Elementary theory of price formation: demand-supply analysis, Microeconomics


We discuss the elementary theory of price formation. Demand curve in the market is derived from the aggregate consumer demand and supply curve is derived from the aggregate firms supply. Since market demand curve for a good is the sum total of demand for that good of all individual consumers and since demand curve for a good for an individual consumer is derived from its utility maximisation, so along the demand curve consumer's optimising behaviour is always fulfilled. That means each point on the demand curve represents that consumers are willing to purchase the corresponding demand quantity with corresponding price. 

We consider perfect competition prevail in the market. In short, run perfectly competitive supply curve of a commodity in the market or industry is determined from supply curve of an individual firm, where supply curve of commodity of individual firm is derived from profit maximising objective of that firm. Hence, along the market supply curve-optimising behaviour of the firm is fulfilled. That means each point on the market supply curve represents that firms are willing to supply the corresponding supply quantity with corresponding price.  

90_demand supply analysis.png

Clearly, at the point of intersection between market demand and supply curve, exchange will take place between consumers and producers, as both of them simultaneously fulfilled their optimising behaviour. Corresponding price and aggregate quantity are short run equilibrium price (say p0) and aggregate quantity (say q0) respectively, which is shown in Figure. 

The process of adjustment of short run equilibrium of a competitive market takes place in the following way. Generally, by adjusting price of the commodity equilibrium in short run perfect competition is achieved as given below:  

It is assumed that for any excess demand (or excess supply) prices will increase (or decrease). According to this behaviour of the market, price adjustment in disequilibrium will take place by a mechanism, which is known as auctioneer mechanism.  

Suppose there is an invisible referee who controls the market price according to the above behavioural assumptions. Producers supply their quantity on the basis of existing market price. Suppose, the referee initially specifies a particular price on the basis of which producers and consumers specify their supply and demand respectively. Then suppose the referee observed that supply quantity is larger than the demand quantity i.e., we have excess supply of the commodity.  

Posted Date: 10/26/2012 5:53:34 AM | Location : United States

Related Discussions:- Elementary theory of price formation: demand-supply analysis, Assignment Help, Ask Question on Elementary theory of price formation: demand-supply analysis, Get Answer, Expert's Help, Elementary theory of price formation: demand-supply analysis Discussions

Write discussion on Elementary theory of price formation: demand-supply analysis
Your posts are moderated
Related Questions
During the 1990s, technological advance reduced the cost of computer chips. Explain, with the use of supply and demand diagrams, how the following markets are affected in terms of

net preparation ranjna baghel

Unemployment: Unemployment refers to a situation where people who are willing and able to work do not find jobs at the existing wage rate.For a person to be referred to as une

Find the best response functions and the mixed strategies Nash Equilibrium if each player randomizes over his actions.

Interest rate sensitivity can also be understood from another perspective.  The total cost of a commodity is not just its price, but also what must be paid to borrow money to purch

Q. Explain General Equilibrium? General Equilibrium: Neoclassical economics presumes that production, employment, investment and income distribution are all determined by a con

Determine the Slutsky Equation. Income-Substitution Effect: The Slutsky Equation A fall into the price of a good may have two sorts of consequences: substitution effect, whe

1. Using personal (work) experience or examples found from companies you research or from text book scenarios: a.  Give an example of at least two "conflicting measurements" bei

when average product is decreasing, marginal product is?