Time Element in the Theory of Price Determination

• According to Marshall, the price of a commodity is determined by both demand and supply.
• The influence of demand and supply on price depends on the time allowed for supply to adjust.
• In a very short time, supply is almost fixed, so demand mainly decides price.
• Over a longer time, firms can change output and enter or leave the industry, so supply and cost of production become more important.

Economists therefore study price determination by dividing time into different periods.

Marshall divided time into four periods based on how much supply can adjust:

1. Market Period or Very Short Period
2. Short Period
3. Long Period
4. Secular Period (very, very long period)

Definition

• The market period is a very short period in which the supply of a commodity cannot be changed at all.
• It usually applies to highly perishable goods like vegetables, fruits, milk, and some milk products.

Supply and price

• Supply is fixed in the market period; sellers cannot increase or decrease quantity supplied.
• The supply curve is almost vertical.
• Therefore, price is determined mainly by demand in this period.

Example

• In the morning, demand for vegetables may be high, so prices are high.
• As the day passes, demand falls; sellers cannot keep unsold green vegetables for the next day.
• They reduce the price in the afternoon or evening to clear the fixed stock.

Thus, in the market period, demand plays the dominant role in price determination.

Definition

• The short period is a time period in which a firm can change its output only by using the existing plant and equipment more or less intensively.
• The firm cannot change the size of its plant, nor can new firms easily enter or exit the industry.

Supply adjustment

• Some adjustment in supply is possible (e.g., overtime work, extra shifts, better use of existing machines).
• However, there is a limit beyond which output cannot be increased because capital equipment is fixed.

Price determination

• Both demand and supply influence price in the short period.
• Supply can respond partially to changes in demand.
• Short-period equilibrium price is the price at which short-period demand equals short-period supply with existing capital.

Example

• A factory producing fans can increase output in the short period by working overtime or using existing machines more intensively.
• It cannot build a new plant immediately, so total adjustment in supply remains limited.

Other names

• Long-period price is called “natural price” by Adam Smith.
• Marshall called it “normal price”.

Definition

• A long period is a time period long enough for firms to change the size of their plant and for new firms to enter or existing firms to leave the industry.
• All factors of production become variable in the long period.

Role of demand and supply

• In the short period, demand has a relatively greater influence on price because supply cannot fully adjust.
• In the long period, supply (through cost of production) has a relatively greater influence on price because firms can fully adjust output and scale of production.
• The normal price of a commodity tends to equal its long-run cost of production, subject to the laws of returns (increasing, diminishing, or constant costs).

Cost conditions

• If the industry operates under increasing returns (decreasing costs), the long-period price may be lower than the original market price.
• If it operates under diminishing returns (increasing costs), the long-period price may be higher than the original market price.
• With constant returns (constant costs), the long-period price may be equal to the original market price.

Example

• Over several years, if demand for a product rises, firms can build new plants and new firms can enter.
• Supply expands fully; the long-period price settles around the level of long-run average cost.

Definition

• A secular period refers to a very, very long period during which all fundamental economic factors can change.
• In this period, factors like size of population, availability of raw materials, level of technology, and general conditions of capital supply can all undergo major changes.

Nature

• Because the period is extremely long, it is difficult to make precise generalisations about price behaviour.
• This period is mainly used for studying long-term trends in the economy rather than determining a specific price.

Example

• Changes in the structure of an economy over many decades, such as a shift from agriculture to industry and services, belong to the secular period.

• The time element is important because it controls how much supply can adjust to demand, and therefore how price is determined.
• In the market period, supply is fixed; demand alone determines price.
• In the short period, supply adjusts partially; both demand and supply influence price.
• In the long period, all factors are variable; cost of production and supply play the main role, giving the normal or natural price.
• In the secular period, very long-term forces change basic conditions, so no simple price rule applies.