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Applications Of Demand And Supply Analysis Under Perfect Competition

 Applications of Demand and Supply Analysis under Perfect Competition

Application on Farm Products

            There is perfect competition in the market for farm products. Farm products like wheat or rice are usually standardised. As defined by Samuelson, “Farming is an up and down industry.” This is for the reason that it based on the farmer. Moreover agriculture is subject to the law of diminishing returns earlier that in industry because (i) land is limited in supply, (ii) Agricultural operations are largely dependant on nature and (iii) economies of large scale production are not available except on very large farms in nations like America and Australia.

The prices of farm products are determined by demand and supply.

  • Demand for Farm Products – Farm products generally drop under the category of requisites commodities and that their demand is inelastic. This means that when the price of a farm product drops its demand will not hike much and when its demand will not drop much.
  • Supply of Farm Products – The supply of farm products is also less elastic. The less elastic supply is due to the inelasticity of the factors of production at the discarding of the farmers. The cultivable land of producers is fixed and inflexible. Further, all costs of farm production are fixed and the proportion of variable costs is very insignificant. So irrespective of the volume a farmer produces, his costs do not vary.
  • Price Determination – The price of a farm product is ascertained at a point where its demand and supply curves intersect each other.

Agricultural Price Support

            In the developing nations, state provides the facility of price support to the farm producers and at the same time, it gives farm commodities at fair price to farmers. It also gives price support so that the prices of farm products do not drop below specified levels. The state also fixes minimum prices to protect farmers’ earnings from price fluctuations of farm products and to create bumper stocks to prevent feasible future shortages of farm products. The specified level of minimum prices is called price floor.

            The excess is eradicated by the state government in three ways.

  1. Supply, i.e. limiting the estate of land for the farmers to grow specified agricultural products
  1. Motivating demand i.e. new uses for farm products are sought and
  1. Purchasing surpluses i.e. certain farm products are bought and stored by the state for future use as “buffer stocks”.

Price Control
            Sometimes the state may think it required to impede in the market progression and set maximum (low) price limits for some basic goods. These are known as price ceilings. Producers of such merchandise cannot charge prices higher than the ceiling prices i.e. the maximum prices fixed by the government.

            Price ceilings are normally levied on many indispensable consumer goods during combat on other crucial inflationary periods to put off them from increasing above a certain level. In the case of such products the maximum prices fixed by the state are below the equilibrium price. At a price lower than the equilibrium price, the quantity supplied which leads to the shortage of the product. This requirements the prologue of rationing by the state whereby constraint is levied on the volume of a good that a consumer can buy.

Black Market


            Black market of a product is the market in which merchandise is sold illegitimately by the sellers at a price than the controlled legal maximum price or ceiling price. It enlarges on account of surplus demand in the market. Some buyers are equipped to pay a higher price for acquiring more volume of the produce. Sellers are also concerned in the black market to sell the products at higher prices and earn more profits.

The working of black market is represented in the figure where D and S are demand and supply curves. They intersect at point E and determine OP market price and OQ market quantity. But the available quantity of the product is OQ1 due to OP2 price ceiling. But the demand is OQ2 and Q2Q1 is the shortage of the commodity. Hence the buyers are ready to offer OP1 price for procuring more units of product.

If the total quantity OQ1 is sold in the black market, the total amount paid by the consumers will be OP1 YQ1. But the receipts of the producers will only be OP2 XQ1 since the price ceiling. Thus the amount OP1 YQ1 – OP2 XQ1 = P1 YXP2 will be the extra gain black marketers shown by the shaded area. Nevertheless the entire supply is usually not sold in the black market, because of price laws.

Consumer’s surplus and Producer’s surplus

            Demand and supply study is very essential in knowing consumer’s surplus and producer’s surplus. Consumer’s surplus is the disparity amidst the total value that consumer is willing to pay and payment that they essentially makes for the purchase of product. The total value that a consumer is ready to pay is the region under the demand curve. On the other hand what he essentially pays is the market price line.


            Producer’s surplus is the region above the supply curve and beneath the market price line. It is the disparity amidst the actual amount that a producer receives by selling a given volume of a product and the minimum amount that he expects to receive for its same quantity.

            In the figure, the demand curve and SS1 is the supply curve. Both overlap at E and determine OP price and PE is the market price line. OQ is the equilibrium quantity. The consumer’s surplus on OQ units of the product is the area EPD and the producer’s surplus on the same units of the product is ESP. The sum of consumer’s and producer’s surplus will be the maximum when the market structure is perfectly competitive.

Minimum wage Legislation

            Fixation of minimum wages by the state can also be presented by demand supply study. Fixing minimum wages will so increase the earnings of workers that their utilization expenditures will hike which will in turn direct to enlargement of the consumer’s goods industries and to the capital goods industries. This will hike employment opportunities, productivity and national revenue.


            When the state feels that the market price for the farm product is too low for the farmers it makes a decision to pay them a subsidy. They will take delivery of it in adding to the market price. A subsidy is a government funding provided to producers to decrease the price per unit of a product. This is to persuade the farmers to produce more which will in turn diminish the market price. The profit shift from the producers to the buyers which depend on the elasticity of demand and supply. Subsidy shifts the supply curve downward to the right.


            The demand and supply analysis is pertinent to the difficulty of occurrence of indirect taxation. The occurrence of a tax engrosses the course of shift from the person on whom the tax is levied primarily to the eventual taxpayer who stands the money burden of the tax. The occurrence of product taxation is shared amidst the buyers and sellers in the ratio of the elasticity of supply of the taxed product to the elasticity of demand for it.

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