Question

Explain how the market price of a good is determined using a diagram.

Answer 1

Market price or equilibrium price is determined by the forces of market demand and market supply. Considering market demand schedule on one hand and market supply schedule on the other, we identify equilibrium price as the one where market demand is equal to market supply or where market demand curve and market supply curve intersect each other.

Market Equilibrium Price (Schedule)

$\begin{array}{ccc}\text{Price of commodity X}& \text{Quantity supplied of a}& \text{Quantity demanded for}\\ \text{(Rs)}& \text{commodity X (Dozen)}& \text{a commodity X(Dozen)}\\ \begin{array}{c}5\\ 4\end{array}& \begin{array}{c}50\\ 40\end{array}& \begin{array}{c}\\ \end{array}]\begin{array}{c}10\\ 20\end{array}\}\text{Excess supply}\\ 3& 30& \text{30 (Equilibrium)}\\ \begin{array}{c}2\\ 2\end{array}& \begin{array}{c}20\\ 10\end{array}& \begin{array}{c}\\ \end{array}]\begin{array}{c}40\\ 50\end{array}\}\text{Excess demand}\end{array}$

In the above schedule and diagram, demand and supply become equal only at the price of Rs. 3.00, so that is the equilibrium price. Also, it is clear that equilibrium price is determined at the point where demand and supply curves intersect each other at 30 units of commodity 'X'.