Chapter 9: The Price Puzzle: What Drives the Market (Economics)

Refute: not always.

• For most goods (normal goods) a rise in income does increase demand: people buy more clothes, fruit, gadgets, eating out, better-quality products.
• But for some cheap, low-quality goods (inferior goods), demand falls when income rises, because people switch to better alternatives: e.g. coarse grains replaced by rice and wheat, travel by bus replaced by a car, cheap unbranded goods replaced by branded ones.
• For basic necessities like salt or matchboxes, demand hardly changes with income.
• Demand also depends on other factors: price, tastes, prices of related goods, seasons and future expectations.

Refute: higher income raises demand for normal goods, but demand for inferior goods (e.g. coarse grains, cheap transport) falls and for necessities like salt it barely changes, so it is not always true.

• a. Diesel cars: demand rises (likely), since diesel cars are a substitute for petrol cars and become relatively cheaper to run (if diesel prices do not rise as well).
• b. Electric cars: demand rises, as they are a substitute that does not use petrol at all.
• c. Car accessories: demand falls (for those linked to petrol cars), since petrol and petrol cars are complements; fewer people buy or use petrol cars, so they buy fewer accessories.
• d. Public transport: demand rises, since buses, metro and trains become a cheaper substitute for driving.

(a) rises (b) rises (c) falls (d) rises; substitutes of petrol cars gain demand while complementary goods lose demand.

a. Cost of production per unit falls: he uses 40% less water and less labour, and gets 30% more output from the same land, so each unit costs less to produce (after the initial cost of installing the system).

b. He is willing to supply more at every price: with lower costs and higher output, each price is now more profitable, so his supply curve shifts to the right.

c. Market supply increases (the market supply curve shifts right). With more supply, the market price of the crop is likely to fall, benefiting consumers, while efficient farmers still earn well. Water is also saved, which helps sustainability.

(a) Cost per unit falls. (b) He supplies more at each price (supply shifts right). (c) Market supply increases, which tends to lower prices.

Why sellers cut prices:

• To clear old stock (excess supply) before new models arrive.
• The law of demand: at lower prices, quantity demanded rises sharply, so they sell in much larger volumes.
• Competition among online platforms and brands for festival shoppers.
• To attract new customers and build loyalty; costs are lower because of bulk deals with manufacturers.

Effect on equilibrium: if the price is set below the usual market price, quantity demanded rises well above the usual level; sellers plan for this by increasing supply (stocking up). The market moves to a larger quantity traded at a lower price, and stocks get cleared.

Who benefits: both.

• Consumers get goods cheaply and buy items they otherwise could not afford.
• Sellers gain from higher total sales and revenue, clearing unsold stock, gaining customers, and earning from large volumes even with smaller profit per item.

Sellers cut prices to clear stock, attract buyers and sell in bulk; the lower price raises quantity demanded, so more is traded at a lower price; both consumers (cheaper goods) and sellers (higher volume, cleared stock, new customers) benefit.

Answer: (b) Shortage.

A maximum price (price ceiling) below the equilibrium price makes the vaccine cheaper, so more people want it (quantity demanded rises), while producers find it less profitable and supply less (quantity supplied falls). Quantity demanded exceeds quantity supplied: a shortage.

To prevent problems like queues, hoarding or black marketing, the government may also produce or subsidise the vaccine, increase supply, or ration it fairly (as with priority groups in vaccination drives).

(b) Shortage: below the market price, demand increases and supply decreases, so demand exceeds supply.

Examples of price controls in India:

• Essential medicines: ceiling prices fixed by the National Pharmaceutical Pricing Authority (NPPA), so that life-saving drugs are affordable.
• Medical devices like coronary stents and knee implants: capped prices to stop overcharging.
• Hand sanitisers and masks during COVID-19: capped under the Essential Commodities Act, 1955 (₹100 for 200 ml of sanitiser), to stop hoarding and black marketing.
• Minimum Support Price (MSP) for crops like wheat and rice: a price floor to protect farmers' income.
• Minimum wages: a price floor for labour, to ensure fair pay.
• Ration (PDS) items: subsidised prices for the poor.
• Fares of public buses, railways and taxis/autos in many cities, and electricity tariffs set by regulators.

Reasons: to make essential goods affordable, protect consumers from exploitation and monopolies, protect producers and workers (MSP, minimum wages), prevent hoarding in emergencies, and discourage harmful consumption (taxes on tobacco and alcohol).

Medicines and stents (NPPA ceilings), sanitisers during COVID-19, MSP for crops, minimum wages, PDS rations and public transport fares; the aim is affordability, fairness, protecting producers and workers, and preventing exploitation and hoarding.

Yes. Regulation is needed, but too much can harm markets:

• Shortages and black markets: if price ceilings are set too low for too long, producers supply less, causing shortages, long queues and black marketing.
• Less investment and innovation: too many licences, permits and inspections ("licence raj" before 1991) discouraged businesses; India's growth picked up after reforms reduced controls.
• Inefficiency: protected industries face little competition, so quality stays low and costs high.
• Wasted surpluses: a price floor set too high can create surpluses (e.g. excess grain stocks).
• Corruption and delays when approvals depend on officials.

So government should regulate to protect fairness and welfare, but keep rules simple and transparent (ease of doing business).

Yes: very low price ceilings cause shortages and black markets, too many licences and permits discourage investment and innovation (as in the pre-1991 licence raj), and protection breeds inefficiency and corruption.

Sample data (yours will differ, but it should follow the law of demand):

Market demand curve (the total column):

Each person's graph: price on the y-axis and quantity on the x-axis; joining the points gives a downward-sloping individual demand curve. Adding everyone's quantities at each price gives the market (total) demand curve, which is flatter.

Fill the table with your own data, plot each person's demand curve (price on y-axis, quantity on x-axis) and the total; all curves should slope downwards (law of demand).

a. No single person decides. Prices are set by the interaction of demand and supply: wholesale prices are set at the mandi (auction among traders and farmers), and retail sellers add transport and margins; bargaining between buyers and sellers also matters.

b. Because supply and demand keep changing:

• Season: in the harvest season supply is high, so prices fall; off-season supply is low, so prices rise.
• Weather and disasters: heavy rain, floods or heat waves damage crops and transport, cutting supply (e.g. tomato and onion price spikes).
• Festivals and weddings raise demand.
• Transport costs (fuel prices) and storage problems; hoarding by some traders.

c. Yes. Vegetables are perishable and cannot be stored long without cold storage. In the morning, produce is fresh and buyers are many, so prices are high. By evening, sellers want to clear the remaining stock before it spoils, and fewer buyers remain, so they lower prices. In effect, supply left over is high relative to demand.

(a) Demand and supply (mandi auctions and bargaining) set prices. (b) Changes in season, weather, festivals, transport and hoarding shift supply and demand. (c) Perishable vegetables must be sold before they spoil, so sellers cut prices in the evening when buyers are fewer.

Substitutes: (c), (d), (f). Complements: (a), (b), (e), (g).

(Values read from the figure are approximate.)

a. E is the market equilibrium: the point where the demand curve and the supply curve intersect, so quantity demanded equals quantity supplied and there is neither shortage nor surplus.

b. Equilibrium price ≈ ₹250; equilibrium quantity ≈ 30 kg.

c. At the higher price (₹300), A shows the quantity demanded (about 23 kg) and B the quantity supplied (about 37 kg). Supply is greater than demand, so the gap AB (about 14 kg) is excess supply (a surplus).

d. At the lower price (about ₹160), C shows the quantity supplied (about 16 kg) and F the quantity demanded (about 44 kg). Demand is greater than supply, so the gap CF (about 28 kg) is excess demand (a shortage).

e. With a shortage, buyers compete for the limited goods and sellers find they can charge more, so the price rises. As it rises, quantity demanded falls and quantity supplied increases, until the market returns to equilibrium at E (about ₹250 and 30 kg).

(a) Market equilibrium. (b) About ₹250 and 30 kg. (c) At ₹300, supply (B) exceeds demand (A): AB is excess supply. (d) At about ₹160, demand (F) exceeds supply (C): CF is excess demand. (e) The price would rise until equilibrium E is restored.

Note on the data: as printed, quantity demanded rises with price and quantity supplied falls, which goes against the laws of demand and supply. The two rows appear to be swapped. Using the correct relationships (demand falls as price rises; supply rises as price rises):

a.

b. Equilibrium price = ₹30; equilibrium quantity = 15 kg (at ₹30, quantity demanded = quantity supplied = 15 kg).

c.

• At ₹20 (below equilibrium): demand 20 kg, supply 10 kg, so there is excess demand (shortage) of 10 kg. Buyers compete and the price rises towards ₹30.
• At ₹40 (above equilibrium): demand 10 kg, supply 20 kg, so there is excess supply (surplus) of 10 kg. Sellers cut prices to sell their stock, and the price falls towards ₹30.

(With the table exactly as printed, the curves would slope the wrong way, but they would still cross at ₹30 and 15 kg.)

Equilibrium at ₹30 and 15 kg. At ₹20 there is a shortage of 10 kg, so the price rises; at ₹40 there is a surplus of 10 kg, so the price falls; both move back to ₹30.