•Law of Demand states that other things being equal, there is a negative relation between demand for a commodity and its price (other factors remaining the same)
•When price of the commodity increases, demand for it falls and
•when price of the commodity decreases, demand for it rises,
Market supply curve
•The market supply curve shows the output levels (plotted on the x-axis) that firms in the market produce in aggregate corresponding to different values of the market price (plotted on the y-axis).
Equilibrium for a perfectly competitive market
with a fixed number of firms
•Here SS denotes the market supply curve and DD denotes the market demand curve for a commodity.
•The market supply curve SS shows how much of the commodity firms would wish to supply at different prices, and
•The demand curve DD tells us how much of the commodity, the consumers would be willing to purchase at different prices.
Price increase due to excess demand
•If the prevailing price is p1, the market demand is q1 whereas the market supply is q1' .
•Therefore, there is excess demand in the market equal to q1' q1.
•Some consumers who are either unable to obtain the commodity at all or obtain it in insufficient quantity will be willing to pay more than p1.
•The market price would tend to increase.
Price decreases due to excess supply
•If the prevailing price is p2, the market supply (q2) will exceed the market demand ( q 2' ) at that price giving rise to excess supply equal to q2' q2.
•Some firms will not be then able to sell quantity they want to sell; so, they will lower their price.
Point of Equilibrium
•Equilibrium occurs at the intersection of the market demand curve DD and market supply curve SS.
•The equilibrium quantity is q* and the equilibrium price is p*.
•At a price greater than p*, there will be excess supply, and at a price below p*, there will be excess demand.