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A detailed analysis of demand and supply demonstrates how a market forces solve the problems of what, how, and for whom. It illustrates how prices and quantities of various goods and services are determined.
A demand schedule shows the relationship between the price and the quantity demanded of a good. Demand curves for almost all commodities slopes downward owing to inverse relationship between price and quantity demanded. The law of demand states that other things being constant, quantity demanded for a good tends to fall as price rises. In addition to price, there are other factors such as population, average family incomes, prices of related goods, and tastes that influence the demand for a good. When these factors change, the demand curve will shift. However, there are few exceptions like Giffen goods and prestigious good to law of demand. Price elasticity of demand of a good measures the responsiveness of the quantity demanded to a change in price. It is defined as the percentage change in quantity demanded resulting from one percent change in price of the good. Typically price elasticity of demand is classified into five categories: (a) Demand is perfectly elastic when the percentage change in quantity demanded infinitely exceeds the percentage change in price. (b) Demand is perfectly inelastic for a good when a change in its price, however large it may be, causes no change in quantity demanded (Ep 0). (c) Demand for a good is said to be unit elastic when a given change in the price causes an equally proportionate change in the quantity demanded, the value of price elasticity of demand is unitary (Ep = 1).(d) Demand for a good is regarded as relatively elastic when a change in its price results in more than proportionate change in the quantity demanded (Ep > 1). When a percentage change in quantity demanded is less than the percentage change in price, then the demand for that good is relatively inelastic (Ep < 1). Slope of the demand curve is not the elasticity of demand. Price elasticity of demand for necessary goods like food and shelter tends to be low and for luxuries, the price elasticity of demand is high.
The relationship between average revenue, marginal revenue and price elasticity of demand is such that MR P (1 — l/ep), where ep is the absolute value of price elasticity of demand.The supply schedule (or curve) shows — other things constant — the relationship between the price and quantity supplied. Quantity supplied for most goods responds positively to the price, and therefore the supply curve rises upward and to the right. Price elasticity of supply measures the percentage change of output supplied for a percentage change in price of the
good.If a specific tax is imposed or subsidy is given, the burden or benefit is shared by the buyers and suppliers in the ratio of elasticity of supply and elasticity of demand respectively. Sometimes, the government imposes price ceiling or price floor for the benefit of buyer or supplier respectively.