4. Price Determination

4. Price Determination

1. Definition: A market can be defined as an arrangement whereby buyers and sellers can negotiate in order to exchange (buy and sell) goods, services, or factors of production at an agreed price.

2. Market Equilibrium

   • Where quantity demanded equals quantity supplied, the market is in a state of equilibrium.
     • Equilibrium is a state of rest where there is no tendency for any change. This is known as market equilibrium.

3. Equilibrium Price & Qty/Output

   • Equilibrium price/quantity/output refers to the price and quantity/output respectively, at which quantity demanded equals quantity supplied.
     • Once equilibrium price and quantity is reached, there is no tendency to change unless there are changes in D/S conditions.

4. Interactions between Demand & Supply Forces

   • Qs > Qd
     • At ___ price, the Qs is (Big) while Qd is (small). Qs exceeds Qd by (Difference). Thus, there is surplus and this exerts downward pressure on price. As price falls, Qs falls and Qd increases in accordance to law of S/D. This will continue until surplus eliminated, market equilibrium reached. At market equilibrium, no pressure for prices to fall further.
   • Qd > Qs
     • At ___ price, the Qs is (Small) while Qd is (Big). Qd exceeds Qs by (Difference). Thus, there is shortage and this exerts upward pressure on price. As price rises, Qs rises and Qd falls in accordance to law of S/D. This will continue until shortage eliminated, market equilibrium reached. At market equilibrium, no pressure for prices to fall further.

5. Change in Demand only, Ceteris Paribus

   • Increase in Demand leads to Increase in equilibrium price & qty, ceteris paribus.
     • Increase in demand from D0 to D1, ceteris paribus creates shortage of Q0Q2 at initial price P0.
       • Shortage drives the price up which causes Qd to fall and Qs to rise in accordance to law of D/S.
         • Rise in demand ceteris paribus will cause rise in equilibrium price and qty.

6. Change in Supply Only, Ceteris Paribus

   • Increase in Supply from leads to decrease in equilibrium price and increase in equilibrium qty, ceteris paribus.
     • Increase in supply S0-S1, ceteris paribus, creates surplus Q0Q2 at initial price P0.
       • Surplus drives price down which in turn cases Qd to rise, Qs to fall in accordance to law of D/S.
         • Rise in supply ceteris paribus causes fall in equilibrium price, rise in equilibrium qty.

7. Simulteaneous Change in Demand & Supply

   • When both demand and supply change in same direction, equilibrium qty will increase while equilibrium price will be indeterminate depending on the magnitude of the shifts in dd/ss. However, if demand and supply change in opposite direction, equilibrium qty will be indeterminate depending on magnitude while equilibrium price will be following the direction of change in demand.

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