Time Periods and Price Fixation Time Element
Time element plays an important role in economics. Modern economists
divide time periods into short period and long period. The equilibrium price
acquired above is valid only for a particular time period. Any change in demand
and supply over a period of time will shift the demand and supply curves and
different equilibrium will be obtained. For instance, the flexibility of a firm in
adjusting its production to meet the change in demand depends on the nature of
its inputs. There are two types of inputs namely fixed inputs and variable inputs.
The fixed input is one whose quantity cannot be adjusted in a limited time period.
Heavy machinery, buildings and capital equipments are such fixed inputs and they
may need more time for installation or replacement.
However, variable inputs like labour, raw materials and electricity can be
changed quickly to change the supply until the full plant capacity is reached. Now
it is possible to distinguish between short period and long period. The short period
for a firm is the time period during which at least one of the inputs is fixed input.
The long period is the time period during which all the inputs are variable inputs.
The specific duration of the short period and long period will vary from firm to
firm.
A small Bonda stall on the roadside pavements can easily variable. The seller
can install one more stove, use more oil and other ingredients of Bonda within a
day to meet any sudden increase in demand. Hence, for him the duration of long
period can even be a single day. On the other hand, installation of a specialized
machinery for the Ariyalur cement plant may take years, because the production,
transportation, installation require a long period of time.
Price Fixation in the Short Period
Alfred Marshall introduced time element in the determination of equilibrium
and divided them into market period, short period and long period.
Market Period
Market period is the period during which the ability of the firms to affect any
changes in supply in response to any change in demand is extremely limited or
almost nil. Thus supply is more or less fixed in the market period without any
change. However, the demand may vary during this period.
The equilibrium price will be determined according to the changes in
demand, given the fixed supply. Figure 5.4 explains the equilibrium price in market
period. As the supply is fixed in the market period, it is shown as a vertical line
SMP. It is also called as inelastic supply curve. When demand increases from DD
to D1D1, price increases from P to P1. Similarly, a fall in demand from DD to
D2D2 pulls the price down from P to P2. The market for perishables can be a
good illustration. The demand for plantain fruits increases during the festival
season, so the prices will naturally go up as the supply cannot be increased
immediately to meet the demand. Thus, demand determines the equilibrium price
in the market period.
Short period
As mentioned earlier short period is the one during which at least one of the
factors will be a fixed input and the supply will be adjusted by changing the
variable inputs. The equilibrium price will be determined by adjusting supply
(within the plant capacity) according to the changes in demand (Figure 5.5) SSP is
elastic implying that supply can be increased by changing the variable input. Note
that the corresponding increase in price from P to P1 for a given increase in
demand from D to D1 is less than that of the market period. It is because; increase
in demand is partially met by the increase in supply from q to q1. Thus during the
short period both demand and supply exert their influence on price and the
equilibrium price is determined accordingly.
Long Period
In the long period supply can be changed by changing all the inputs (both the
fixed and variable inputs). Any amount of change in demand will be met by
changing the supply, to the extent of changing the plant, machinery and the
quantum of technology. In figure 5.6, the long period supply curve SLP is more
elastic and flatter than that of the SSP. This implies the greater extent of flexibility
of the firms to change the supply. The price increases from P to P2 in response to
an increase in demand from D to D1 and it is less than that of the market period
(P1) and short period (P2). It is because the increase in demand is fully met by the
required increase in supply. Hence, supply plays a significant role in determining
the lower equilibrium price in the long run.