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Information about price, supply, and demand

This Blog discusses price fluctuation, the concept of supply and demand. How the rise and fall of price happens, and what is the concept behind price control. The following block diagram shows a roadmap for understanding the concept of price, supply, and demand.

how price, supply, and demand changes. price fluctuation.
price control,
what is supply and demand

Price fluctuations – first step to understand price, supply and demand relationship

It is essential to understand the price supply and demand relationship, especially for business people and business-related professionals as it will tell you how to price your product. Also, it is necessary if you are a consumer; it keeps you informed and helps in choosing the right deal, for yourself then.

In the previous blog, we tried to understand demand and supply and how they are price dependent on it, right from the basics. If any product is allowed to operate freely in a free market economy will find its equilibrium point, supply and demand aggregate. If the demand is more than the Supply, then the prices rise, and the producers will increase their Supply, as the price is high.

Eventually, their Supply will meet the demand, and the prices and quantity will find equilibrium. In the same way, if the supply is higher than demand, the prices will be low, and the producers will reduce their Supply as the prices are low.

Eventually, the demand will match the supply, and the prices and quantity will find equilibrium. This is how basically price fluctuates according to Supply and demand. This fundamental law holds only mostly to essential things and up to certain levels. But how do Supply and demand fluctuate according to price is yet to be known. To understand this, the concept of Supply and demand at the current prices play an important role.

Concept of price, supply, and demand at existing prices

In typical situations, the demand and supply are not the same at all price levels. It is a fundamental concept, but many people don’t know about it.

They believe that increment and decrement in demand and Supply are the only influential factors. Let us understand this with an example of apple, and the standard prices of apple are 100 bucks per Kg. If the apple price is set at 70 bucks, then the person ready to buy the apple at 100 bucks will buy more apples at 70 bucks.

It is evident that at lower prices, that person will increase his buying by 2 kilograms of Apple instead of buying 1 kilogram of apple. And the person who is not ready to purchase apples at 100 bucks per kg is prepared to accept the apples at 70 bucks per kg, which is an increment in demand. So we can see that demand at 70 bucks is different than demand at 100 bucks.

Oppositely, if the prices are set at 120 rupees, then the people who are ready to buy at 100 bucks will buy less or will not be willing to buy at all. As prices change, you can see that demand at those prices is different, which is why demand decreases. But an apple a day keeps the doctor away. The demand should have been constant at all prices, but it is not the case. The demand changes according to the prices, and Supply will make adjustments accordingly. After all the adjustments, we will see that 100 rupees will be the equilibrium position. To sum it up means the quantity demanded varies according to how high or low prices are.

Rise And Fall of price – indicates how price, supply, and demand relationship are related

The prices rise because the amount demanded exceeds the amount supplied at existing prices. i.e., suppose more people start feeling that apples are essential for health. In that case, the demand will rise as people who were not willing to buy at 100 rupees will also start buying it more.

The Supply cannot be increased because, obviously, the apples take time to grow. As the demand is high at 100 and Supply is low at 100, the equilibrium price will shift to 120, where the Supply and demand will match. The equilibrium prices will change to 120 rupees from 100 as more people are willing to buy at 100 rupees than the Supply. There is a shortage at 100 rupees and equilibrium at 120 where the demand and Supply are proportionate.

The prices fall because the amount supplied exceeds the amount demanded at existing prices. If more people start to feel that apples are not that important to health than it is believed to be, the demand will fall as fewer people will be willing to buy at 100 rupees. Then the demand will drop as fewer people are ready to buy, and the Supply cannot be reduced as the apples have already been grown.

As the demand is low at 100 and Supply is high, the equilibrium price will shift to 70, where the Supply and demand will match. The equilibrium price will change to 70 from 100 as fewer people are willing to buy at 100 rupees than the Supply.

Exception in price, supply, and demand relationship

The Supply and demand are the same at all price levels, only for essential things and dire situations. Let’s take the example of the ongoing pandemic situation. No matter how high the prices are or how low the prices are, the needs and demands of beds and medical aid will stay the same, which is high in this case because of the situation. We are also trying to increase the supply of beds and medical assistance to the people. On regular days the demand for beds had been different at different prices.

Price Controls

Even in a free-market economy, we see governments control the prices of a few essentials things. They can control prices in two ways

Not allowing them to rise
Not allowing them to fall
Not allowing prices to rise

In this, the prices are set to lower values than the market equilibrium prices. These are mainly done to help the consumers. Imagine if the rent of the houses are assigned to a low value so that everyone can afford shelter and the number of people living in dire conditions at least reduce if not eradicate.

The USA did this after Second World War. We know from the above discussion that the demand rises at lower prices, and the Supply was the same. This situation created a shortage in the market even though there was no scarcity. The ratio of population to houses had stayed constant even after World War II. There was no scarcity. But due to lower prices, people were going for bigger houses than they went for before World War 2. Some people who had no houses were going for smaller homes. But you get my point. It created a shortage.

The problems with price-controlled from rising are:

Loss of quality

Due to rent control law, the house owner and builders were not making profits. They were not spending the money on maintenance, and new houses were not being built. In the next 10 years, the USA’s quality of homes reduced substantially, and very few new houses were made by the builders as profit was not good.

Hoarding

The decision to control rent was very popular among the people. The intended people hardly got the boon. Many celebrities had taken many rented houses in different cities to stay when they travel to that city, which was more than they required. They did so as they could afford even more houses at much lower prices. The needy people hardly got the benefits.

No matter how popular these decisions are, free to market economy prices are best in the long and short term.

How free to market economy prices are best in the long and short term

Not allowing prices to fall

In this, the prices are set to higher values than the equilibrium prices. This price control is mainly done to benefit the producers. After the 1930 great depression, the farmers could not make enough money from the sale of the crops. So the prices were maintained higher so the farmers could survive. But as we know, demand at higher prices is lower, and the Supply is high—this created surplus of crops in the market.

The problem with price control for falling are:

Surplus even though required: after the crop’s price gets higher, it created a surplus. And many people were dying due to hunger. There was a surplus even though the market was scarce. The food did not reach them as due to the great depression, many people became poor and could not afford the food.

Misallocation: due to a surplus of crops, the government had to buy those crops from the farmers and store them. Which required investment in the infrastructure of the godown. This led to the misallocation of resources to infrastructure, which was not that necessary. The government also told farmers not to take the crops of perishable items. When people dying at one end, money is spent on infrastructure.

But in the long term, the strategy proved to be successful.