Chapter - 12
Why Prices Changes: The Story of Demand and Supply
Why do prices change?
Prices in a market mainly change because of demand and supply.
1. Change in Demand
- Increase in demand → Price rises
- Decrease in demand → Price falls
- Example:- If more people want smartphones, demand increases → prices go up.
2. Change in Supply
- Increase in supply → Price falls
- Decrease in supply → Price rises
- Example:- If farmers produce a large quantity of wheat → supply increases → price falls.
3. Other factors affecting prices
- Seasonal changes (vegetables cheaper in season)
- Cost of production (fuel price increase → transport cost increases → prices rise)
- Government policies (tax, subsidy)
- Natural factors (drought, flood)
Prices as Signals in Markets:- Prices act like signals or indicators for both buyers and sellers.
1. Signal for Producers (Sellers)
- High price → Profit opportunity → Increase production
- Low price → Loss → Reduce production
- Example:- If onion prices rise, farmers grow more onions next season.
2. Signal for Consumers (Buyers)
- High price → Buy less / shift to alternatives
- Low price → Buy more
- Example:- If petrol becomes expensive, people may use public transport more.
Prices also change when conditions change – Reason:- Prices don’t stay fixed because market conditions keep changing. When these conditions change, demand or supply shifts, and that leads to a change in price.
Change in Income
- Income increases → people buy more → demand rises → price rises
- Income decreases → demand falls → price falls
Change in Cost of Production
- Higher cost (fuel, raw material) → supply decreases → price rises
- Lower cost → supply increases → price falls
Change in Tastes and Preferences
- If a product becomes popular → demand increases → price rises
- If people lose interest → demand falls → price falls
Demand:- Demand means the quantity of a good or service that consumers are willing and able to buy at a given price and time.
Example:- If you want a mobile phone and also have money to buy it, it is demand.
Law of Demand:- The law of demand states:
“Other things being equal (ceteris paribus), when the price of a good increases, its demand decreases, and when the price decreases, its demand increases.”
Simple meaning:
- Price ↑ → Demand ↓
- Price ↓ → Demand ↑
Example:
- If the price of ice cream falls → more people buy it
- If the price rises → fewer people buy it
Demand Curve:- A demand curve is a graphical representation of the relationship between price and quantity demanded.
It is drawn:- Price on Y-axis
- Quantity on X-axis
- Shape of Demand Curve:
- It slopes downward from left to right
- y = -x + 10
- This represents a downward-sloping demand curve where price decreases as quantity increases.
Reason:
- Because of the law of demand (inverse relationship between price and demand)
Quantity Demanded:- Quantity demanded refers to the amount of a product consumers buy at a particular price. It is always related to a specific price
Example:- At ₹20 per pen, a student buys 5 pens → quantity demanded = 5 pens
What is Shift in Demand?
- A shift in demand means a change in the entire demand curve, not just movement along it.
- It happens when factors other than price change.
Types of Shift in Demand
1. Increase in Demand (Rightward Shift →)
- More quantity demanded at the same price
- Demand curve shifts right
- Example: More people start buying electric scooters
2. Decrease in Demand (Leftward Shift ←)
- Less quantity demanded at the same price
- Demand curve shifts left
When does Shift in Demand happen?:- A shift happens when non-price factors change, such as:
- Income
- Tastes and preferences
- Prices of related goods
- Population & number of buyers
- Expectations about future
Important:
- Change in price → movement along curve
- Change in other factors → shift of curve
- Example: People stop buying a product due to health concerns
Supply:- Supply means the quantity of a good or service that producers are willing and able to sell at different prices during a given period of time.
- Example:- A shopkeeper is ready to sell 50 pens in a day → this is supply.
Law of Supply:- The law of supply states:
- “Other things being equal (ceteris paribus), when the price of a good increases, its supply increases, and when the price decreases, its supply decreases.”
Simple meaning:
- Price ↑ → Supply ↑
- Price ↓ → Supply ↓
Example:
- If the price of wheat rises → farmers supply more wheat
- If price falls → supply decreases
Quantity Supplied:- Quantity supplied refers to the amount of a product that sellers offer for sale at a particular price. It is always linked to a specific price
Example:- At ₹10 per pen → seller supplies 20 pens, So, quantity supplied = 20 pens
Supply Curve:- A supply curve is a graph showing the relationship between price and quantity supplied. It is drawn:
- Price on Y-axis
- Quantity on X-axis
- Shape of Supply Curve:- It slopes upward from left to right
- Reason:- Because of the law of supply (direct relationship between price and supply)
- A Change in Quantity supplied:- this happens when the price of the good changes, and producers move along he same supply curve.
- A change in supply: this happens when something other than the price changes, and the whole supply curve shift.
What is Shift in Supply?:- A shift in supply means a change in the entire supply curve, not just movement along it. It happens due to factors other than the price of the good.
Types of Shift in Supply
1. Increase in Supply (Rightward Shift →)
- More quantity supplied at the same price
- Supply curve shifts right
- Example: Better technology increases production
2. Decrease in Supply (Leftward Shift ←)
- Less quantity supplied at the same price
- Supply curve shifts left
- Example: Rise in cost of raw materials reduces supply
When does Shift in Supply happen?:- hen non-price factors change, such as:
- Technology
- Cost of production
- Government policies
- Natural conditions
- Number of Sellers
- Expectations about future
Market Equilibrium:- Market equilibrium is a situation where:
Quantity demanded = Quantity supplied
At this point:
- There is no excess demand
- There is no excess supply
- The market is stable
Equilibrium Price and Quantity
- Equilibrium Price:- The price at which demand equals supply.
- Equilibrium Quantity:- The quantity bought and sold at equilibrium price.
Graph of Equilibrium:- x=5 - (This represents the point where demand and supply intersect — equilibrium point.) At this point:
- Buyers are satisfied
- Sellers are satisfied
Surplus (Excess Supply):- Surplus occurs when:- Quantity supplied > Quantity demanded
- When does it happen?:- When price is higher than equilibrium price
- Effect:- Goods remain unsold, Sellers reduce prices
- Example:- If price of a product is too high → fewer buyers → extra stock remains
Shortage (Excess Demand):- Shortage occurs when:- Quantity demanded > Quantity supplied
- When does it happen?:- When price is lower than equilibrium price
- Effect:- Not enough goods available, Prices tend to rise
- Example:- If price is too low → many buyers → shortage of goods
What is Change in Equilibrium?:- Change in equilibrium means a change in:
- Equilibrium price
- Equilibrium quantity
- It happens when demand or supply shifts (not just movement along curves)
When Demand Changes (Supply constant)
(A) Increase in Demand:- Demand curve shifts right
Effect:
- Equilibrium price ↑ (increases)
- Equilibrium quantity ↑ (increases)
- Example:- More people want electric vehicles → demand rises → price and quantity both rise
(B) Decrease in Demand:- Demand curve shifts left
Effect:
- Equilibrium price ↓ (decreases)
- Equilibrium quantity ↓ (decreases)
- Example:- Product becomes unpopular → demand falls → price and quantity fall
When Supply Changes (Demand constant):-
(A) Increase in Supply:- Supply curve shifts right
Effect:
- Equilibrium price ↓ (falls)
- Equilibrium quantity ↑ (rises)
- Example:-Better technology → more production → price falls, quantity increases
(B) Decrease in Supply:- Supply curve shifts left
Effect:
- Equilibrium price ↑ (rises)
- Equilibrium quantity ↓ (falls)
- Example:- Flood damages crops → supply decreases → price rises, quantity falls
When Markets Do Not Follow Simple Theory
The basic theory says:- Price ↑ → Demand ↓ and Price ↓ → Demand ↑
But in real life, this does not always happen because of different types of goods.
Necessities (Essential Goods):- Necessities are goods required for basic living.
- Examples: food, medicines, water
Behavior:
- Demand does not change much with price
- People must buy them even if prices rise
Result:
- Price ↑ → Demand almost same
- Price ↓ → Slight increase in demand
- Example:- Even if medicine prices increase, people will still buy them.
Luxuries (Non-Essential Goods):- Luxuries are goods used for comfort, not survival.
- Examples: expensive cars, branded clothes
Behavior:
- Demand changes a lot with price
- Sometimes higher price increases demand (status symbol)
Result:
- Price ↑ → Demand may increase or decrease
- Price ↓ → Demand may increase
- Example:- Some people buy costly brands to show status.
Perishable Goods:- Perishable goods are goods that spoil quickly.
- Examples: milk, fruits, vegetables
Behavior:
- Sellers must sell quickly
- Even at low prices, they cannot store goods
Result:
- Price ↓ → Supply still high (forced selling)
- Price ↑ → Supply cannot increase much immediately
- Example:-A vegetable seller sells at low price at the end of the day to avoid spoilage.
Why Simple Theory Fails Here
- Human needs (necessities) are unavoidable
- Social factors (luxuries) affect demand
- Physical limits (perishable goods) affect supply
What are Expectations?:- Expectations mean what consumers and producers think will happen in the future, especially about:
- Prices
- Income
- Availability of goods
- These expectations affect current demand and supply.
Expectations and Demand:- Consumers change their buying behavior based on future expectations.
(A) Expectation of Price Rise:- People expect prices to increase in future
- Effect:- Demand increases now
- Example:- If people expect petrol prices to rise, they may buy more now.
(B) Expectation of Price Fall:- People expect prices to decrease
- Effect:- Demand decreases now
- Example:- If a mobile price is expected to fall, people wait → demand decreases
Expectations and Supply:- Producers also react based on future expectations.
(A) Expectation of Price Rise:- Sellers expect higher prices later
- Effect:- Supply decreases now (they store goods)
(B) Expectation of Price Fall:- Sellers expect lower prices later
- Effect:- Supply increases now (they sell quickly)
What are Price Controls?:- Price controls are limits set by the government on how high or low prices can be. Types:
- Price Ceiling (maximum price)
- Price Floor (minimum price)
Price Ceiling:-A price ceiling is:
- The maximum price that sellers are allowed to charge
- It is usually set below the equilibrium price to make goods affordable.
- Example:- Government fixes a low price for essential goods like food or medicines.
Effect of Price Ceiling:
- Demand increases (because price is low)
- Supply decreases (less profit for sellers)
- Result: Shortage in the market
Shortage in Market:- Shortage occurs when:
- Quantity demanded > Quantity supplied
- This happens when price is kept below equilibrium price.
4. Effects of Shortage (Important)
1. Queues and Waiting Time
- People stand in long lines to buy goods
- First come, first served
- Example: Long queues for ration or fuel
Rationing:- Government limits how much each person can buy
- Example: Fixed amount of sugar per family
Falling Quality or Reduced Services
- Sellers may reduce quality to cut costs
- Services may become poor
- Example: Lower quality products at controlled prices
What is a Black Market?:- A black market is an illegal market where goods are sold:
- At higher prices than government-fixed prices
- Secretly, outside official rules
- Example: Selling essential goods at very high prices during shortage
Why do Black Markets happen?:- Black markets usually arise when there is a price ceiling (low fixed price).
Main Reasons:
Shortage in Market
- Price is low → demand increases
- Supply decreases → goods become scarce
- This creates an opportunity to sell illegally at higher prices
High Demand for Limited Goods
- People are ready to pay more to get the product
- Sellers take advantage of this situation
Profit Motive
- Sellers can earn extra profit by breaking rules
Weak Enforcement
- If laws are not strictly enforced, illegal selling increases
Other Unintended Outcomes of Price Controls:- Besides black markets, price controls can create several problems:
- Corruption:- Officials may take bribes to allow illegal sales
- Hoarding:- Sellers store goods to sell later at higher prices
- Reduced Supply:- Producers lose profit → produce less
- Misallocation of Resources:- Goods may not reach those who need them most
What is Market Failure?:-Market failure happens when:
- The market does not allocate resources efficiently
- Goods and services are not produced or distributed properly
- The market fails to give the best outcome for society
- Example:-Pollution from factories harms people, but the market ignores this cost
What are Externalities?
- Side effects of an economic activity that affect others
- These effects are not reflected in market prices
Types of Externalities:
- Negative Externalities
- Positive Externalities
Negative Externalities:- Negative externalities are harmful effects on others.
Features:
- Cause damage to society
- Not included in price
- Lead to overproduction
- Examples:- Air pollution from factories, Noise pollution, Traffic congestion
- Result:- Society bears extra cost (health problems, environment damage)
Positive Externalities:- Positive externalities are beneficial effects on others.
Features:
- Benefit society
- Not included in price
- Lead to underproduction
Examples:
- Education (educated people help society)
- Vaccination (protects others also)
- Plantation of trees
Result:- Society gains more benefits than the buyer pays for
Why Externalities Cause Market Failure
- Market considers only private costs and benefits
- Ignores social costs and benefits
What is Information Asymmetry?:- One party in a transaction has more or better information than the other
Example:- A seller knows the real quality of a product, but the buyer does not
Two Problems Caused by Information Asymmetry
Adverse Selection Low Trust (Before Purchase):- Adverse selection happens before a transaction.
The buyer cannot distinguish between:
- Good quality goods
- Bad quality goods
Result:
- Low-quality goods may dominate the market
- Good-quality sellers may leave
- Example:- A person buying a used phone cannot know its true condition
Moral Hazard (After Purchase):- Moral hazard happens after a transaction.
One party takes more risks because:-
- They do not bear full consequences
- Result:- Careless or risky behavior increases
- Example:- A person with insurance may act less carefully because losses are covered
What are Public Goods?:- Public goods are goods that are available for everyone to use and are usually provided by the government.
- Examples: street lights, national defence, public parks
Key Features of Public Goods
(A) Non-Excludable:- People cannot be prevented from using the good Even if they don’t pay
Example:- You cannot stop someone from enjoying street lighting
(B) Non-Rival:- One person’s use does not reduce availability for others
Example:- One person using a street light does not reduce its use for others
Why Markets Underprovide Public Goods:- Private markets do not provide enough public goods because:
Free Rider Problem:- People can use the good without paying
Result:
- No one wants to pay voluntarily
- Firms cannot earn profit
No Profit Incentive:- Private producers aim for profit
- But public goods do not generate enough revenue
Difficulty in Charging Price
- Since goods are non-excludable:
- It is hard to charge individuals separately
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