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(Interdependent Prices)

We have discussed the determination of price and output of a firm (market price) producing a single commodity. Now, we will be dealing with the pricing of jointly demanded goods (interconnected commodities).

Concept of Joint Demand with Example:

When goods are demanded jointly in order to satisfy a particular want or for producing a certain commodity, they are said to be in joint demand. For example, pen and ink are needed for writing; ball, bat and wickets are demanded together for playing cricket; masons, carpenters plaster, etc., are jointly required for constructing a building. The commodities which are jointly demanded are also called complementary goods.

The demanded for the final product in the jointly demanded goods is called the direct demand and the demand for various factors of production used for making a final product is called the indirect demand or derived demand.

For example, the demand for house is a direct demand, while the demand for various raw materials and labor used in constructing the house is a derived demand.

A demand for the jointly demanded goods represent two types of relations:

(1) Substitutive and (2) Complementary.

(1) Substitutive Goods and their Pricing Relationship:

If two goods are close substitute of each other (called substitutive goods), then the rise in the price of one commodity will result in the rise in price of the other.

For example, if the price of tea rises, the price of coffee will also go up and vice versa. Here, the concept of cross elasticity will be very useful for measuring the mutual relationship of the demand for interrelated commodities. The cross elasticity of the demand is measured with the help of the following formula:

Formula:

Here, X stands for tea and Y for coffee.

(2) Complementary Goods and their Pricing Relationship:

When two or more goods are demanded jointly to satisfy a particular want, they are said to be complementary goods.

For example, the demand for car is directly related to the demand for petrol. Car as alone or petrol alone does not serve any useful purpose. If the demand for cars increases, the price of the related goods, i.e., petrol will also go up. The extent of the price movement will depend on the elasticity of demand, for car and the elasticity of supply of petrol.

Is a factor of production in joint demand able to obtain higher price by withholding its supply? In order to answer this question, we suppose the demand of cars goes up and their prices rise. The direct result of the rise in prices of cars will be that the prices of raw material such as steel, rubber, glass, etc., used in manufacturing the cars will also go up.

But the rise in prices of each of them will be affected differently depending upon their (i) conditions of supply, (ii) elasticity of demand, and (iii) the possibility of varying it in combination with other commodities.

First, just to make it more clear, we take one item; say rubber which is in joint demand and see how its price is affected by rise in the price of the cars, if its supply is withheld. Other things remaining the same, if the demand for rubber is indispensable and there are no good substitutes available, then its price will have a tendency to rise.

Secondly, if demanded for cars remains inelastic, i.e., a considerable change in price is followed by a slight change or practically no change in the quantity demanded, then the price of rubber will show upward trend.

Thirdly, if the price of rubber forms a small part of the total cost, then its price can rise as the total cost is not very much affected by its rise and the entrepreneur can afford to pay higher price for it.

Fourthly, if the demand for other co-operating factors is squeezable, i.e., it is elastic, then the price of the non-co-operative factor, i.e., rubber will go up.