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.

Some special cases of equilibrium

We have already explained the effects of change in demand and supply on the equilibrium price and quantity when demand and supply curves are normal slope, i.e. negatively sloping demand curve and positively sloping supply curve.

Let us consider how increase and decrease in demand affect equilibrium price in two exceptional situations:

1) When supply of the commodity is perfectly elastic        

2) When supply of the commodity is perfectly inelastic

When supply of the commodity is perfectly elastic

When supply curve is perfectly elastic i.e. supply curve is parallel to X axis, increase or decrease in demand  for a commodity does not cause any change in its price, equilibrium quantity tends to change. 

This is shown in the graph below:

perfectly elastic

E is the initial point of equilibrium when perfectly elastic supply curve(SS) intersect demand curve (DD). OP is the equilibrium price and OQ is the equilibrium quantity.

Forward shift in demand curve from DD to D₁D₁ leaves price of the commodity unchanged at OP. Equilibrium quantity increases from OQ to OQ₁.Equilibrium point shifts to E₁.

Backward shift in demand curve from DD to D₂D₂ leaves price of the commodity unchanged at OP. Equilibrium quantity decreases from OQ to OQ₂. Equilibrium point shifts to E₂.

Effect of Simultaneous changes in Demand and Supply

We have already discussed the effects of changes either in demand alone or in supply alone on the equilibrium price and quantity. But in reality changes in demand and supply take place simultaneously.  When demand changes, supply will also change as a consequence of that.

We will discuss below two situations of simultaneous changes in demand and supply :

a) Simultaneous Increase in Demand and Supply :

Simultaneous increase in demand and supply must cause increase in equilibrium quantity of the commodity.

But would there be any changes in price or not depends on whether demand increases more than, equal to, or less than supply.

So there can be three situations in this respect. As shown by the graphs below.