Scribd
Upload
59 views10 pages

Price Determination: Market, I.E. One in Which Demand and

This document discusses how price is determined in a free market through the interaction of supply and demand. It explains: 1) The demand and supply curves intersect at the equilibrium price and quantity, where the amount demanded is equal to the amount supplied. 2) Changes in demand or supply curves, due to factors like income, tastes, costs of production, will cause the equilibrium to shift to a new price and quantity. 3) An increase in demand will lead to a higher equilibrium price, while a decrease in demand or increase in supply will lead to a lower equilibrium price.

Uploaded by

Muhammad Afzal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
59 views10 pages

Price Determination: Market, I.E. One in Which Demand and

This document discusses how price is determined in a free market through the interaction of supply and demand. It explains: 1) The demand and supply curves intersect at the equilibrium price and quantity, where the amount demanded is equal to the amount supplied. 2) Changes in demand or supply curves, due to factors like income, tastes, costs of production, will cause the equilibrium to shift to a new price and quantity. 3) An increase in demand will lead to a higher equilibrium price, while a decrease in demand or increase in supply will lead to a lower equilibrium price.

Uploaded by

Muhammad Afzal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 10

Price Determination

• Usually we assume that we have a free


market, i.e. one in which demand and
supply alone determine the price.

• Since our demand and supply curves have


the same axes, i.e. price and quantity, we
can put them on the same diagram.

• We can see that at price P1 the demand


and supply curves intersect at the same
quantity, Q1
Price Determination
• Any price other than P1
there will clearly be a
tendency for change and
will result into:
• Excess Supply
• Excess demand
Price Determination
Changes in market price and quantity

• We have seen that changes in the


conditions of demand or supply will shift the
demand or supply curves.

• This in turn will cause changes in the


equilibrium of price and quantity in the
market.

• Therefore, it will be useful to consider how


increases and decreases in both demand
and supply will influence price and quantity
equilibrium.
Price Determination
• Causes for the increase in Demand

• Demand curve may shift to the right (increase) for a number of reasons:
• a rise in the price of a substitute in consumption;

• a fall in the price of a complement in consumption;

• a rise in income for a normal product;

• a change of consumer tastes in favour of the product, etc.


Price Determination
• In this figure demand increases from D to D’,
therefore the original equilibrium price quantity
P1–Q1 can no longer continue.
• At price P1 we now have a situation of excess
demand.

• In a free market, price will be bid up.


• As price rises, supply expands along S and demand
contracts along D, until we reach the higher price
P2 at which demand and supply are again equal at
Q2.

• We call P2–Q2 the new price and quantity


equilibrium.
Price Determination
Decrease in demand 
• In the opposite case (In this figure), where
demand shifts leftwards from D to D”, we
find the new price-quantity equilibrium at
P2–Q2.  
• At price P1 we now have a situation of excess
supply. In a free market price will fall.  
• As price falls, demand expands along the
new demand curve D” and
supply contracts along S until we reach the
lower price P2 at which demand and supply
are again equal at Q2. 
Price Determination
• Increase in supply and its conditions

• We have seen that the supply curve may shift to the


right (increase) for a number of reasons: a fall in the
price of a substitute in production; a rise in the
price of a complement in production; a fall in costs
of production; a reduction in tax on the product etc
Price Determination
• In this figure supply shifts from S to S’
therefore the original equilibrium price
quantity P1–Q1 no longer continues.
• At price P1 we now have a situation of
excess supply.
• In a free market, price will fall as producers
try to dispose of surplus stock.
• As price falls, supply contracts along S, and
demand expands along D until we reach the
lower price P2, at which demand and
supply are again equal at Q2
Price Determination
• Decrease in supply
• In the opposite case (This figure), where
supply shifts leftwards from S to S-, we find
the new price-quantity equilibrium to be
P2–Q2. At price P1 we now have a situation
of excess demand.

• In a free market price will be bid upwards.


As price rises, supply expands along the new
supply curve S- and demand contracts along
D until we reach the higher price P2 at
which demand and supply are again equal at
Q2
Price Determination

• Q&A

You might also like