STANDARD XII (ISC)

ECONOMICS
Chapter 6: Market Mechanism

Q.What is meant by equilibrium price? How do the forces of demand and supply
determine the equilibrium price?
The price at which the quantity demanded of a commodity equals the quantity supplied is
known as equilibrium price.
It is evident from the definition above that equilibrium price is determined by the market
forces of demand and supply.
If the price is too high consumers will not be willing to buy so the demand stays low. But
at the same time at higher prices suppliers will be induced to supply more in the market.
Hence supply increases. This leads to a situation of Excess supply. This excess supply
pushes the equilibrium prices down.
The above phenomena settles at a point where whatever is demanded by the consumer is
also supplied by the supplier. Price prevailing at that point becomes the equilibrium price.
This can be shown in the table and graph below:

Q. Explain the effects of simultaneous changes in demand and supply on equilibrium

price and equilibrium quantity.

A. The effect of simultaneous changes in demand and supply on equilibrium price and
equilibrium quantity. Can be explained in three categories:
a) When both change in equal magnitude
b) When change in demand is more than change in supply
c) When change in demand is less than supply.

(1)
As is seen in the diagram above -
When change (decrease in this case) in demand is equal in magnitude to the change (decrease
in this case) in supply, the equilibrium price remains the same but equilibrium quantity
transacted in the market decreases
***********

As is seen in the diagram above -

When demand decreases in a larger proportion than the decrease in supply both the
equilibrium price and the equilibrium quantity decrease.
**********

(2)
As is seen in the diagram above -
When the supply decreases more than proportionately than the decrease in demand the
equilibrium price rises but the equilibrium quantity decreases.

Importance of time element in determination of price in a competitive market.

Alfred Marshall has divided the time period into four phases.
a) Very short period
b) Short period
c) Long period
d) Very long period

In the above graph we see the supply curves with respect to the three time periods;
An equilibrium price prevailing
An increase in demand curve.
Very short period – also known as market period is a time period where suppliers have no
time to increase the supply in order to meet the increased demand if any. Therefore demand
plays the major role in determination of price in a very short period. Supply curve of the
commodity id perfectly inelastic. For ex agricultural produce cannot be increased until the
next harvest season.

(3)
Short period – refers to the time period where the supply of a commodity can be increased by
making more intense use of fixed factors. Variable factors can be increased in order to utilize
the fixed factor more intensely. But increase in supply is limited to fuller utilization of the
existing fixed factors. Hence the increase in price in a short period is a little lesser than the
increase in price under very short period.
Long period – refers to the period which is long enough to enable to industry to adjust its
supply completely to change in demand. This is so because in the long run industry and
firms can expand their scale of operation. New firms may enter the industry. Existing firms
may install new plant and machinery, so both capital and variable factors change. Price that
prevails in the long run is known as ‘normal price’.
Very long period – refers to the time period in which full adjustment can be done both in
demand and supply. Price prevailing in the very long period is called ‘secular price’

Q. Define price ceiling. What is its effect on equilibrium price and output? How is the
problem of allocating limited supply tackled?

A. The price ceiling is the maximum legal price which the suppliers can charge for a
particular good or service. It is set for the benefit of the consumers.
If the price ceiling is set above the equilibrium price (at OP1 in Fig 10), it has no effect
on price and quantity.
To be meaningful, the price ceiling must be below the equilibrium price. If the
government fixes a price which is less than the equilibrium price (OP2 in Fig 10), it will
result in a situation of excess demand or shortage of the commodity. It is seen from Fig
10 that at OP2 price, the quantity demanded is OQ2 while the quantity supplied is only
OQ1. Since the quantity demanded exceeds the quantity supplied, a shortage of the
commodity will develop in the market. This shortage is equal to OQ2 – OQ1= Q1Q2
(=KL).

Some of the possible methods of allocation are:

(i) First Come, First Served: In this system, sellers will sell the limited
quantity available with them to the buyers who are first to arrive. This

(4)
 system has been used in Indian during the period of shortage of kerosene,
petrol, onions etc.
(ii) Allocation by Sellers’ Preferences: In this method the shopkeepers will
decide who will get the scarce products. For instance, they may sell the
scarce product only to regular customers.
(iii) Rationing: Rationing is a system of distribution of a specified quantity of a
product at the price fixed by the government. For instance, in India, BPL
families (families below the poverty line) are issued ration cards which
enable them to purchase wheat, rice, etc. at the prices fixed by the
government

Q. Define floor price. What is its effect on equilibrium price? How is the problem
of surplus supply tackled?

A. Sometimes the government may legally fix a minimum price at which the seller may
sell a particular good or service. It is set for the benefit of the producers.
Fixed price is supposed to be set for the benefit of the supplier of a good or service.
Therefore to be meaningful it is important that it is set above the equilibrium price.
Thus rise in the equilibrium price of the commodity or service induces the suppliers
to increase the supply and hence there exists a situation of excess supply.

Some of the possible ways to tackle with this surplus:-

a) Government generally purchases the surplus stock of product which remains
unsold. For example the government of India has pursued such a floor price
fixing for agricultural products the surplus produce was held at the central;
buffer stock by procuring it from the farmers at minimum support price.
(5)
 b) At times the suppliers find it difficult to dispose off their unsold stock. In
desperate efforts to overcome this problem suppliers flout the law and sell
the goods at lower prices.

INSTRUCTIONS TO STUDY THIS CHAPTER:

 Please read your book for detailed information of the above topics.
 The length of the answer depends on the marks in the question paper and may not
only be
Substituted with what is mentioned in the notes.
 Examples can be used to elaborate your points for this chapter

(6)