Question

Explain price determination in a competitive market, and show how equillibrium changes in response to changes in determinants of damage and supply. Try these problems: 6, 14.

Short answer

Price being an important determinant changes the demand and supply of the commodities in a market.

Step-by-step solution

Demand and Supply

Demand and supply indicate the number of commodities the producer supplies and the consumer demands in a market. The determinant on which demand and supply depend is known as price. A change in price induces a change in supply and demand of quantities in the respective markets.

Analyzing with an example:

For exaple, if suppose the demand and supply equation is given as:

$$\begin{gathered} {\mathrm{Q}}^{\mathrm{d}}=60-\mathrm{P} \\ {\mathrm{Q}}^{\mathrm{s}}=\mathrm{P}-20 \end{gathered}$$

The equillibrium price and quantity can be decided if the quantity demanded and quantity supplied equation is equal.

$\begin{array}{rcl}{\mathrm{Q}}^{\mathrm{d}}& =& {\mathrm{Q}}^{\mathrm{s}}\\ 60-\mathrm{P}& =& \mathrm{P}-20\\ 2\mathrm{P}& =& 80\\ \mathrm{P}& =& 40\end{array}$

The equilibrium quantity can be calculated as:

$\begin{array}{rcl}\mathrm{Q}& =& 60-40\\ \mathrm{Q}& =& 20\end{array}$

Now, if say the government induces a price floor, where the suppliers cannot charge price below the price of $50. In this case, the quantity supplied would be:

$\begin{array}{rcl}{\mathrm{Q}}^{\mathrm{s}}& =& 50-20\\ & =& 30\end{array}$

The quantity demanded would be

$\begin{array}{rcl}{\mathrm{Q}}^{\mathrm{d}}& =& 60-50\\ & =& 10\end{array}$

Thus it can be seen that a rise in price has decresed the quantity demanded to 10 units and increased the supply to 30 units. This led to a surplus of the quantity supplied by 20 units.

Moreover, if a price ceiling is imposed by the government where the producer cannot charge the consumers higher than the price of $32. Then, the quantity supplied:

$\begin{array}{rcl}{\mathrm{Q}}^{\mathrm{s}}& =& 50-32\\ & =& 18\end{array}$

The quantity demanded is:

$\begin{array}{rcl}{\mathrm{Q}}^{\mathrm{d}}& =& 60-32\\ & =& 28\end{array}$

Hence, the quantity supplied has decreased to 18 units and the demand increased to 28 units leading to a shortage of 10 units in the economy.

Hence, it can be seen that change in price changes the demand and supply in the market.