Price Elasticity of Demand
Price Elasticity of Demand
Supply and demand plays a vital role in the economy. Price is the central determinant of both the demand and supply, for example the higher the price of a good or a service the less the product is demanded. In circumstance where the price goes down, demand increases. The response of price and quantity demanded create an inverse relationship between the two. Whereas demand portrays the consumer decision making in purchases, supply is drawn on producer’s willingness to make profit (Parkin, 2002).
The overriding factor in determining price elasticity of demand is the willingness and ability of consumers to easily switch from one good to another (substitute goods) in case of any price change. If the demand for corn increases due to its use as an alternative energy source, its supply will also increase making the soybean (substitute) supply and demand to go down. This will force farmers to shift their soybeans farms to produce more corn because of the increasing demand at the market.
The total revenue of the suppliers of corn oil will increase because of the increasing demand at the market. This is also because of other determinants of supply like price of the product; a producer (farmer) is always aimed at maximizing his/her profits and minimizing his/her cost thus a rise in price will increase the producer willingness to supply and vice versa. Other factors that are likely to affect the supply of products include tax and technology, a producer aim at maximizes his profit but an increase will raise his expenses.
Technology helps a producer in minimizing his cost of production-provided that mass production is possible with technology. Parkin (2002) hints that in a market setting, the law of supply and demand predicts that the price level tends to move toward the point that equalizes the quantity supplied and demanded. Therefore, equilibrium point is created; a point where quantity supplied at the market and quantity demanded at the same market is in balance, where the supply curve crosses the demand curve.
At equilibrium, when demand exceeds supply there is excess demand and prices will increase. On the other hand, when supply exceeds demand there is excess supply and prices will decrease. Such instances where supply or demand exceeds one another are very common in the market and will cause shifts in price. But when supply and demand balances, there will be no change in price. The price which makes the supply and demand to balance is referred as market price or equilibrium price. Reference Parkin, M. , Melanie, P. & Kent, M. (2002). Economics. Harlow: Addison-Wesley Publisher.