Supply and Demand Lesson in Market

You can learn your supply and demand lesson in your everyday life.

Yesterday, I went to market with my ten years old son Huzaifa to refill a cylinder of liquefied petroleum gas (LPG) for our generator which we have to run during electricity breakdown or load shedding as the government terms. We have installed gas kit in the electricity generator to avoid high prices of the petrol, like millions of other Pakistani people.

On reaching retailer, my son was shocked to see the increase of Rs.5/- per KG in the gas within three days. He had seen an increase of Rs.20/- three days before. He asked me why gas sellers are increasing prices of gas almost on a daily basis. I encouraged him to ask the question from the seller.

He was hesitant, so I forwarded his question to the gas filling boy. He told that he was just a servant and did not know why gas prices were increasing. He also said that he was asked by the owner of the shop to place an enhanced price on the board for the customers.

“Are prices of gas increasing in other cities too?” my son asked him.

“I don’t know,” he said.

Then he started muttering that increase in price has become essential because they have to bear the extra cost of transportation. He continued that the retailers send their empty gas cylinders to the gas producers, but they have to wait in queues for 24 hours or more. This causes them to pay transport charges for the idle time. He also said that it was natural for them to charge extra rupees from the customers to meet their costs.

On the way back home, I asked my son what reasons he has learned for an increase in the price of the gas. He said that it was an extra cost of transport that was compelling the retailers to increase their prices.

I agreed that he was right to some extent. However, it is not the only reason because extra cost on transport charges could not add 25% increase in price. The other reason is high demand for gas due to a shortage of electricity and intense heat wave during June and July. The petrol prices are higher, so there is a lot of demand for gas which is cheaper than petrol to be used in generators.

This is forcing the gas production companies to produce more gas than usual. The companies are unable to maintain a balance in the supply chain to high demand, so they are charging high. However, the heavy demand for gas on the consumer side is forcing the retailers to increase prices at their retails not only to meet extra expenditures but also to earn extra money. This is a clear-cut loss to the consumers but an extra benefit to the sellers.

Meanwhile, we reached home. I don’t know whether Huzaifa could understand his first lesson of supply and demand economics, but if we place both together, we shall get the following picture:

Supply and Demand in Market Mechanism

In the normal market mechanism, the students are taught the first lesson of supply and demand with simple crossing curves named as supply and demand. We get the point which is called equilibrium or clearing quantity (and price) where quantity demand is equal to quantity supplied. In this graph, we can see Q0 as

A point where there is no pressure to increase or decrease prices of the gas. We get market clearing price as P0 where both seller and customers are getting their rightful share of the market mechanism.

However, if we increase the price of the gas, we shall get the price above the equilibrium as in this graph is P1. In this situation, the gas sellers try to sell more at a higher price for more profits. However, the demand for gas shall decrease, and a surplus shall be available in the market.

On the other hand, if the price is reduced to a lower level (say with subsidy), the new price would be P2, and the buyers shall try to purchase more than the supply of the gas. This situation may result in a shortage of gas which will demand an increase in the price. In this situation the quantity demanded will be more than being supplied.

The market forces try to settle price at market efficiency level.

Energy Crisis in Hot Summer

In our particular situation the market mechanism is not working correctly. Due to hot weather the temperature goes upward to 50 degree centigrade and everybody feels a strong need for air conditioners. However, shortage of electricity is forcing the government to manage load so that power can be provided to everyone to some extent. Long electricity breakdowns force the consumers to go for alternatives. The solar system is not only costlier but also needs further developments to be used at household level. The more accessible option is generator which can be run either on petrol or liquefied petroleum gas. The later is cheaper so most of people prefer to go for that. These high demand shifts demand curve to the right side as under:

The graph shows the shift in demand to the right side. The price shall increase to P1. If LPG companies don’t increase the supply, the price will remain higher. Some increase in quantity (Q1) can create a new equilibrium or market clearing price.

Supply and Demand Model

Origin of Supply and Demand Model

Elasticity Definition

Price Elasticity

Price Elasticity of Demand

Measurement of Demand Elasticity

Point Elasticity of Demand

Income Elasticity of Demand

Applications of Income Elasticity of Demand

Supply Curve and Elasticities

Perfect Price Elasticity of Supply

Relative Elasticities and Inelasticity of Supply

Exceptions to Demand and Supply