Importance of Time Element
The price of a commodity is determined at a point where demand is equal to supply.
The time element plays an important role in price determination. The relative importance of demand and supply in price determination depends on the time taken by demand and supply to adjust themselves.
Marshall was the first economist who acknowledged the role of time element in price determination. According to him,
“The shorter the time period, the greater will be the influence of demand in price determination and the longer the time period, the greater will be the influence of supply on prices.”
Marshall has divided the time periods on the basis of supply and not on the basis of demand, because the supply of commodity takes time to adjust itself to a change in demand.
Time is short or long according to the extent to which supply can adjust itself. Marshall felt it is necessary to divide time into the different periods on the basis of response of supply because it always takes time for the supply to adjust fully to the changed conditions of demand.
The reason why supply takes time to adjust itself to a change in demand conditions is that nature of technical conditions of production is such as to prohibit instantaneous adjustment of supply to changed demand conditions.
A period of time is required for changes to be made in the size, scale and organisation of firms as well as of the industry.
Marshall has divided the time element into four periods:
1. Very Short Period or Market Period
2. Short Period
3. Long Period
4. Very Long Period
1. Very Short Period or Market Period :
It refers to the time period in which the supply of a given commodity is absolutely fixed.
It means supply curve of the commodity is perfectly inelastic.
The firm does not have time to produce additional output. Such a very short period may be called market period.
In other words, supply in the market period is limited by the existing stock of the good, no adjustment can take place in supply conditions. So the price of the commodity is determined by the demand.
For example, after the harvest, the amount of rice available in the market is absolutely fixed, it can not be increased until the next harvest. Similarly the supply of perishable goods like vegetables, fruits, milk and milk products is fixed. If demand for such products increases, supply can not be increased immediately. The price of these perishable goods are influenced by their demand. Supply has no influence on price because it is fixed. Therefore, the price of a perishable commodity rises with the increase in its demand and falls with the decrease in its demand.
The price that prevails in the very short period is called the market price.
Equilibrium under different Time Period
In the given figure, DD is initial demand curve, when demand of the commodity increases, a new demand D1D1 is formed.
A vertical straight line SMP represents very short period supply curve which is perfectly inelastic, OP is initial equilibrium price while OQ is initial equilibrium quantity.
When demand is increased from DD to D1D1, during the very short period, price for the existing available stock would increase OP3. There is a sharp rise in price since the competitive industry is unable to produce more to meet the increased demand.
2. Short Period:
Short period refers to the time period in which supply of a commodity can be increased by making more intensive use of the fixed factors.
During this functional time period, the size of the firm and its plant cannot be altered, thus a set of fixed factors remains unchanged in its production function and more output can be produced only by increasing the input of variable components under the given state of technology.
During the short period, the plants and equipments are fixed, but it is possible to increase the output by applying more of variable factors on the given amount of fixed factors.
Thus, during the short period, the stock of a given commodity can be increased but to a limited extent by an intensive use of the given production plant. As such the supply curves of existing firms will tend to be relatively inelastic. Therefore, the supply curve of industry will be relatively inelastic.
The short period price is thus determined by the interaction of the forces of short run demand and supply.
Graphically, the short period equilibrium price is determined at the point of interaction between short run demand curve and short run supply curve as shown in the given figure.
In this figure, OP is the initial equilibrium price and OQ is the initial equilibrium quantity obtained by the interaction of demand curve DD with the short run supply curve SSR at point A.
An increase in demand, results in the shifting of DD to D1D1 which results in a rise in price to OP1 which gives rise to a new equilibrium price OP1 and new equilibrium quantity OQ1.
Therefore, increase in price in the short period is less than the increase in price in the very short period because supply has increased to some extent.
3. Long Period Market Price or Normal Price :
Long period refers to the period which is long enough to enable the industry to adjust its supply completely to a change in demand.
Long period is long enough to enable the existing firms to change their scale of production,new firms to enter the industry or old firms to leave the industry.
Long run market price is also known as “normal price”. Normal price is “the price that prevails in the long run is called the normal price.”
According to Marshall: “Normal or natural value is that which economic forces would tend to bring about in the long run”.
During this period all factors of production in the input components of the firms in an industry become variable. As such in the long run, the firms can change the scale of production. The size of the firms and their plant capacity can be altered. Thus, in the long run, supply can be adjusted completely to the changing demand conditions.
Long run supply curve is relatively more elastic than the short period supply curve. Supply curve SLR is the is the long run supply curve in the given figure. Supply plays more important role in the price determination in the long run.
Graphically, initial equilibrium price OP and initial equilibrium quantity OQ is obtained by the intersection of demand demand curve DD and long run supply curve SLR.
An increase in demand shifts the demand curve DD to D1D1. And the intersection of D1D1 and SLR curve at E give rise to a new equilibrium price OP2 and new equilibrium quantity OQ2.
Conclusively, in the long run quantity changes will be more and price changes will be less for a given in demand.
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