Price Equilibrium – Explanation with Illustration

price equilibrium

Price equilibrium is the price where the quantity supplied and demanded of a commodity in the market are equal.

What is Price Equilibrium?

The price at which buyers are ready to buy and sellers are ready to sell the goods and services in the market is known as Equilibrium Price. The point where demand and supply are equal is the price equilibrium point.

PRICE EQUILIBRIUM :

where Demand of a commodity  =  Supply of a commodity

Demand refers to the willingness and ability of buyers to purchase a commodity in the market. It is indicated by the demand schedule or demand curve.

Supply refers to the availability of a commodity by all firms in the market and indicated by supply schedule and supply curve.

The oversupply of commodities results in a decrease in price, causing a rise in demand. This effect of balancing the demand and supply in the market is shown by price equilibrium.

In other words, the point where the demand and supply curve intersect each other is known as the price equilibrium point. There is no excess demand or excess supply in the market.

Explanation with Illustration :

We can understand this with the following illustration:

Suppose, the demand and supply schedule for a commodity ‘X’ at different prices in the market is as follows:

Price of commodity ‘X'(In Units) Quantity demanded of commodity ‘X'(In Units) Quantity Supplied of Commodity ‘X'(In Units)
50 100 500
40 200 400
30 300 300
20 400 200
10 500 100

The above table shows that at price Rs.50, the quantity demanded is 100 units whereas quantity supplied of commodity ‘X’ is 500 units. At this price, there is excess supply as the sellers have excess stock to offer. It means that sellers are willing to sell more than what consumers want to buy. This excessive supply forces the price to lower down in the market. Suppose the price falls to Rs 40, it leads to a rise in quantity demanded to 200 units and fall in supply to 400 units. Even at this price, the supply of commodity ‘X’ > its demand, thus the situation of excess supply prevails in the market. It again forces the price to fall, resulting in a new price at Rs 30. This fall in price leads to an increase in demand to 300 units and a decrease in supply to 300 units. Thus, Rs.30 is the equilibrium price as the quantity demanded and supplied are equal i.e.300 units. Similarly, at any price below the equilibrium price, there would be excess demand. It means that there is a shortage of stock in the market as the quantity demanded by buyers is more than what sellers want to sell. At the equilibrium price, there is no excess demand and supply.

Graphical Representation : 

price equilibrium min - Price Equilibrium - Explanation with Illustration
Price Equilibrium

In fig, X-axis shows the quantity demanded by buyers and quantity supplied by sellers of commodity ‘X’ whereas Y-axis shows the different price levels. DD is the demand curve and SS is the supply curve. The point E is the equilibrium point where both curves intersect each other which implies Demand= Supply. This point shows that the equilibrium price is Rs.30 and the equilibrium quantity is 300 units. If the price is more than equilibrium price i.e. Rs.40, it results in excess supply and shown by points P & Q where Supply is 400 units whereas Demand is only 200 units. The excess supply pressurizes the price to fall down in the market which leads to an increase in demand (movement along the curve from P to E)   and a decrease in supply (movement along the supply curve from Q to E). At point E, the excess supply is eliminated and results in demand = supply=300 units.

Likewise, if the price is less than the equilibrium price i.e. Rs 20, it results in excess demand and shown by points R & S where Supply is 200 units and Demand is 400 units. The excess demand forces the price to rise in the market which leads to an increase in supply(movement along the supply curve from R to E)  and a decrease in demand (movement along the supply curve from S to E). At point E, the excess demand is eliminated and results in demand = supply=300 units. Thus, the market is cleared and the equilibrium price is prevailing.

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Movement Along Supply Curve and Shift in Supply Curve

change in supply

In Economics, the “movement along the supply curve” and “shift in supply curve” represent very different market situations. These two terms define the change in supply due to a change in its factors.

Meaning of Supply Curve  : 

Supply Curve is a graphical representation of the correlation between the price of the commodity and quantity supplied for a given period of time.

This curve is affected by the change in quantity supplied. The movement along the supply curve and shift in the supply curve explains the change in the supply. When the supply of a commodity change due to changes in its price, it is shown by movement along the supply curve and shift in the supply curve shows the change in quantity supplied due changes in factors of supply other than its price.

Movement along Supply Curve :

A movement refers to a change along the supply curve. On the supply curve, a movement expresses a change in both price and quantity supplied from one point to another on the curve. Therefore, it can be said that movement along the supply curve represents the variation in quantity supplied of a commodity with a change in its price, assuming other factors constant.

As we know, the quantity supplied of a commodity change in with increase or decrease in its on price while other factors of supply remain unchanged. When we show this change on a graph, it is known as movement along the supply curve.

The movement along the supply curve can be classified as :

  1. Extension of Supply
  2. Contraction of Supply

Extension of Supply : 

When the quantity supplied of a commodity increase with a rise in its price, it is known as an extension of supply, other things being equal.

This can be understood by the following illustration:

Suppose, the price of ice cream is Rs.10 and the quantity supplied is 5 units. When the price increases to Rs. 20, the supply extends to 10 units.

Price of Ice Cream (in Rs.) Quantity Supplied (in units)
10 5
20 10
extension of supply min - Movement Along Supply Curve and Shift in Supply Curve
Extension of Supply

In Fig, X-axis shows the quantity and Y-axis shows the price. When the price is Rs10, the quantity supplied of ice cream is 5 units. As the price increases to Rs20, its supply also increases to 10 units. It implies the movement from a lower point to a higher point along the same supply curve, thus known as an extension of supply. 

Contraction of Supply : 

When the quantity supplied of a commodity decrease with a fall in its price, it is known as an extension of supply, other things being equal.

This can be understood by the following illustration:

Suppose, the price of ice cream is Rs.20 and the quantity supplied is 10 units. When the price increases to Rs. 10, the supply extends to 5 units.

Price of Ice Cream (in Rs.) Quantity Supplied (in units)
20 10
10 5
contraction of supply min - Movement Along Supply Curve and Shift in Supply Curve
Contraction of Supply

In fig, X-axis shows the quantity of ice cream and Y-axis shows the price. When the price is Rs 20, the supply is 10 units. As price decreases to Rs10, its supply also falls to 5 units. It implies the movement from the upper point to a lower point on the same supply curve, thus called a contraction of supply.

Shift in Supply Curve : 

When the supply of a commodity change due to changes in factors other than its price such as the price of related goods, cost of production, technology etc., the supply curve doesn’t extend or contract but shifts entirely. Then, it is known as the Shift in Supply Curve. 

For example, the improvement in technology increases the production with low cost of production, which leads to more supply due to change in other factors of supply.

The shifts in the supply curve can be classified as :

  1. Upward Shift in Supply Curve
  2. Downward Shift in Supply Curve

Upward Shift in Supply Curve:

When the supply increases due to change in determinants of supply other than its price, it refers to an upward shift in the supply curve. Increase in supply implies two things :

a) Same Price More Supply:

When the supply of a commodity increase but its price remains the same, there is an upward shift in the supply curve.

For Example,

when the price a commodity is Rs20, the supply is 20 units. Keeping the price the same as Rs.20, if supply increases to 30 units. It denotes an upward shift in the supply curve.

Price of Ice cream (in Rs) Quantity Supplied(in units)
20 20
20 30

b) Less Price Same Supply:

When the price of a commodity fall but its supply remains constant, there is an upward shift in the supply curve.

For Example,

when the price of a commodity is Rs 20, the supply is 20 units. If the price falls to Rs 10 and there is no change in the supply, it denotes an upward shift in the supply curve.

Price of Ice cream (in Rs) Quantity Supplied(in units)
20 20
10 20
upward shift min - Movement Along Supply Curve and Shift in Supply Curve
Upward Shift in Supply Curve

In fig, X-axis shows the quantity of ice cream and Y-axis shows the price. SS is the supply curve. At price Rs 20, the supply is 20 units. When there is an increase in supply due to change in factors other than its price, the supply curve shifts downwards to the right in two ways :

i) If supply increases from 20 units to 30 units.

ii) Price of ice cream declines to Rs.10 but supply remains the same as 20 units.

This shift of the supply curve is known as an upward shift.

Reasons for an upward shift in the supply curve :

a) Improvement in Technology

b)Reduction in the prices of factors of production causing a fall in the cost of production. 

c) When the price of related goods decreases.

d)Increase in the number of firms in the market.

e) When the firms expect a fall in the price of commodity near future.

f) When the motive of the firm shifts from profit maximization to sales maximization.

g) The decrease in taxations or grant of subsidies. 

Downward Shift in Supply Curve : 

When the supply increases due to change in determinants of supply other than its price, it refers to an upward shift in the supply curve. Increase in supply implies two things :

a) Same Price Less Supply:

When the supply of a commodity decrease but its price remains the same, there is a downward shift in the supply curve.

For Example,

when the price a commodity is Rs10, the supply is 20 units. Keeping the price the same as Rs.10, if supply increases to 10 units. It denotes a downward shift in the supply curve.

Price of Ice cream (in Rs) Quantity Supplied(in units)
10 20
10 10

b) More Price Same Supply:

When the price of a commodity rise but its supply remains constant, there is an upward shift in the supply curve.

For Example,

when the price of a commodity is Rs 10, the supply is 20 units. If the price falls to Rs 20 and there is no change in the supply, it denotes an upward shift in the supply curve.

Price of Ice cream (in Rs) Quantity Supplied(in units)
10 20
20 20
downward shift min 1 - Movement Along Supply Curve and Shift in Supply Curve
Downward Shift in Supply Curve

In fig, X-axis shows the quantity and Y-axis shows the price. At price Rs10, the supply is 20 units. When there is a change in any factors of supply other than own price, supply decreases and supply curve shifts to upwards to left by two ways. The new supply curve implies two things : 

i)New supply curve indicates that at the same price Rs.10, the new supply has fallen to 10 units of ice cream.

ii)It also means that at a higher price of Rs20, the supply remains 20 units of ice cream.

Thus, the supply curve represents a decrease in supply.

Reasons for a downward shift in the supply curve :

a) When technology becomes obsolete resulting in the high cost of production.

b)Rise in the prices of factors of production causing an increase in the cost of production. 

c) When the price of related goods increases.

d) A decrease in the number of firms in the market.

e) When the firms expect a rise in the price of commodity near future.

f) When the motive of the firm shifts from sales maximization to profit maximization.

g) The increase in taxations or withdrawal of subsidies.

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The elasticity of Supply- Meaning, Types and Methods

elasticity of supply

The elasticity of supply is an economic term that refers to the sensitivity of supply of a good or service to changes in other economic variables such as the price of goods, price of related goods and sellers’ expectations etc.

Meaning of Elasticity of Supply :

The elasticity of supply is the responsiveness of quantity supplied of a product to changes in one of the variables on which supply depends. According to basic economic theory, the supply of a commodity increases with a rise in price and decreases with a fall in price. 

Definitions:

According to Bilas, 

“Elasticity of Supply is defined as the percentage change in quantity supplied divided by percentage change in price.”

According to Lipsey,

“Elasticity of Supply is the ratio of the percentage change in quantity supplied over the percentage change in price.”

Price Elasticity of Supply:

The term which measures the rate of quantity demanded due to change in price is known as Price Elasticity of Supply. It measures the relationship between the change in quantity supplied and change in the price of a commodity.

It can be calculated as:

Price Elasticity of Supply(PES) = Percentage change in quantity supplied
Percentage change in price

Methods to measure the Price Elasticity of Supply:  

There are mainly two methods of measuring the price elasticity of supply which are:

1)Proportionate or Percentage Method

2) Geometric Method

These methods can be explained as:

1.Proportionate or Percentage Method : 

According to this method, the elasticity of supply can be defined as the ratio between ‘percentage change in quantity supplied’ and ‘a percentage change in price’ of the commodity.

Es= Percentage change in quantity supplied/Percentage change in price

Symbolically,

Es  = ΔQ X 100
Q
ΔP X 100

 

 

 

 

Es = ΔQ X P
ΔP Q

For Example,

Suppose, a seller offers to sell 500 units of a commodity when its price is Rs.10 per unit, while only 250 units are offered if price reduces to Rs.5 per unit. Then,

Es = ΔQ X P
ΔP Q
Es = 250-500 X 10
5-10 500
Es = -250 X 10
-5 500

Es  = 1

2. Geometric Method :

Geometrically, the elasticity of supply depends on the origin of the supply curve. Assuming the supply curve to be a straight line and positive sloped, the geometric method measures the elasticity of supply as follows:

geometric method min 1 - The elasticity of Supply- Meaning, Types and Methods
In fig,

P= Rs 50 (initial price)

P1= Rs 55 (new price)

Q= 200 units (initial quantity)

Q1= 220 units (new quantity)

ΔP = 55-50 = Rs 5

ΔQ = 220-200 = 20 units

Es = ΔQ X P
ΔP Q

 

Es = BC X P
AC Q

 

Es = 20 X 50
5 200

 

Es = 1

Types of Price Elasticity of Supply:

  1. Perfectly elastic
  2. Perfectly inelastic
  3. Unitary elastic
  4. Relatively elastic
  5. Relatively inelastic

a)Perfectly Elastic Supply : 

The supply is said to be perfectly elastic when a small rise in price would result in supply to become infinite, while a small fall in price would result in a fall in supply to zero. It is also known as infinite elasticity. 

This is shown by a straight line supply curve parallel to the horizontal axis.

For Example,

Suppose the price of a commodity is Rs.10 and its Supply is 50 units. As the price increases to Rs.15, its supply increases to infinity.

perfect elastic supply min - The elasticity of Supply- Meaning, Types and Methods
In fig, the X-axis shows the quantity and Y-axis shows the price. SS is the supply curve. The initial supply at price P is Q units. When the price is slightly increased, it leads to an increase in supply by large amount i.e. Q1. Thus, it shows perfectly elastic supply.

b) Perfectly Inelastic Supply : 

When the supply doesn’t change with the change in price(whether falling or rising), the supply is said to be perfectly inelastic. It means supply remains constant against any value of price in the market. This is represented by a straight line parallel to the vertical axis.

For example,

Suppose the price of a commodity is Rs 10, and supply is 200 units. As the price increases to Rs 20, the Supply remains constant at 200 units. It implies that the supply is perfectly inelastic.

perfectly inelastic supply min - The elasticity of Supply- Meaning, Types and Methods
In fig, X-axis shows the quantity and Y-axis shows the price.SS is the supply curve. At price P, the quantity supplied is Q units. As the price increases to P1, there is no effect on the quantity supplied. It remains constant at initial quantity Q. Thus, it implies that the supply is perfectly inelastic.

c) Unitary Elastic Supply:

When the change in the supply of a commodity is in the same ratio as the change in its price, it is known as unitary elastic supply. 

For Example,

Suppose the price of a commodity is Rs.50 and the quantity supplied in a specific market is 200 units. As the price increases to Rs.55, its supply rises to 220 units. It implies the unitary elastic supply.

unitary elastic supply min 3 - The elasticity of Supply- Meaning, Types and Methods

In fig, X-axis shows the quantity and Y-axis shows the price. SS is the supply curve. When the price is P, the quantity supplied is Q units. As price increases to P1, the quantity supplied also rises to Q1 with the same proportion. That is why it is known as a unitary elastic supply. 

d) Relatively Elastic Supply : 

Relatively Elastic Supply occurs when the proportionate change in supply is greater than proportionate change in price. It means that there will be a greater change in supply due to a small change in price. It is also known as highly elastic supply and more than unitary elastic supply.

For Example,

Suppose the price of a commodity is Rs50 and quantity supplied is 200 units. As the price increases to Rs55, its supply increases to 250 units. It implies the supply to be relatively elastic.

relative elastic supply min - The elasticity of Supply- Meaning, Types and Methods
In fig, X-axis shows the quantity and Y-axis shows the price. SS is the supply curve. When the price is P, the quantity supplied is Q units. As the price increases to P1, the quantity supplied also increases to Q1 but with more proportion. Thus, it implies a relatively elastic supply.

e)Relatively Inelastic Supply : 

The supply is said to be relatively inelastic when a proportionate change in quantity supplied is less than proportionate change in price. It means that greater change in price leads to a smaller change in quantity supplied.

For Example,

Suppose the price of a commodity is Rs50 and quantity supplied is 200 units. As the price increases to Rs70, its supply increases to 220 units. It implies the supply to be relatively inelastic.

relative inelastic supply min - The elasticity of Supply- Meaning, Types and Methods

In Fig, X-axis shows the quantity and Y-axis shows the price. SS is the supply curve. When the price is P, the quantity supplied is Q units. As the price increases to P1, the supply also increases to Q1 units with less proportion as compared to price. It implies the relatively inelastic supply.

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The Law of Supply- Explanation with Illustration

law of supply

The law of supply reflects the producers’ or sellers’ general tendency in selling their products to consumers at various prices.

What is the Law of Supply :

Law of Supply expresses the relationship between price and quantity supplied of a given commodity. It states that “other things remain constant, supply increases with the rise in price and decreases with fall in price” This happens due to change in producer’s behaviour for change in price.

Thus, it shows the direct relationship between quantity supplied of given commodity and its price. This law defines the direction in which quantity supplied changes with a change in price. The other things include all those factors which directly or indirectly affect the supply such as the price of related goods, technology and expectations of sellers.

Definitions of Law of Supply :

According to Dooley,

“The law of supply states that other things being equal, the higher the price, the greater the quantity supplied or the lower the price, the smaller the quantity supplied.”

In the words of Lipsey, 

“The law of supply states that other things being equal, the quantity of any commodity that firms will produce and offer for sale is positively related to the commodity’s price, rising when price rises and falling when the price falls.”

Assumptions of Law of Supply :

  1. There is neither any improvement nor innovation in technology.
  2. The cost of production is unchanged.
  3. There is no change in the expectations of sellers.
  4. The prices of related goods are constant.
  5. There is no change in the scale of production.
  6. Government policies remain constant.

Characteristics of Law of Supply:

  1. There is a positive relationship between price and quantity supplied.
  2. Price is an independent variable.
  3. Supply is the dependent variable on the price of that commodity.

For Example, 

Suppose, when the price of cupcakes decreases from Rs 100 per piece to Rs 80 per piece, the quantity supplied will decline. The bakeries will lessen its output to avoid profits from the fall in price whether increases the supply of doughnuts having a higher price.

Similarly, if the price of coffee at local Starbucks raises from Rs.800 to Rs.1000, the quantity supplied will be increased. The suppliers would prefer to sell more to earn more profits.

Illustration of Law of Supply :

The law of Supply can be illustrated with the help of supply schedule and supply curve. These are shown as follows :

Supply Schedule :

The following schedule shows the series of prices and quantity supplied of ice cream as follows:

Price of Ice Cream
(Rs)
  Quantity Supplied
(in units)
10 5
20 10
30 15
40 20
50 25

The above table shows that when the price of ice cream is Rs 10, there are 5 units of ice cream supplied. As the price rises to Rs  20, the quantity supplied increases to 10 units. Similarly, the rise in price to Rs.30,40 and 50 follows an increase in quantity supplied as 15,20 and 25 units.

Supply Curve :

The following graph shows the relationship between price and quantity supplied as the law of supply defines. In this graph, X-axis shows the quantity supplied of ice cream and Y-axis shows the price. SS is the supply curve whereas A, B, C, D and E points show the relationship between price and quantity supplied. When the price is Rs 10, the quantity supplied is 5 units of ice cream. As the price increases to Rs 20, the quantity supplied also rises to 10 units. Similarly, as the price goes up to Rs 30,40 and 50, its supply also increases to 15,20 and 25 units respectively.

law of min 1 - The Law of Supply- Explanation with Illustration

It clears that the price of commodity increases, the quantity supplied of the same also increases and vice-versa, provided other things being constant. In short, we can say that the law of supply describes the behaviour of producers and sellers as they plan to increase the production of the product to gain from market conditions which lead to an increase in supply. When this direct relationship between price and quantity supplied is graphed, the result is a supply curve.

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Theory of Supply and its graphical representation

theory of supply

Theory of supply is the economic relationship between the quantity of goods and services supplied by sellers and their prices at a given period of time.

 

 

What is the theory of Supply?

Supply refers to anything in demand that is sold in a competitive marketplace. It mainly refers to goods, services and labour. The price of goods, price of related goods and price of inputs affect the supply as these contribute to the overall cost of goods sold.

Terms related to the theory of supply:

The theory of supply is related to the following terms:

  1. Supply Schedule
  2. Supply Curve

Supply Schedule :

It is a tabular representation of the correlation between the price of a commodity and its quantity supplied for a given period of time. It has two aspects :

a) Individual Supply Schedule :

It is defined as the tabular representation of different quantities of commodity a seller is offering to sell at different price levels during a given period of time.

The following table shows the supply schedule of commodity ‘X’:

Price of Commodity (in Rs) Quantity Supplied (in Units)
30 05
40 10
50 15
60 20
70 25

As shown in the above schedule, the quantity supplied of Commodity’X’ increases with an increase in price. The seller can sell 5 units at price Rs.30. When the price increases to Rs 40, the seller increases the supply to 10 units. Similarly, as the price rises, the quantity supplied increases keeping other factors constant.

Market Supply Schedule : 

It is a tabular statement showing different quantities of a commodity that all sellers are offering to consumers at different prices in the market during a given period of time.

Following is the supply schedule of Commodity ‘X’ by individual ‘P’  and individual ‘Q’ and market supply :

Price of Commodity
(in Rs)

Quantity Supplied by ‘P’
(in units)

Quantity Supplied by ‘Q’ 
(in units)
Market Supply(P+Q)
(in units)
30 5 10 15
40 10 15 25
50 15 20 35
60 20 25 45
70 25 30 55

As shown in the schedule, at price Rs 30, the quantity supplied by P is 5 units of commodity ‘X’ whereas the quantity supplied by Q is 10 units which result in 15 units as market supply. As price increase to Rs 40, the quantity supplied by P and Q rise to 10 and 15 units respectively and the market supply reaches at 25 units. Similarly, the price goes on increasing, the market supply keeps on rising.

Supply Curve :

It is a graphical representation of the correlation between the price of the commodity and quantity supplied for a given period of time.

Individual Supply Curve : 

It refers to the graphical representation of corresponding quantities supplied by an individual seller of a particular commodity at different price levels. It is the locus of all those points showing various quantities of a commodity that a seller is ready to sell at various prices during a given period of time.

individual supply curve - Theory of Supply and its graphical representation

In the above graph, X-axis shows the quantity and Y-axis shows the price. The points A, B, C, D and E defines the relationship between price and quantity. SS is the supply curve. It has a positive slope meaning thereby that as price rises, the supply extends. It is evident that at price less than Rs. 30, the seller is not prepared to sell any unit. The price below which the seller is not prepared to sell any unit is known as Reserve Price or Minimum Supply Price.

Market Supply : 

It refers to the summation of individual supply curves in the market. In other words, it is the graphical representation of the total of all individual supply for a specific commodity in the market and various price levels.

 

Market Supply curve. png min - Theory of Supply and its graphical representation
In the above graph, (A) and (B) are the individual supply curves and (C) is the market supply curve. It indicates that when the price is Rs30, the market supply is (5+10)=15 units, when the price is Rs40, the market supply is (10+15)=25 units. Similarly, at price Rs50, the market supply is (15+20)=35 units. The market supply curve is a horizontal summation of the individual supply curves of the various firms producing a particular commodity in the market.

Why Supply Curve Downward Sloping:

The supply curve is always upward sloping as there is a positive relationship between the price of a commodity and its quantity supplied. The reasons for the upward-sloping supply curve:

1) Profit as a motive:  When the market price increases in the market following a rise in demand, the sellers tend to increase its output. It results in an increase in supply as well as profits.

2)Production and Costs: When the seller expands its output to increase the supply, the firm’s cost of production tend to increase which results in higher prices to cover those extra costs. This may be due to the law of diminishing returns as more inputs are engaged in production.

3)New entrants in the market: High prices works as an incentive for newcomers in the market. Thus, it leads to an increase in supply in the market.

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Meaning of Supply and its Determinants:

supply

Demand and Supply are the two main concepts of business economics. As we know the demand is the total amount of commodity at which consumers are willing and able to purchase it whereas supply refers to the quantity of good or services the sellers are ready to sell. In this article, we will understand the meaning of supply and its determinants.

The Content covered in this article: –

  1. Meaning of Supply in economics
  2. Determinants of Supply 

Meaning of supply in economics:

Meaning of supply refers to that amount or quantity of a good/ service which the market participants are ready to sell in the market to the consumers at given prices for a given period of time.

A commodity can be said as supplied when

  • it is ready to sell in the market but not yet sold.
  • it is related to a given period of time.

 

According to Thomas,

“The supply of goods is the quantity offered for sale in a given market at a given time at various prices.”

Example of the meaning of Supply: –

A book Seller has 70 books of Business Economics for class 11th and 80 books of the same subject for class 12th at his shop and he is ready to sell them. So the total supply of the material is equal to 150(70+80) books. 

Determinants of Supply :  

 It refers to the factors which influence the supply of a particular commodity during a given period of time. These factors directly or indirectly affect the supply of a commodity in the market. This can be written as : 

This is the function of

               Qs = f( P, R, F, E, T )

where,

  • Qs denotes Quantity Supplied
  • f denotes function
  • P denotes the price of the commodity
  • R denotes the price of related commodities
  • F denotes the price of factors of production
  • E denotes the expectations of sellers
  • T denotes the technology

Besides these, there are some other factors that affect the supply of a commodity :

  • Taxation And Subsidies
  • Number of Sellers
  • Other Factors like the goal of firm, competition, transportation conditions and natural conditions etc

 

   

These factors derive the supply of the commodities and also, growth of the economy providing other things remain the same. the organization should understand the impact of these determinants of supply. Some of these are explained as under :

Price of the Commodity :

It is the most important determinant. It affects the supply at a large extent. As per the law of supply, there is a positive relationship between the price of a commodity and supply.  The supply of a commodity increases with a rise in price, assuming other things constant, and vice versa.

For Example, 

the supply of mangoes initially derives from the climate that is ideal for growing mangoes. As the price increases, farmers will start growing it in less friendly climate raising the supply at more costs.

Price of Related Goods : 

Supply of a good or service is affected by the price of related goods. these related goods include : 

    a)Substitute Goods:

Substitute goods are those which can be used in place of each other giving equal satisfaction to the consumers e.g. wheat and rice, tea and coffee etc. There is an indirect relationship between the price of substitute goods and supply of the given commodity,  other things being constant and vice versa. It implies that as the price of substitute goods increases, the supply of given commodity starts declining. 

  For Example,

If the price of coke rises, it will result in more supply of coke as it becomes more profitable for firms to supply coke instead of limca. Thus, an increase in the price of coke leads to a fall in the supply of limca.

   b) Joint Products:

Joint products are those which are produced from a single production process to satisfy the needs of consumers e.g. production of butter and cheese from milk, different grades of wood and tree etc. There is a direct relationship between the price of joint products and the supply of the given commodity, other things remain the same and vice versa. It implies that as the price of joint products increases, the supply of given commodity starts increasing.

For Example,

If the price of milk increases, it will result in more supply of milk and further, the prices of cheese and butter also increase. 

Prices of Factors of Production:   

The cost of production depends on various factors like : 

                                    a) Price of raw material

                                    b) Rent and interest on capital

                                    c) Cost of machinery

                                    d) Wages and salaries

                                    e) Transportation cost     

 The increase in the price of any of these increases the production costs thus lessens the overall profits and vice versa. Since profit works as a major incentive for suppliers to supply goods and services, profits and supply go hand in hand. The increase in profits leads to more supply and decrease in profits reduces the supply. In other words, profits and supply are directly related to each other.

 Expectations of Sellers :  

If the price of a commodity is expected to rise in future, the producers prefer to withhold more with them to benefit from higher prices in future, reducing the supply now. For Example, if it is expected that the price of wheat is going to rise, the farmers would retain their agricultural production with them to get benefit from the high price in future, lowering the supply now. 

Similarly, if there is an expectation that the prices are going to fall in the near future, the suppliers would increase the supply now to eliminate losses in future. Thus, price expectations also make a significant impact on the supply by the suppliers.

 Technology :

Improvement in technology like technological innovations and inventions enables more efficient and better quality of production of goods and services. More efficiency brings more profits with a reduction in production costs. As a result, supply is increased. Thus, the state of technology increases or decreases the supply of particular products.

 Taxation and Subsidies : 

The government policy also affects the supply of commodity at a large extent. The commodity taxes like excise duty, import duties and GST etc. imposed by the government increases the overall cost of production. Hence, the increase in cost lowers the profit and supply of the given commodity. Similarly, subsidies decrease the overall cost of production and lead to more profits and increase in supply.

 Number of Sellers: 

The number of sellers affects the market supply. As market supply is defined as the sum of the supply of each individual supplier, thus, more and more sellers entering the market leads to more supply. Similarly, departing the market leads to less supply in the market.

Other Factors : 

There are many other factors which affect the supply of goods and services like the goal of the firm, infrastructural facilities including transportation and communication services, market structure and other factors etc.

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What are the Methods of Demand Forecasting

METHODS min 1 150x150 - What are the Methods of Demand Forecasting

Demand Forecasting is the activity in which the demand for a product or service is estimated for a future period of time. There are several methods of demand forecasting applied in terms of:-

  • Purpose of forecasting
  • Data required
  • Data availability
  • The time frame for forecasting.

Each method varies from one another and to invest money and other factors in business, we require a reasonably accurate forecast of demand. Hence, the forecaster must select that method which best suits the requirement. There is no particular method that enables organizations to anticipate risks and uncertainties in future.

The Content covered in this article: –

  • Methods of Demand Forecasting :
    • Qualitative Methods of Demand Forecasting
    • Quantitative Methods of Demand Forecasting

The methods of demand forecasting can be classified as:

  • QUALITATIVE/ SURVEY METHODS:
    1. CONSUMER SURVEY
    2. OPINION MODEL
    3. DELPHI MODEL
    4. NOMINAL GROUP TECHNIQUE
  • QUANTITATIVE/ STATISTICAL METHODS:
    1. TREND PROJECTION
    2. BAROMETRIC METHOD
    3. ECONOMETRIC METHOD
    4. OTHER STATISTICAL METHODS

These methods can be explained as under:

QUALITATIVE METHODS OF DEMAND FORECASTING:

Survey method or qualitative method is one of the most commonly used methods for forecasting demand in the short term. In this, organizations conduct surveys to determine demand directly from consumers. Some of the survey methods are :

Consumer survey:

This method includes direct contact with consumers to carry out a survey of what they prefer and intends to buy. The survey method depends upon the type of product and buyers for which survey has to be conducted.

For example, if a product is consumer durable, a sample survey can be carried out about what they are planning to buy and intending to buy. If a product is sold to large industrial buyers, the survey would include interviewing them.   

 The consumer surveys can be through direct contact or questionnaire through the mail. These surveys build a relationship between

i)Price and demand

ii)Demand and income of consumers

iii)Demand and expenditure on the advertisement.

This method is useful when—– bulk sales made to industrial purchasers and only a few of them have to be contacted. This method is not useful for households as interviewing them is difficult as well as expensive.

Opinion model:

In this method, sales representatives predict the estimated future sales individually in their respective areas. The individual estimates are then aggregated to determine the total estimated future sales. The principle underlying this method is that salesmen are closest to the consumers and they have the intimate feel of the market. They are more likely to understand the reason behind the changes in consumers’ needs and demands. Thus, they are most suitable for assessing the consumer’s reaction to the company’s products. Therefore, a company having good sales personnel can utilize their experiences to predict the demands. Hence, this method is also called Salesforce opinion or Grassroots approach method.

Although this method is simple, direct, first hand, easy and acceptable, it includes following drawbacks——-

i) Salespersons may not prepare demand estimation with seriousness and care

ii) The salesperson may not have the required knowledge and experience

iii) Each salesperson has knowledge about a small portion of the market, thus, predicting total demand on this may be risky.

Delphi method:

This technique was developed at RAND Corporation in the 1950s. It is a group process where experts in the field of marketing research make demand forecasting. The experts are interrogated through a sequence of questionnaires in which responses to the first questionnaire are used to prepare the second questionnaire. The information available to some experts is shared with all experts for forecasting. This method is used for long term forecasting to estimate potential sales for new products. This method presumes two conditions:-

1)The panellists must be rich in expertise, knowledge and experience.

2)The conductors are objective in their job. This method saves time and other resources.

Nominal Group Technique of Demand Forecasting:

It was originally developed by Delbecq and Vandeven. It is further modification of Delphi method. In this technique, a panel of 3-4 groups of up to 10 experts is created and allowed to interact, discuss and rank all suggestions.

In the first phase of this technique, experts are asked to speak to each other while sitting together. The experts are asked to write down a list of ideas regarding the questions needing forecast. After writing down the ideas, the administrator asks each expert to share the best idea and show that on the flip chart. The ideas from all the experts are shown on the flip chart and about 15-20 ideas have emerged. In this phase, no discussion takes place whereas only ideas are examined.  

In the next phase, the experts discuss their respective ideas and similar ideas are combined to minimize the number of ideas. After the discussion, the experts are asked to rank the ideas according to their perception of priority.

QUANTITATIVE/STATISTICAL METHODS OF DEMAND FORECASTING:

The statistical methods are used when forecasting is to be done for a longer period of time. These methods utilize the time series and cross-sectional data to estimate demand. these methods are considered more superior as compared to other methods due to the following reasons: 

1)The estimates are real. 

 2)There is a minimum subjectivity in these methods.

 3) The cost involved is minimal.

Methods are scientific and based on the relationship between the dependent and independent variables. some of the quantitative methods are :

1.Trend Projection:

Trend projection is the classical method of forecasting in business. In this method, the sales forecasts made through analysis of historical data taken from previous year’s books of accounts. This technique assumes that whatever past years demand pattern will be continued in future too. The historical data are arranged chronologically yield what is referred to as ‘time-series’.

Time series data are composed of:

A) Secular Trend (T):

It refers to the long-run changes that occur as a result of a general tendency.

B) Seasonal Variation(S):

It refers to changes in short-run weather pattern or social habits.

C) Cyclical Element(C):

It refers to the changes that occur in the industry during boom and depression.

D) Random Variation (I):

It refers to the factors which are generally able such as wars, strikes, flood and so on. This is the most popular method as it is simple and inexpensive.

 The trend projection includes more methods:

Graphical Method:

In this, the forecasting is done with the help of graphs. The sales belonging to previous years are plotted on a graph and a line is drawn on plotted points to know the trend in past years. This method is very simple and less expensive but data may be biased by the forecaster.   

Least Square Method:

In this, a trend line can be fitted to the time series data with the help of least square regression. There are two types of trends are taken into account in this method, which are —

Linear Trend:

It implies the trend in which sales show a rising trend. In this, a straight line trend equation is fitted: S = A+Bt

where S = annual sales,

t = time (in years)

A and B are constant where B gives the measure of the annual increase in sales.  

Exponential Trend:

It implies the trend in which sales increase over the past years at an increasing or constant rate. In this, trend equation be used as Y =aTb

Where Y = Annual sales,   

T= time in years 

a and b are constant.

 This method is very easy and inexpensive to use.

Barometric Technique:

The barometer is an instrument which measures changes. This method was introduced by Harvard Economic Service in 1920 and further revised by the National Bureau of Economic Research (NBER) in the 1930s. In this method, barometric techniques are used which are based on the idea that certain events of the present can be used to predict the pattern of changes in future. this can be accomplished by the economic and statistical indicators such as savings, investment and income which serve as a barometer of economic change.

Generally, forecasters correlate firm’s sales with three series:  

i)The Leading Series:

The leading series includes those factors which moves up or down before the recession or recovery phase of the business cycle starts. For example, the data relating to working women would act as a leading indicator for the demand of working women hostels. The most common examples for leading indicators are net business investment index, a new order for durable goods, change in the value of inventories, corporate profits after tax etc. though these indicators provide a way to understand future demand, their major drawback is that they may not be always precise.  

ii) Coincident or Concurrent Series:

The coincidental series include indicators which move up or down simultaneously with the general level of economic activities. The most common examples for coincidental series are the rate of unemployment, sales by manufacturing, retail and trading sectors, gross national product at all prices.      

  iii) Lagging Series:

The lagging series comprises of the indicators which take place after happening. These indicators are very much important to understand how the economy would shape up in the future as these follow the economic cycle.  Inflation and data relating to unemployment levels are top indicators that help in analyzing the performance in the economy.

3. Econometric method:

This method is a tool that reveals relationships among economic variables to forecast future developments. It combines statistical tools with economic theories for forecasting. This method is regarded as more reliable than others. This model can either be a single equation regression model or may consist of a system of simultaneous equations. In most commodities, the single equation regression model is used but in the case where economic variables are so interdependent or interrelated to each other that unless one is defined, the other can’t be determined, and then a system of simultaneous equations is used to forecast. The economic method comprised of two basic methods:  

 a) Regression method:

It is the most commonly used method to forecast the demand for a product. This method combines the economic theory with statistical tools of estimation. The economic theory is used to specify the demand determinants and relation between product demand and its determinants. While the statistical techniques are used to estimate the value of parameters in the projected equation. Under this method, the first thing is to determine the demand function. While specifying the demand function, it is very important to understand that whether the demand depends by or large, on a single independent variable or multiple variables. If demand depends upon a single independent variable, such demand function is called single variable demand function and simple regression equation is used for forecasting. And if demand depends on multiple variables, such demand function is known as multiple variable functions and a multivariable equation is used for estimating the demand for a product.

 For instance, if it is found that in a city, the demand for necessity goods depends largely on the population of a city, then it would be regarded as a single variable demand function. On the other hand, if it is found that the demand for products like fruits, vegetables etc. depends on a number of variables such as the price of the product itself, prices of substitutes, the income of consumers, population etc., it would be regarded as multi-variable demand function. 

b) Simultaneous equation Model:

In this model, demand forecasting involves the estimation of several simultaneous equations. These equations are generally the behavioural equations, market-clearing equations and mathematical identities. This technique is based on the assumption that independent variables cause variation independent variable but not vice versa. In other words, the independent variables are no way affected by dependent variables. On the contrary, this model enables the forecaster to study the simultaneous interaction among dependent and independent variables. Thus, it is considered as a systematic and complete approach for forecasting as it employs several mathematical and statistical tools for estimation.

 4.Other Statistical Methods:

Apart from statistical tools, there are other methods for demand forecasting. These methods are very specific and used for particular data sets. These methods cannot be used for all types of research. These methods are :

a) Index Number:

It refers to the measures which are used to study the fluctuations in a variable or set of variables with respect to time. These are the most commonly used measures in economics and financial research to study factors such as price and quantity of product. The index number can be classified as:

i) Simple Index Number:

It refers to the number that measures the relative change in a single variable with respect to the base year.  

ii) Composite Index Number:

it refers to the number that measures a relative change in a set of variables with respect to the base year.

iii) Price Index Number:  

It refers to the number that measures the relative change in the price of a product in different time periods.  

iv) Quantity Index Number:

It refers to the number that measures the change in the physical quantity of goods produced, consumed or sold in different time periods.

b) Time Series Analysis:

It refers to the analysis of a series of observations over a period of equally spaced time intervals. It is applicable in various fields such as public sector, economics and research. It comprises of:

i) Secular Trend:

It refers to a trend that is denoted by T and prevalent over a period of time. The secular trend for a data series can be upward or downward depending upon the trend. The upward trend shows an increase in the variables whereas the downward trend shows declining phases.

ii) Short Time Oscillation:

It refers to the trend that remains for a shorter period of time. It can be classified as:

 Seasonal Trend:

It refers to the trend that occurs year after year for a particular period. The reasons for such trends can be weather conditions, festivals or some other customs. For example, an increase in the demand for sweets near Diwali or other festivals.

 Cyclical Trend:

It refers to the trend that lasts more than for a year. These trends are neither continuous nor seasonal in nature. For example, the business cycle.   

Irregular Trend:

It refers to the trend that is short and unpredictable. For example, volcano eruptions, floods and earthquakes.         

c) Decision Tree Analysis:

It refers to the model that is used to make a decision in an organization. In this analysis, a tree-shaped structure is drawn to find out the best solution for a problem. In this, firstly, we have to find out different options that we can apply to solve a particular problem. Then, we will find out the outcome of each option. The flow of the decision tree should be from left to right. In the flow chart, the options are connected with a square nod and outcomes are shown with a circle nod.

In short, there are several methods to determine future demand but which method or technique is used; it is an extremely difficult process for a business to carry out. Even with the wealth of data and a panel of full experts, trying to predict the future is not an easy task. Thus, while selecting methods for forecasting, it becomes necessary to consider all the factors whether internal or external.

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What are the types of Demand Forecasting??

types of demand forecasting

 

 

There are several types of demand forecasting based on the different factors such as the size of the business, levels in the economic environment, the flexibility of enterprise and others.

The Content covered in this article: –

  1.  Meaning of Demand Forecasting
  2. Types of Demand Forecasting

MEANING OF DEMAND FORECASTING:

Demand Forecasting is an estimate of sales during a specified future period based on the proposed marketing plan and a set of particular uncontrollable and competitive forces.

Check for more Explanation from below link: –

https://tutorstips.com/what-is-demand-forecasting

Types of demand forecasting:   On the basis of time and different levels in the economic environment, the demand forecasting can be classified as: 

  1. Active demand forecasting
  2. Passive demand forecasting
  3. Short term demand forecasting
  4. Long term demand forecasting
  5. External or national group demand forecasting
  6. Internal or group demand forecasting
  7. Macro-level forecasting
  8. Industry-level forecasting
  9. Firm-level forecasting
  10. Product line forecasting

These are explained as under:

1.Active demand forecasting:   

In-active demand forecasting, The forecasting is done on the assumption that the firm changes the course of its action. The prediction is done under the condition of favourable future changes in the operations by firms.

2.Passive demand forecasting:

It is a rare type of forecasting and mostly done by the businesses which are stable and having very conservative growth plans. The forecast is based on the assumption that the firm doesn’t change the course of its action. Small and local businesses prefer it for planning.

3.Short term demand forecasting:

In short term demand forecasting,  forecasting is done for a shorter period of 3 months to 12 months. The demand pattern and the effect of the strategic decisions on customer demand are analyzed under this.

4.Long term demand forecasting:

When forecasting is carried out for a period of more than 12 months, such forecasting is known as long term demand forecasting. Long term forecasting is helpful in suitable capital planning, business strategy planning, sales and management planning etc.

5.External or National group forecasting:

The forecasting carried out by a company’s research wing or by outside consultants is known as external group forecasting. It deals with the trends in general business.

6.Internal or Company group forecasting:

It refers to the forecasting estimation by the operations of a particular enterprise such as production group, sales group and financial group. It includes a forecast for annual sales, forecast of operating profit, forecast of cash resources and forecast of a number of employees etc.

7.Macro-level forecasting:

  In this, the broad market operations are analyzed and then forecasting is carried out in macro economic environment. It is measured by an appropriate index of industrial production, national income or expenditure.

8.Industry-level forecasting:

This type of forecasting is prepared by different trade associations based on the survey of consumers’ intention and analysis of statistical trends.

9.Firm-level forecasting:

This forecasting is prepared from the viewpoint of managers and is related to an individual firm.

10.Product line forecasting:

This forecasting is related to the product or products being produced by the firm. It helps the firm to decide which of the products should have priority in the allocation of the firm’s limited resources.

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What is Demand Forecasting – Meaning and Definition

What is Demand Forecasting - Meaning and Definition-min

Demand forecasting refers to predicting the demand for future based on historical data and other information.

The Content covered in this article: –

  1. What is Demand Forecasting
  2. Definitions
  3. Examples 

What is Demand Forecasting: 

It is a process in which probable demand for a product or service is estimated for the future period of time. It implies the study of past demand which is used as historical data for that product or service in the present market conditions. It helps the business in the estimation of total sales and revenue by using scientific methods and facts in the foreseeable future. Critical business assumptions like turnover, profit margins, cash flow, capacity planning, capital expenditure, risk assessment etc. are dependent on it.

Definitions: –

According to Cundiff and Still,

“Demand Forecasting is an estimate of sales during a specified future period based on the proposed marketing plan and a set of particular uncontrollable and competitive forces.”

According to Prof. Philip Kotler,

“ The company(sales) forecast is the expected level of company sales based on a chosen marketing plan and assumed marketing environment.”

In the words of Evan J. Douglas,

“Demand Forecasting may be defined as a process of finding values for demand in future.”

For Example: –

Some practical examples of demand forecasting are :

Example No. 1: –

Suppose, a manufacturing company had sales of  1200, 1400 and 1600 units during January, February and March.  Now,  it can be forecasted that approximately 1400 units would be demanded for next month based on the average sales of the last three month’s data assuming other things the same.

Example No. 2: –

A leading electronics company, while estimating the demand for its product for future period i.e. mobiles, refers to the last 12 months of actual sales of its product,  and will conduct market research to know the market conditions i.e. features demanded by customers. If market research reveals the demand for new features in the existing product and the sales during the last 12 months is declining, it can easily be estimated that the demand for its product will fall down in future. Thus, the short term demand forecasting will be done accordingly for the purchase, production and inventory planning. 

Example of Demand Forecasting min - What is Demand Forecasting - Meaning and Definition
Example of Demand Forecasting

In simple words, demand forecasting refers to making estimations about future customer demand using historical data and other information. A correct demand forecasting provides valuable information to the business about their potential in their current market so that managers can make informed decisions about pricing, production planning, purchasing raw material, managing funds, business growth strategies and market potential.  A Business can take help of specialized consultants or market agencies or go for making own estimates called guess estimates to forecast its demand.

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Cross elasticity of demand-Explained with examples

Cross-Elasticity-of-Demand

Cross elasticity of demand is refers to the sensitivity of demand for one product to the price of another related product. It is the ratio of the percentage change in quantity demanded of good X and the percentage change in the price of good Y.

Cross elasticity = % change in quantity demanded of good X/ % change in the price of good YFormula of Cross elasticity of Demand 1 - Cross elasticity of demand-Explained with examples% Δ quantity demanded of goods x = percentage change in quantity demanded
% Δ Price of goods y  = percentage change in Income of Consumer

Types of cross elasticity of demand :

  1. Substitute Goods
  2. Complementary Goods
  3. Unrelated Goods

1. Substitute goods:

When the cross elasticity of demand for good X relative to the price of good Y is positive, it means the goods X and Y are substitutes to each other. It implies that in response to an increase in the price of good Y, the quantity demanded of good X has increased as people start consuming product X as the price of good Y goes up.

Substitute goods  - Cross elasticity of demand-Explained with examples
Substitute goods

For example, suppose a 10% increase in the price of tea results in an increase in demand for coffee by 15%. This shows that the goods are substitutes for each other.

2. Complementary goods:

When the cross elasticity of demand for good X relative to the price of good Y is negative, it means the goods are complementary to each other. It implies that in response to an increase in the price of good Y, the quantity demanded of good X has decreased due to the increase in the price of Y.

Complementary goods  - Cross elasticity of demand-Explained with examples
Complementary goods

For example, suppose the 10% increase in the prices of Android phones results in a decline in the quantity demanded of Apps by 15%. This relation shows that the goods are complementary to each other.

3. Unrelated goods:

When the cross elasticity of demand for good X relative to the price of good Y is zero, it means goods are unrelated to each other. It implies that there is no relationship between these both goods.

Unrelated goods  - Cross elasticity of demand-Explained with examples
Unrelated goods

 For example, suppose the 5% increase in the prices of coke results in no change in quantity demanded of butter. This shows that the goods are unrelated to each other.

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