small rise in price and a greater percentage change in quantity supplied as shown in Figure 11.10.
On the other hand if supply is inelastic an increase in demand will cause a relatively large rise in price and a smaller percentage in the quantity supplied. This is shown in Figure 11.11.
In markets where both demand and supply are inelastic, as occurs in the markets of many agricultural products, a shift in demand and/or supply will have a significant effect on price. This is illustrated in Figure 11.12 which shows the effect of decrease in supply.
In markets where both demand and supply are elastic, a change in demand and/or supply will have a significant impact on the quantity bought and sold but only a small impact on the equilibrium price. Figure I I . I 3 shows the effect of decrease in supply in such a market.