Determination of Price and Quantity

Both demand and supply of a commodity are affected by change in price of the commodity. The change in both demand and supply of a commodity also influences the price of the commodity.

When a seller sells a commodity, he exchanges it for money. The buyer pays money to the seller in exchange of goods and services. The amount of money which a buyer pays for one unit of a good or service to the seller, is called the price of the good or service. For example a buyer pays Rs 46 to buy one litre of full cream milk, the price of full cream milk will be Rs 46 per litre.

Normally, the main aim of the seller is to earn profit. Profit is the difference between total revenue and total cost. Total revenue means total money receipts of the producer from the sale of given volume of output. Total cost means total expenditure incurred by a seller in the production of that output.

Meaning of Price

The seller fixes the price of the commodity supplied by him. The market price of a commodity is the price at which it is sold in the market. While fixing the price of a commodity the seller keeps in mind many factors besides earning maximum profit. Some of the important factors which influence the decision of a seller in fixing the price of a commodity are:

1. Cost of production: A seller fixes the market price of his commodity which is more than the per unit cost of production of commodity. The difference between the per unit price and per unit cost of production of the commodity is profit per unit. Thus, higher the difference between price and per unit cost of production greater will be the margin of profit. So per unit cost of production is of great importance in fixing the price of the commodity by a seller.

2. Price fixed by other sellers: While fixing the price of his commodity, the seller also considers the price of commodity fixed by the other sellers of similar commodity. If a seller fixes the price of his commodity which is much higher than the price fixed by other sellers of similar commodity, he may not be able to sell more quantity of the commodity. So in order to increase his sales he will have to decrease the price of his commodity. Thus, it is also very important for the seller of a commodity to fix the price of his commodity which is comparable to the price of other sellers in order to earn maximum profit.

3. Expected sales at different prices: The seller also considers the quantity of the commodity he will be able to sell at different prices. So, the price of the commodity fixed by him must be such that the total quantity of the commodity sold by him gives him maximum total profit.

Determination of Price

If the seller fixes a higher price of the commodity, the quantity supplied of the commodity may be more than the quantity demanded and if he fixes the lower price of the commodity, the quantity demanded of the commodity may be more than its quantity supplied.

According to the law of demand the buyer of a commodity buys more of a commodity at a lower price and less of it at a higher price when all other factors determining demand
remain constant. According to the law of supply, the sellers of a commodity are willing to sell more of it at a higher price and less of it at a lower price, other factors determining supply remaining constant.

The aim of buyer is to get maximum satisfaction by spending minimum and the aim of the seller is to get maximum profit. If at a price both quantity demanded and quantity supplied of a commodity are equal that is called equilibrium price of the commodity. In this way, the price of a commodity is determined by the forces of demand and supply in the market.

But in case of some commodities, the price is determined by the government to protect the interest of consumers or producers.

Equilibrium Price

Equilibrium literally means a state of balance from where there is no tendency to change. In other words equilibrium is a situation where the forces determining equilibrium are in balance or are equal to each other. Here the forces determining equilibrium price are quantity demanded and quantity supplied of the commodity. The price at which quantity demanded of a commodity is equal to its quantity supplied is called the equilibrium price.

At equilibrium price quantity demanded and quantity supplied of a commodity are equal. This quantity is called the equilibrium quantity of the commodity.

In practical life, the price at which the seller or firm wants to sell a commodity, its quantity supplied may be greater or lesser than its quantity demanded. So, this price is not the equilibrium price of the commodity.

Excess demand is a situation when at a given price quantity demanded of a commodity is greater than its quantity supplied. Excess supply is a situation when at a given price quantity supplied of a commodity is greater than its quantity demanded. When there is excess demand of the commodity the price starts rising and it continues to rise till equilibrium price is reached. When there is excess supply of the commodity its price starts falling and continues to fall till equilibrium price is reached.

Effect of Change in Demand on Equilibrium Price and Quantity

An increase in the demand of the commodity will lead to increase in equilibrium price and quantity demanded and supplied of the commodity. On the other hand, if demand for the commodity decreases but its supply remains the same, it will lead to decrease in equilibrium price and quantity demanded and supplied of the commodity.

Effect of Change in Supply on Equilibrium Price and Quantity

When the supply of a commodity increases but its demand remains the same, equilibrium price will decrease but equilibrium quantity demanded and supplied will increase. On the other hand when the supply of a commodity decreases but its demand remains the same, its equilibrium price will increase but equilibrium quantity demanded and supplied will decrease.