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Question
Equilibrium price of an essential medicine is too high. Explain what possible steps can be taken to bring down the equilibrium price but only through the market forces. Also explain the series of changes that will occur in the market.
Solution
If the equilibrium price of an essential medicine is too high then the price can be reduced by increasing the supply of the commodity. This can be explained with the help of the following diagram.
In the above diagram, we can see that the demand and supply forces intersect at each other at point E. This is initial the market equilibrium with equilibrium price at P and equilibrium quantity at Q.
Now let us suppose that there is an increase in the supply of the commodity. This increase will shift the supply curve towards right from SS to S1S1 . Holding the demand constant, at the initial price OP, we can observe that there will be an excess supply. This excess supply will increase competition among the producers and consequently they would be willing to sell their output at a lower price. The price now, will continue to fall until it reaches OP1 , where the new supply curve intersects the initial demand curve. This new equilibrium will be established at E1 with the new equilibrium price at OP1. Thus, we can observe that the equilibrium price has fallen from P to OP1.
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