Time Element and Equilibrium Price

Equilibrium price is determined by the industry at that point where total demand is equal to total supply.

But, whether demand will have more effect or supply on the determination of the price, will depend on how much time will it take for the demand and supply to stabilize.

Importance of time element in the determination of price has been first examined by Dr. Marshall.

According to him, shorter the time period, greater will be the influence of demand in price determination and longer the period, greater will be the influence of supply on prices.

Marshall has divided the time elements into four periods:

1) Very short period or market period

2) Short period

3) Long period

4) Very long period

Very short period or market period

It is the time period during which supply of a commodity can be increased only up to the extent of its existing stock.

In case of perishable commodity which cannot be stored, supply becomes absolutely fixed or perfectly inelastic.

This is so because very short period is too short to increase production either through the application of fixed factors or the variable factors, all factors are rendered to be fixed during the very short period.

In such a situation demand plays a major role in the determination of price as supply is inelastic

(fixed).

For example, when the farmer brings his perishable vegetables to the market, the quantity is fixed, now price will be high or low depending upon the demand for the vegetables.

The price that prevails in very short period is called market price.

As shown by the graph below:

Equilibrium Price

X axis shows a perishable commodity and price on Y axis. Supply curve is perfectly inelastic, parallel to Y axis, which signifies that supply is fixed in very short period.

OP is the initial market price with the intersection of the demand curve (DD) and supply curve.

If the demand increases in very short period, as shown by the demand curve D₁D₁, then equilibrium price rises to OP₁, quantity remains the same OQ.

If the demand decreases in very short period, as shown by the demand curve D₂D₂, then equilibrium price falls to OP₂, quantity remains the same OQ.

Short period

Short period is the period of time during which production can be increased only through the application of variable factors, fixed factors(new machine, plants, entry of new firms) continue to be constant simply because time is too short to change them.

So supply assumes flexibility but cannot fully adjust itself to changes in demand.

Graphically (as shown below), the short run supply curve is more elastic than the very short period supply curve.

equilibrium price

S_R is the short run supply curve, with initial price and quantity be OP and OQ respectively.

In short run period supply can be increased by changing variable factors, so rise in the price is low as compared to in very short period(as supply was fixed).

Price rises to P₁ and quantity to Q₁. New equilibrium is E₁.

The price which prevails in short period is Sub- normal price.

Long period

It is the period of time when supply can fully adjust itself to changes in demand.

Long period is long enough to enable existing firms to change their scale of production, new firms to enter.

The price which prevails in long period is normal price.

Long run supply curve is relatively more elastic than the short run supply curve.

As shown in the graph above. S_L is the long run supply curve. Supply plays more important role in price determination in the long run.

The long run equilibrium is given by the point E₂ , with the intersection of D₁D₁ with S_L. The long run equilibrium price and quantity is OP₂ and OQ₂ respectively.

In the long run quantity changes will be more and price changes will be less for a given change in demand than in case of the market period or short period.

Very long period

Very long period refers to the time period in which full adjustment can be done in both demand and supply.

Demand and supply can adjust to changes in all the factors affecting demand and supply.

Very long period price is called secular price.