PRICE DETERMINITION Page 12.

1
VINAY GUPTA
M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

CHAPTER 12
Price Determination

Market Equilibrium under perfect competition and effect of shift
in Demand and Supply.

Market Equilibrium:
Market Equilibrium is a situation of the market in which demand
for a commodity is exactly equal to its supply corresponding to a
particular price.
a) Equilibrium Price:
Equilibrium Price which corresponds to the quality between
the market demand and market supply of a commodity.

b) Equilibrium quantity:
Equilibrium quantity which corresponds to the price in the
market.

Determination of Market Equilibrium under:
Perfect Competition:
In perfect competition firm is price taker and price are
determined by industry with the help of market forcer of demand
and supply.

Equilibrium refers to state of balance under perfect competition
market equilibrium is determined when market demand is equal
to market supply.

Here Market Demand is the sum of total of demand for a
commodity by all the buyers in the market. Its curve slope
downwards due to Law of Demand.

Market Supply is the total of supplies of a commodity by all the
producers in the market. Its curve slopes upward due to
operation of law of supply.
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Market Equilibrium under Perfect competition:
Price of
Chocolate
(Rs)
Market
Demand of
Chocolate
Market
Supply of
Chocolate
Storage(-)
OR
Supply (+)
Remarks
2 100 20 (-)80
Excess
Demand
4 80 40 (-)40 MD > MS
6 60 60 0
Equilibrium
Level,
MD = MS
8 40 80 (+)40
Excess
Supply
10 20 100 (+)80 MS > MD

1) Market Equilibrium is determined at
point E when MD = MS.
2) Equilibrium Price = Rs 6.
3) Equilibrium Quantity = 60 units.

Three Basic Assumption of (Price
Determination) Market Equilibrium
under Perfect Competition:
1. Price & Quantity supplied are positively related.
2. Price & Quantity demanded are negatively related.
3. Forcer of supply & Demand operate freely without any
government intervention.

Excess Demand OR When Market Price < Equilibrium Price:
Excess Demand refer to a situation when quantity Demanded >
Quantity Supplied at prevailing market Price. Here market Price
is less than equilibrium price.

In the given Diag & Previous table:
When price is < equilibrium price then:
1. There shall be excess demand D > S.
2. Here consumers want more quantity but
supply is less. Leads to increase in price.
3. With increase in price quantity
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demanded will fall due to law of Demand & Quantity
supplied will rise due to law of supply.
4. This process will continue till the equilibrium price will set
again & excess demand will wiped out.
Thus price will increase to a level where market
Demand = Market Supply.

Excess supply OR When Market Price > Equilibrium Price:
Excess Supply refers to a situation when prevailing market price.
Here market price is more than equilibrium price.

In the given diag. & previous table when price > Equilibrium
Price
1. There will be excess supply S>D.
2. Due to this excess supply there will be
reduction in market price.
3. In response to a reduction in price
quantity supplied will start decreasing
this triggers downward moment along
the supply curve & Quantity demanded
will increase their triggers right ward movement along the
same demand curve
4. This process will continue till the equilibrium price will set
again & excess supply will wiped out. Thus price will
decrease to level where Market Demand = Market Supply
various cases of change (shift) in Demand & Supply on
Equilibrium price
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


Here in both situation number of firms are fixed or supply is
fixed or no change in supply


VARIOUS CAUSES OF CHANGE(SHIFT) IN DEMAND & SUPPLY ON
EQUILIBRIUM PRICE
Change In Demand
Increase In
Demand
(Rightward Shift)
Decrease In
Demand Leftward
Shift
Change In Supply
Increase In Supply
(Rightward Shift)
Decrease In Supply
(Leftward Shift)
Change In Both
Demand & Supply
Both Demand And
Supply
Decrease Both
Demand And
Supply
Demand &
Supply
Demand
Supply
Special Cases
Change In Demad
When Supply Is
Perfectly Elastic
Change In Supply
When Demand Is
Perfectly Elastic
Change In Demand
When Supply Is
Perfectly Inelastic
Change In Supply
When Demand Is
Perfectly Inelastic
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

CHANGE IN DEMAND: (Assuming No Change in supply)
i. INCREASE IN DEMAND: Numbers of firms are fixed Or
supply is fixed.

Chain of effect:
1. Due to increase in Demand- Demand
curve will shift from DD to D1D1 to right
side
2. Due to that there will be excess Demand
= EF
3. It leads to in price.
4. Rise in price inducer extension of supply & contraction in
Demand.
5. This process will follow till the new equilibrium with point
E1 will set
Here (i) new will Equilibrium Price= OP1
(ii) New Equilibrium Quality =OQ1
Decrease in Demand:
Chain of Effect
1. Due to decrease in Demand, Demand
curve will shift to left side from DD to
D1D1.
2. Due to this there will be excess supply
= EF.
3. It leads to in price.
4. Decrease in price inducer contraction
in supply & extension of Demand
5. This process will follow till the new equilibrium point E1 will
set. Here (i) New Equilibrium Price = OP1 (ii) New
Equilibrium =OQ1


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CHAIN IN SUPPLY: (Assuming no change in Demand)
(i) Increase in Supply
Chain of Effect:
1. Due to in Supply, supply curve will
shift from SS to S1S1 to right side.
2. Due to their will be excess supply = EF.
3. It leads to in price.
4. in price inducer extension of demand &
contraction of supply.
5. This process will continue till the new equilibrium point E1
will set here
(i) New equilibrium price will fall to OP1
(ii) New equilibrium quantity will rise to OQ1

(ii) Decreasing Supply:
Chain of Effect:
1. Due to decrease in supply, supply
curve will shift to left side from SS
to S1S1.
2. Due to this there will be excess
Demand = EF.
3. It leads to in price.
4. in price inducer extension of supply & contraction of
Demand.
5. This process will continue till new equilibrium Point E1 will
set.
Here (i) New equilibrium Price will raise to OP1
(ii) New equilibrium quantity will fall to OQ1
I. When both Demand & Supply Decreases:
Case 1: Decrease in Demand = Decrease in Supply
When decrease in demand is proportionately equal to decrease in
supply, then leftward shift in demand curve from DD to D1D1 is
proportionately equal to leftward shift in supply curve from SS
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toS1S1 (Fig.). The new equilibrium is determined at E1. As
demand and supply decrease in the same proportion, equilibrium
price remains same at OP, but equilibrium quantity falls from OQ to
OQ1.

Case 2: Decrease in Demand > Decrease in Supply
When decrease in demand is proportionately more than decrease
in supply, then leftward shift in demand curve from DD to D1D1
is proportionately more than leftward shift in supply curve born
SS to S1S1 (Fig.). The new equilibrium is determined at E1,
equilibrium falls from OP to OP1 and equilibrium quantity falls from
OQ to OQ1.

Case 3: Decrease in Demand < Decrease in Supply
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

When decrease in demand is proportionately less than decrease
in supply, then ad shift in demand curve from DD to is
proportionately less than leftward shift in supply curve from SS
to S1S1 (Fig.). The new equilibrium is determined at E1, equilibrium
price rises from OP to OP1 whereas, and equilibrium quantity fails
from OQ to OQ1.

(ii) Both Demand and Supply Increase
Original Equilibrium is determined at point E, when the original
demand curve DD and the original supply curve SS intersect each
other, OQ is the equilibrium quantity and OP is the equilibrium
price. The effect of increase in both demand and. supply on
equilibrium price and equilibrium quantity is discussed under
three different cases:
Case 1: Increase in Demand = Increase in Supply
When increase in demand is proportionately equal to Increase in
supply, then rightward shift in demand curve from DO to DD Is
proportionately equal to rightward shift in supply curve from SS
to S1S1 (Fig.). The new equilibrium is determined at E. As both
demand and supply increase in the same proportion, equilibrium
price remains the same at OP, but equilibrium quantity rises from
QQ to OQ1.
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


Case 2: Increase in Demand > Increase in Supply
When increase in demand is proportionately more than increase
in supply, then rightward shift in demand curve from DD to D1D1
is proportionately more than rightward shift in supply curve from
SS to S1S1 (Fig.). The new equilibrium is determined at E
equilibrium price rises from OP to OP1 and equilibrium quantity
rises from QQ to OQ1

PRICE DETERMINITION Page 12.10
VINAY GUPTA
M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

Case 3 Increase In Demand < Increase in Supply
When increase in demand is proportionately less than increase in
supply, then rightward shift in demand curve from DD to D1D1 is
proportionately less than rightward shift in supply curve from SS
to S1S1 (Fig.). The new equilibrium is determined at E, equilibrium
price falls front OP to OP whereas, equilibrium quantity rises from
QQ to OQ1.

(iii) Demand decreases and Supply Increases
The effect of simultaneous decrease in demand and increase in
supply on equilibrium price and equilibrium quantity is analyzed
in the following three cases:
Case 1: Decrease in Demand = Increase in Supply
When decrease in demand is proportionately equal to increase In
supply, then leftward shift in demand curve from DD to D1D1 is
proportionately equal to rightward shift in supply curve from 55
to SS (Fig.), The new equilibrium is determined at E. equilibrium
quantity remains the same at OQ, but equilibrium price falls from
OP to OP1.
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


Case: 2. Decrease in Demand > Increase in Supply
When decrease in demand is proportionately more than increase
in supply, then leftward shift in demand curve from DD to D1D1
is proportionately more than leftward stilt in supply curve from
SS to S1S1 (Fig.). The new equilibrium is determined at E,
equilibrium quantity falls from OQ to OQ1 and equilibrium price
falls from OP to OP1

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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


Case 3 Decrease in Demand < Increase in Supply
When decrease in demand is proportionately less than increase
in supply, then leftward shift in demand curve from DD to D1D1
is proportionately less than rightward shift in supply curve from
SS to SlS1 (fig.). The new equilibrium is determined at E1,
equilibrium quantity rises from OQ to OQ1 whereas, and
equilibrium price falls from OP to OP1.

(IV) Demand increases and Supply decreases
The effect of increase in demand and decrease in supply on
equilibrium price and equilibrium quantity is discussed in the
following three cases.
Case 1: Increase in demand = Decrease in supply
When increase in demand is proportionately equal to decrease in
supply, then rightward shift in demand curve from DD to D1D1 is
proportionately equal to leftward shift in supply curve from SS to
PRICE DETERMINITION Page 12.13
VINAY GUPTA
M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

S1S1 (Fig.). The new equilibrium is determined at E1. As the
increase in demand is proportionately equal to the decrease in
supply, equilibrium quantity remains the same at OQ, but
equilibrium price rises from OP to OP1.

Case 2: Increase in Demand > Decrease in Supply
When increase in demand is proportionately more than decrease
in supply; then rightward shift in demand curve from DO to DD
is proportionately more than leftward shift in supply curve from
55 to SS (Fig.). The new equilibrium is determined at E1. As the
increase in demand is proportionately more than the decrease in
supply, equilibrium quantity rises from OQ to 0Q1 and equilibrium
price rises from OP to OP1.
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


Case 3: Increase in Demand < Decrease in Supply
When increase in demand is proportionately less than decrease
in supply then rightward shift in demand curve from DD to D1D1
is proportionately less than leftward shift in supply curve from
SS to S1S1 (Fig.). The new equilibrium is determined at E1. As the
Increase in demand is proportionately less than the decrease in
supply, equilibrium quantity falls from OQ to OQ
1
whereas,
equilibrium price rises from OP to OP1.
PRICE DETERMINITION Page 12.15
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005



SPECIAL CASES
Let us now discuss the effect on equilibrium price and
equilibrium quantity in the following four special cases:

I. Change in Demand when Supply is Perfectly Elastic
II. Change in Supply when Demand is Perfectly Elastic
III. Change in Demand when Supply is Perfectly Inelastic
IV. Change in Supply when Demand is Perfectly Inelastic

I. Change In Demand when Supply is Perfectly Elastic
When supply is perfectly elastic, then change in demand
does not affect the equilibrium price of the commodity. It
only changes the equilibrium quantity. Original Equilibrium
is determined at point E, when the original demand curve DD
and the perfectly elastic supply curve SS intersect each other.
OQ is the equilibrium quantity and OP is the equilibrium
price. The change may be either an Increase in Demand or
Decrease in Demand.
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

a) Increase in Demand:
When demand increases, the demand curve shifts to the
right from PD to D1D1 (Fig), Supply curve 55 is a horizontal
straight line parallel to the X-axis, Due to increase in
demand for the product, the new equilibrium is established
at E1. Equilibrium quantity rises from OQ to 0Q1 but
equilibrium price remains same at OP as supply is perfectly
elastic.

b) Decrease In Demand:
When demand decreases, the demand curve shifts to the left
from DD to D2D2 (Fig.). Supply curve SS is a horizontal
straight line parallel to the X-axis. Due to decrease in
demand, the new equilibrium is established at E2.
Equilibrium quantity falls from OQ to OQ2 but equilibrium
price remains the same at OP as supply is perfectly elastic.
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005



II. Change In Supply when Demand as Perfectly Elastic
When demand is perfectly elastic, then change in supply does not
affect the equilibrium price of the commodity. It only changes the
equilibrium quantity. Original Equilibrium is determined at point
E, when the perfectly elastic demand curve DD and the original
supply curve SS intersect each other. OQ is the equilibrium
quantity and OP is the equilibrium price. The change may be
either an increase in Supply or Decrease in Supply.

a) Increase in Supply When supply increases, the supply curve
shifts to the right from SS to S1S1 (Fig.). Demand curve DD
is a horizontal straight line parallel to the X-axis; Due to
increase in supply for the product the new equilibrium is
established at E1. Equilibrium quantity rises from OQ to OQ1
but equilibrium price remains the same at OP as demand is
perfectly elastic.
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b) Decrease in Supply: When supply decreases, the supply
curve shifts to the left from SS to S1S1 (Fig.). Demand curve
DD is a horizontal straight line parallel to the X-axis; Due to
decrease in supply for the product, the new equilibrium is
established at E2. Equilibrium quantity fails from OQ to OQ2
but equilibrium price remains same at OP due to perfectly
elastic demand.


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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005

III. Change In Demand when Supply is Perfectly Inelastic
When supply is perfectly inelastic, then change in demand does
not affect the equilibrium quantity. It only changes the
equilibrium price. The change may be either an Increase in
Demand or Decrease in Demand. Here quantity supplied is fixed
or constant supply.

a) Increase in Demand:
When demand increases, the demand curve shifts to the
right from DD to D1D1 (Fig.). Supply curve SS is a vertical
straight line parallel to the Y-axis. Due to increase in
demand for the product, the new equilibrium is established
at E1. Equilibrium price rises from OP to OP1 but
equilibrium quantity remains same at OQ as supply is
perfectly inelastic.

b) Decrease in Demand:
When demand decreases, the demand curve shifts to the
left from DD to D2D2 (fig.). Supply curve SS is a vertical
straight line parallel to the Y-axis. Due to decrease in
demand, the new equilibrium is established at E2.
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Equilibrium price falls from OP to OP2 but equilibrium quantity
remains the same at OQ as the supply is perfectly inelastic.



IV. Change In Supply when Demand Is Perfectly Inelastic
When demand is perfectly inelastic, then change in supply
does not affect the equilibrium quantity. It only changes the
equilibrium price. The change may be either an Increase in
Supply or Decrease in Supply. Here quantity demanded is
fixed or constant demand.
a) Increase in Supply:
When supply increases, the supply curve shifts to the right
from SS to S1S1 (Fig.). Demand curve DD is a vertical
straight line parallel to the Y-axis. Due to increase in supply
for the product, the new equilibrium is established at point
E1. Equilibrium price falls from OP to OP1 but equilibrium
quantity remains the same at OQ as demand is perfectly
inelastic.
PRICE DETERMINITION Page 12.21
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M.B.A., M. Com., PGDCA, B.Ed., STET Qualified Ph. 9896254005


b) Decrease in Supply:
When supply decreases, the supply curve shifts to the left
from SS to (fig.). Demand curve DD is a vertical straight line
parallel to the Y-axis, Due to decrease in supply for the
product, the new equilibrium is established at point E2,
Equilibrium price rises from OP to OP2 but equilibrium
quantity remains the same at OQ as demand is perfectly
inelastic.