The price comes to settle at a level where the marginal utility to the purchaser coincides with the marginal cost of production to the producer.
This is the point of equilibrium between the forces of demand and the forces of supply. But it takes time for the equilibrium to be attained.
On the basis of time, we may distinguish four broad types of equilibrium prices:
1. Market price;
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2. Short-period price or sub-normal price;
3. Long-period price or normal price; and
4. Secular price, embodying changes occurring in a generation or so.
The importance of the time element lies in this that the price which comes to prevail depends on the time allowed for the forces of demand and supply to adjust themselves.
Effect of Increase in Demand:
Suppose demand for blazer cloth of a particular type increases all of a sudden in a market, say, Delhi. Let us study the effect of this increase in demand on its price in a day, in a month, in a year or two, and in a generation. The equilibrium price will be obviously different in all the four cases.
(i) Market Price:
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In the short period of a day, supply means the stock of blazer cloth on hand, or in sight. It cannot be increased at a short notice. The price will be settled by the marginal utility to the consumers of this cloth. When demand has increased, the market price will shoot up very high.
(ii) Short-period Price:
Given more time, the merchants of Delhi will obtain blazer cloth from Bombay, Calcutta or elsewhere. This will increase supply, and lend to depress the price to a certain extent. But, if the demand still remains unsatisfied, the price will not go down to its previous level. In this period, too which may be called the short period, marginal utility still plays an important part in the determination of price, as the supply is comparatively fixed.
(iii) Long-period Price:
In the longer period of a year or two, supply will also include what can be produced by new looms which can themselves be profitably produced and put to use. Thus more blazer cloth will be manufactured on new and better looms. The supplementary or fixed costs, being spread over a larger output, will bring down the cost per unit, and permanently bring down the price of blazer cloth in Delhi. During this long period, the normal price will be influenced by the marginal cost of production and not the demand, as that is known and allowed for.
(iv) Secular Price:
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The secular period is long enough to allow changes caused by the growth of technical knowledge, of population, of capital, of techniques and of standards of living to adjust themselves. The changing conditions of demand and supply from one generation to another have ample time to settle down. It is possible that prices will go down still further as a result of the introduction of new labour-saving devices and a general improvement in the methods of production.