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The price of a commodity in the market is determined by the interaction of two forces of demand and supply.

Concept of Market Equilibrium Price by Demand and Supply:

By “demand for a commodity” at a given price is meant:

“The total quantity of the commodity which buyers will take (purchase or buy) at different prices per unit of time”.

While “supply of a commodity” at a given price refers to:

“The quantity of the commodity which sellers are willing to offer for sale at different prices per unit of time”.

If we construct a list or table of different amounts of a commodity which consumers purchase at different prices in the market, we get the market demand schedule. Similarly, supply schedule is a list or a table of different amounts of a commodity that are offered for sale in the market at different prices per unit of time.

In the market, there are large number of buyers and sellers. It is the desire of every buyer in the market to purchase a commodity at the lowest possible price while the sellers wish to sell it at the highest possible price.

When buyers compete among themselves for the purchase of particular commodity, the price of that commodity goes up and when there is competition among the sellers, the price comes down.

Definition:

The price of a commodity tends to settle at a point where the quantity demanded is exactly equal to the quantity supplied. The price at which the buyers and sellers are willing to buy and sell an equal amount of the commodity, is called the equilibrium price in the market.

We illustrate the above concept of market equilibrium price with the help of a schedule and a diagram.

Schedule:

If we study the above schedule carefully, we will find that when the price of cooking oil is $16 per kilogram, the total quantity demanded in a week is exactly equal to the total quantity supplied. So $16 is the market equilibrium price for the period and the equilibrium amount, i.e. the quantity demanded and offered for sale is 450 kilograms of cooking oil is:

Equation:

Qd = Qs

If the conditions assumed above remain the same, then there can be no equilibrium price other than $16.

Example:

For instance, if the price of cooking oil happens to rise $18 per kilogram. At this price, the sellers are anxious to sell 600 kilograms of oil but the buyers are willing to buy only 250 kilograms. The sellers will compete with one another to dispose off this surplus stock. The competition among the sellers will result in lowering the price. When the price comes down to $16 (i.e., the market equilibrium price), then the whole of the stock will be sold.

Conversely, if the price happens to fall to $14 per kilogram, the buyers would like to buy 700 kilograms of cooking oil, but the sellers are willing to sell only 100 kilograms. The buyers, in order to buy more cooking oil at a lower price will compete among themselves. This competition among the buyers will increase the price of oil. Finally, the price will be reestablished at the equilibrium price which is $16.

Diagram:

The determination of the market equilibrium price can be proved graphically.

In the figure (8.1) DD/is the demand curve which, represents the different amount of the commodity that are purchased in the market at different prices, SS/is the supply cure which indicate, the amount of the commodity that is offered for sale at different prices per unit of time.

MN is the equilibrium price i.e., $16 and ON 450 kg., is the equilibrium quantity. If the price is below the equilibrium price ($16), there are upward pressure on price due to the resulting shortage of good. In case, the price is above the equilibrium, there is a downward pressure on price caused by the resulting surplus of good. Only at price MN, the buyers take of the market exactly what sellers place on the market.