• Demand-Supply and Price discovery

    Demand of a particular good or services is denoted by the quantity that all the buyers are willing to purchase at any particular price of the same good or service. The buyers should have the willingness and credibility to become a valid buyer and then only it will be included in demand. A buyer who is willing to buy a product at Rs 10 when the market price is Rs 20 should not be considered a valid buyer. Let us see the below picture to explain the relationship of demand and price from buyers’ point of view.

    As we have already specified that demand is actually the willingness and ability of the buyers for a particular product, be it goods or services. Now the willingness and ability of the buyer depends on the price of the product. If the price increases, more buyers lose their willingness and ability to buy the product because of money constraint and if the price decreases more buyers become willing and get the ability to buy the product because of cheap pricing. That is the main reason the demand curve respective to price follows a down ward slope. With increased price, the demand of a particular product decreases and with decreased price, the demand of a particular product increases. The demand graph in the above picture explains the same.

    Supply of a particular good or service is denoted by the overall quantity that all the sellers are willing and capable to sell at a particular price. The seller should be willing and capable of selling the goods to become a valid seller in the market and then only it will be included in supply. A supplier who does not have a product or who is willing to sell a product at Rs 20 while the market price is Rs 10 should not be considered as a valid seller. Let us see the below picture to explain the relationship of supply and price from suppliers’ point of view.

    As we have already specified that supply is actually the willingness and capability of the sellers for a particular product, be it goods or services. Now the willingness and capability of the seller depends on the price of the product. If the price decreases, more sellers lose their willingness to sell the product because of lower profit and if the price increases more sellers want to sell the product at the particular higher price. That is the main reason the supply curve respective to price follows a upward slope. With increased price, the supply of a particular product increases and with decreased price, the supply of a particular product decreases. The supply graph in the above picture explains the same.

    Now we will check how the equilibrium condition is achieved where demand equals to supply and price stabilize. To do this, we will first visit the situation of excess demand and excess supply and their effect to reach the equilibrium state.

    Excess Demand

    Check the below graph which shows the situation of excess demand. Here the demand is much higher than the supply at a particular price P1. The price is much lower than the equilibrium price (P2, where demand and supply curves intersect). At that lower price P1, the suppliers become less willing to sell the product and quantity of that product available for sell in the market restricts at Q1. But with the lower price, more buyers become willing to buy the product which increases the demand in the market. The higher willingness to buy pushes the demand to quantity Q2, which is much higher than quantity supply of Q1.

    So what will happen in this scenario?

    Demand will be higher than the supply and buyers won’t get the adequate supply of the product at that price. In that case, buyer will be willing to pay more for that particular product to get the product which will increase the price. At increased price, supplier will increase the supply to make profit of the increased price. This will continue till the excess demand stays in the market and the price equilibrium is reached. When the price reaches the equilibrium point, the demand will be same as supply and there won’t be any further price movement.

    Excess Supply

    Check the below graph which shows the situation of excess supply. Here the supply is much higher than the demand at a particular price P1. The price is much higher than the equilibrium price (P2, where demand and supply curves intersect). At that higher price P1, the buyers become less willing to buy the product and demand for that product in the market restricts at Q1. But with the higher price, more sellers become willing to sell the product which increases the supply in the market. The higher willingness to sell pushes the supply to quantity Q2, which is much higher than quantity supply of Q1.

    So what will happen in this scenario?

    Supply will be higher than the demand and sellers won’t get the adequate number of buyers of the product to sell at that price. In that case, seller will be willing to ask lower price to sell that particular oversupplied product which will decrease the price. At decreased price, supplier will decrease the supply as the profit will be less and the buyers will increase the demand. This will continue till the excess supply stays in the market and the price equilibrium is reached. When the price reaches the equilibrium point, the demand will be same as supply and there won’t be any further price movement.

    Equilibrium

    Now we have understood that the excess demand or excess supply situations don’t last for long. Both the situations drive the price toward the equilibrium price. Equilibrium price is the price where demand equals to the supply for a particular product in a perfect competitive market. Being a perfect competitive market is the most necessary condition to achieve this equilibrium price otherwise the price can be manipulated by the supplier in their favor. The competition details will be explained later. The below graph explains the situation.

    At the equilibrium price, supply of a product equals to the demand of the same product. If the price drops below the equilibrium price, there will be a supply shortage and excess demand which will push the price up again. If the price goes above the equilibrium price, there will be a demand shortage and excess supply which will pull the price down again. The only stable situation can be the equilibrium price.

    Post Tagged with , ,

Leave a Reply

Your email address will not be published. Required fields are marked *