DEMAND, SUPPLY AND MARKET EQUILIBRIUM
The term ‘price’ has a great relevance in economics. In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods and services. It is generally expressed in terms of units of some form of currency. But how does a product sell for a certain price, what constitutes the price of a product and how is the price determined is the bigger question. In economics, for a competitive market the prices for any individual product is determined by the market forces of Demand and Supply.
DEMAND FOR A PRODUCT
The demand for a product maybe defined as the quantity of the product that a consumer will purchase at the prevailing price during a particular period of time. The demand of a consumer if effected by: * Desire to buy
* Ability to buy, and
* Willingness to buy
Clearly the demand depends on the price of the commodity. Hence, the higher the price of an article, the lesser will be the demand of a rational consumer; other things remaining constant. This assumption of – other things remaining constant – is known as the ceteris paribus. This relationship between the price and quantity bought when expressed in a tabular format is known as the demand schedule. There is an inverse relationship between the price and demand for a product.
Demand Schedule The Graphical representation of demand schedule is known as the demand curve. The demand curve shows the price on the vertical axis and the quantity demanded on the horizontal axis.
The demand curve is downward sloping which is also called the law of downward sloping demand curve. This law states that as the price of the commodity is raised, ceteris paribus, buyers tend to buy less of the commodity (as is evident from the figure), and vice versa. This fall in quantity demanded due to the rise in prices can be attributed to two factors: * Substitution Effect: It states that as the price of a good rises, the consumer will substitute the good with its substitute good. For example, a consumer who earlier drank tea, will now prefer coffee due to the rise in price of tea. * Income Effect: Income effect relates to the purchasing power of money. It implies that as the price of a good rises and with the same income of the consumer, he will now be able to buy less of the goods as compared to earlier. Hence, the demand for the good falls. Market Demand – Market demand is the sum total of demands of all the individual households. The market demand curve is found by adding together the quantities demanded by all individual households at each price. Factors affecting demand The ceteris paribus assumption is kept in mind while evaluating the factors affecting demand for a product. * Income of the consumer: A consumer’s demand is influenced by the size of his income. With increase in the level of income, there is increase in the demand for goods and services. A rise in income causes a rise in consumption. As a result, a consumer buys more. For most of the goods, the income effect is positive. But for the inferior goods, the income effect is negative. That means with a rise in income, demand for inferior goods may fall.. * Changes in the price of related goods: Sometimes, the demand for a good might be influenced by prices changes of other goods. There are two types of related goods. They are substitutes and complements. Tea and Coffee are good substitutes. A rise in the price of coffee will increase the demand for tea and vice versa. Bread and butter are complements. A fall in the price of bread will increase the demand for butter and vice versa. * Tastes and preferences of the consumer: Demand depends on people’s tastes, preferences, habits and social customs. A...