Price Elasticity of Demand and Supply - Report Example

Economic Analysis [Type the [Pick the Table of Contents Copy of the Article 3 Summary 4 Introduction 4 Analysis 5 Demand and Supply Analysis 5 Market Equilibrium 8 Price elasticity of Demand and Supply 8 Producer surplus and Consumer Surplus: 9 Effect of Price Ceiling and Price Floors: 9 References 11 Copy of the Article The article has been taken from the following web address on 27-Nov-10: The article is as follows: Banana price up on short supplies NEW DELHI: With 30 per cent supply crunch in the markets, the retail price of banana has rocketed to Rs 40 a dozen much to the discomfort of consumers. “There is about 30 per cent fall in arrival of banana from bulk producing state of Maharashtra, which has pushed the price of the fruit in the national capital upward,” General Secretary of Fruit Merchants Association Mr Sudesh T Sachdev told PTI. Maharashtra is the biggest banana cultivator in the country. Mr Sachdev said intense heat in the month of April and May led to almost 50 per cent of the crop got burnt in the field itself in Maharashtra. This followed by excessive rains in July-August further damaged the fruit, thereby causing the short-supply of the commodity, he said. The decline in banana production in the state has meant that instead of three weekly train supplies, only two are arriving from Jalgaon to Azadpur fruits and vegetables market in a week, he said. The Fruit Merchants Association General Secretary said arrival of 5-10 trucks of banana (each truck carrying 8-12 tonnes) from Uttar Pradesh and Bihar has brought a little respite. Despite the new supplies, the wholesale price of the fruit is still high ranging from Rs 20-25 a dozen in Azadpur market (Asia’s biggest fruit & Vegetables market). Mr Sachdev added the scenario was expected to improve from November onward with arrival of new banana crop from Maharashtra. - PTI Summary The article discusses about the rise in banana prices due to the shortage in its supplies. According to the article the supply of banana in India has fallen by 30%, as a result of which the prices have climbed to Rs 40 for per dozen. Maharashtra being the largest producer of banana in the country has not been able to be consistent with expected supply due to the intense heat from April to May in the region. According the article the scenario was expected to improve in November with the arrival of new crop. Introduction This assignment analyzes the impact of shortage of banana on the price of banana. This would be done using the Law of Demand and Supply and the Market equilibrium theory. The assignment will also analyze the price elasticity of demand for banana by using the price elasticity of demand theory. Finally, analysis of the producer surplus and consumer surplus for banana and also the effect of price ceiling/price floors on producer/consumer. The economic concepts and graphs that would form the basis of analysis will the theory of Law of Demand and Supply and Market Equilibrium, Concept of Price elasticity of Demand and Supply, Concept of Producer surplus and Consumer surplus and the effect of price floors/ceilings on producers/consumers. Analysis Demand and Supply Analysis Before explaining the Law of demand, we need to first understand what we mean by “Demand”. Demand for a good/service refers to the quantity of the good that will be purchased at a specific price and time. (Crimmins 1985)The Law of Demand explains the relationship between the price and quantity demanded of a good/service, assuming other factors influencing demand remains constant. The law states that, ceterus paribus, quantity demanded of a commodity is inversely proportional to the price of the product. In other words, with the fall in price of a commodity, the demand for that commodity increases and vice versa. (Samuelson 2009)The demand curve is also called the willingness to pay curve and is downward sloping. This is because of the Law of Diminishing Marginal Utility, which says that with consumption of more and more units of a commodity, the marginal utility derived from successive units goes on diminishing. Hence, the consumer is willing to consume the additional units only at a lower price. The factors that influencing the demand include the price of the product, Price of the related products i.e. of substitutes and complementary products, Income of the consumer and lastly the tastes and preferences of the consumer. Law of Supply: Supply of a product by a firm refers to the quantity of product offered for sale at a particular price and time. Law of supply states that, other things being constant, quantity supplied of a product is directly proportional to the price of the product. So, when price of a product increases, the supply of that product also increases and vice versa. Factor affecting the supply of a product include the price of the product, state of technology, prices of factors of production, taxation policy, prices of other goods and nature of commodity. The supply curve is upward sloping. This explains that with increase in price, the supply of the product will also increase. (Crimmins 1985)This happens as firstly, the price of a product increases the profits of firms increase. This attracts new firms into the market, thereby increasing supply and secondly when the price increases, firms get more incentivized for selling their previous stock. Market Equilibrium Market equilibrium is achieved when the quantity demanded by the customer equals the supply of that product at a particular price (equilibrium price). Market In-equilibrium: Two situations of Market in-equilibrium are Surplus and Shortage. Surplus arises when the quantity supplied is greater than the demand of the commodity. Surplus causes the price of the commodity to decrease. Since the price decreases and the producers’ profits are also reduced, the supply of the commodity will also reduce, thereby eliminating the surplus (Mankiw 1997). Shortages arise when the supply of a particular commodity falls short of its demand. In such a scenario, the price of the product increases. As the price increase, more firms get attracted towards the market. This increases Supply and gradually market equilibrium is achieved. In the article “Banana price up on short supplies, shortage in supply of banana by about 30%, due to heat and bad rainfall, causes the price of banana to increase. The price increased to Rs.40 a dozen. As the price of banana increases, the demand for banana would decrease and gradually the market equilibrium could be achieved. Price elasticity of Demand and Supply Price Elasticity of Demand- It is the degree of responsiveness of demand of a product to change in its price. Banana is a fruit and can be considered as a necessary product. Hence the Price elasticity of demand for Banana is perfectly inelastic. No matter how far the rates go, the demand for banana will not be elastic (Moffatt 2007). Price elasticity of Supply- it is the degree of responsiveness of supply of the product to changes in its price (Samuelson 2009). Since, the supply of banana is elastic in nature; hence a small reduction will cause the price to sky rocket. Producer surplus and Consumer Surplus: Consumer surplus: Consumer surplus is equal to the difference between the buyer’s willingness to pay and the actual price paid. When price reduces, the initial consumer surplus also increases as the customer gets more at the same time. So if the price of banana falls in near future it will add to the consumer surplus. In the article, due to increase in price of banana, the consumer surplus reduced. Product Surplus: Producer surplus is the price of a good/service less the marginal cost of producing it and is measured by the area below the price and above the supply curve (Moffatt 2007). Effect of Price Ceiling and Price Floors: Price Ceiling: It is the maximum price that is established legally. Price ceiling is followed in conditions of acute shortage, which leads to increase in price of that commodity to a huge extent. Hence, in order to safeguard the interest of the consumer, the government puts a ceiling to the price, above which the producers cannot charge the customer (Mankiw 1997). Price Floor: It is the minimum price that is established legally. In situation of excess supply/ surplus, the price of the product falls. In order that the producer is able to cover its fixed cost and some part of variable cost, the government fixes a price floor, below which the consumer cannot demand. Price floor are established to safeguard the interest of the producer. This majorly happens for agricultural product (Mankiw 1997). Certainly government is also trying to regulate the prices of banana depending upon the conditions of demand and supply by introducing the regulation of price ceiling and floors. References Crimmins Richard, The firtility revolution: demand and supply analysis (Chicago: University of Chicago Press, 1985) Mankiw, N. Gregory, Principles of Microeconimics (Harcourt Brace College, 1997) Joshua I. Weinstein, “Price elasticity of demand,” Journal of economics 104 (2009): 440. Moffatt, Mike. Price elasticity of demand. 2007. http://economics.about.com/cs/micfrohelp/a/priceelasticity.htm (accessed Nov 26, 2010). Samuelson, Paul Anthony. "Microeconomics." In Microeconomics, by Paul Anthony Samuelson, 432. McGraw-Hill, 2009. What is price elasticity of demand. n.d. http://www.wisegeek.com/what-is-price-elasticity-of-demand.htm (accessed Nov 26, 2010). Read More