Factors Influence The Equilibrium Price

Bradford University

School of Management

FT MBA 2007/2008

Business Economics (MAN4101M)

Assessed coursework

I certify that this assignment is the result of my own work and does not exceed the word count noted below.

Bradford, 19th November 2007 ______________________________________

Word Count (excluding tables, diagrams and reference): 1750

Market Equilibrium

Introduction:

Market is a place where buyers and sellers come together and a good is offered for sale by producers and purchased by consumer (Blake, 1993). The relation between the demand and supply determines the equilibrium position of a particular good or a service. In this essay we will take a look at the factors that influence the equilibrium position of a good in the market, and the changes occur to the price and output levels of the good.

Equilibrium

"The market equilibrium occurs at the price where consumer's willing to demand is equal to firm's willingness to supply" (Begg and Ward, 2007). Hardwick et al (1990) define "an equilibrium is a state of rest in which no economics forces are being generated to change the situation". For a particular good in the market this state is said to be existed when there is no excess demand and excess supply. In other words demand should be equal to supply .The fig.1 below shows the equilibrium point where the demand curve meets the supply curve.

Factors influence the equilibrium price

1) Change in demand

a) Demand curve shifts to right normally due to an increase in the price of substitute, a decrease in the price of a complement, increase in income for a normal good , or decrease in income for a inferior good, or improvement in Changes in tastes and preferences for the good (Begg and Ward, 2007).

Fig.2 (Blake, 1993) illustrates the equilibrium position (E1) of a good which is at a cost of ЈP0 when there is trade of Q0 units. But when demand shifts to right, new equilibrium position (E2) will be achieved at a trade of Q1 units (Q0 < Q1) and at a higher price of Ј P1 (P0 < P1).

b) Demand curve shifts to left due to fall in income for a normal good, or rise in income for an inferior good, decrease in the price of substitute, an increase in the price of a compliment or deterioration in the tastes and preferences for the good (Begg and Ward, 2007).

Fig.3 (Blake, 1993) below presents the equilibrium position (E1) of a good which is at a cost of ЈP0 when there is a trade of Q0 units. When demand shifts to left, new equilibrium position (E2) will be achieved at a trade of Q1 units (Q0 > Q1) and at a lower price of Ј P1 ( P0 > P1).

2) Change in Supply

a) Supply Curve shifts to right when more firms enter the market, input and labour costs become cheaper or technology brings in new productivity gains (Begg and Ward, 2007).

Fig.4 (Blake, 1993) explains the shift in the equilibrium position of a good due to shift in supply curve to right. The equilibrium price moves from Ј P0 selling Q0 units to Ј P1 (P0 > P1) selling Q1 (Q0 < Q1) units. When there is an increased competition in the market supply will increase with decrease in the price.

b) Supply curve shifts to left if any firm exit the market or labour, input costs increases (Begg and Ward, 2007).

Fig.5 (Blake, 1993) explains that when supply shifts to left, equilibrium position will change from Ј P0 selling Q0 units to Ј P1 (P0 < P1) selling Q0 (Q0 > Q1) units.

3) Changes in demand when supply is elastic or inelastic

When the demand curve shift to right there will be change in equilibrium for both elastic and inelastic supplies. When the supply is inelastic, there will be very less change in the supply but huge change in the price. In case of elastic supply, supply changes will be more but the price increase will be very less (Begg and Ward, 2007).

In Fig.6 (Begg and Ward, 2007) prices rise from Ј10 pounds to Ј30, but output rises from 100 to 200 for inelastic supply when demand curve shift to right. In case of elastic supply rise in price level will be less from Ј10 to Ј13 but the rise in output will be very significant from 100 to 500.

4) Changes in supply when demand is elastic or inelastic

When demand is elastic, the shift in supply brings small change to the price of the good but huge change to the output. If the demand is inelastic, shift in supply brings huge rise of price levels with small changes to output levels (Begg and Ward, 2007).

In Fig.7 (Begg and Ward, 2007) prices drops to Ј20 pounds from Ј17 due to shift in supply curve but the output increases from 100 to 400 incase of elastic demand. For inelastic demand price drops to Ј10 from Ј20 due to shift in supply curve but the output level increases only to the level 200 from