Microeconomics Unit 1 Part 3: The Market Mechanism PDF

Microeconomics Unit 1 Part 3: The Market Mechanism  The Market Mechanism Demanders and suppliers have different views of price, because demanders pay the price and suppliers receive it. Thus, a higher price is bad news for consumers but good news for producers. As the price rise...

Microeconomics Unit 1 Part 3: The Market Mechanism  The Market Mechanism Demanders and suppliers have different views of price, because demanders pay the price and suppliers receive it. Thus, a higher price is bad news for consumers but good news for producers. As the price rises, consumers reduce their quantity demanded along the demand curve and producers increase their quantity supplied along the supply curve.  A situation in which the quantity demanded is equal Equilibrium and to the commodity supplied for a given commodity. Disequilibrium When this is not the case, we have a situation of market disequilibrium. in the context of price The price at which quantity determination demanded of a commodity equals the quantity supplied is known as equilibrium price. The Demand and Supply Side Marginal utility sets the highest price limit for a commodity, while marginal cost sets the lowest limit. Equilibrium price is therefore the price at which consumers are willing to purchase the same quantity of a commodity which producers are willing to sell. Once the equilibrium is achieved at the equilibrium price, there is no tendency for the producers or consumers to move away from it. In a competitive market, a single seller or consumer cannot influence the market price. The Demand and Supply Schedule A stable equilibrium is the one which, if displaced due to some small disturbance, brings forces in operation which restore the initial equilibrium position. Excess Demand and Excess Supply The amount by which the quantity demanded exceeds the quantity supplied is called excess demand. The amount by which the quantity supplied exceeds the quantity demanded is called excess supply. Effects of Changes in Demand and Supply on the Equilibrium Price and Equilibrium Quantity Effect of Changes in Demand A increase in the demand for a commodity causes an increase in both the equilibrium price and equilibrium quantity. A decrease in the demand for a commodity causes a decrease in both the equilibrium price and equilibrium quantity. Effect of Changes in Supply An increase in the supply a commodity causes an increase in the equilibrium quantity and a decrease in the equilibrium price. A decrease in the supply a commodity causes an increase in the equilibrium price and a decrease in the equilibrium quantity. Effects of Simultaneous Increase in Demand and Supply  If increase in demand and increase in supply are of equal magnitude, price will remain unchanged, but equilibrium quantity will increase.  If the increase in demand is of greater magnitude than the increase in supply, both the equilibrium price and quantity will increase.  If the increase in supply is of greater magnitude than the increase in demand, equilibrium price will fall, but equilibrium quantity will increase. Explore the effects of a simultaneous decrease in both demand and supply Applications of Price Control Maximum Price Legislation Also called price ceiling or rationing It is the maximum legal price which the suppliers can charge for a particular good or service. This is usually done in order to make certain essential goods available at affordable prices to the lower-income groups. Implications To be meaningful, the price ceiling must be set below the equilibrium price. This results in a situation of excess demand or shortage of the commodity. Allocation becomes a problem and is carried out either on first come, first serve basis, by sellers’ preferences, or through the rationing system. The system is beneficial for the poor people but can lead to a black market where goods are sold illegally at prices higher than a legally fixed price by the government. Examples: Rent control in cities like New York, San Francisco; Ceiling on kerosene prices in India Minimum Price Legislation Also called floor price Sometimes the government may fix the minimum price at which the sellers may sell a particular good or service. To be effective and meaningful, floor prices have to be set higher than the equilibrium price. Assures producers get a remunerative price for their product. E,g, minimum wages Implications Surplus supply and the problem of unsold stock. Governments often end up buying the surplus stock at the minimum support prices. E.g. often seen for agricultural products in India