Economic Effects of Low Prices in Markets

READERS QUESTION: how low price can affect the market?

This depends on several factors. Firstly it depends why there is a low price in the market.

1. Increase in supply, inelastic demand.

Many agricultural markets have an inelastic demand. For example, if the price of potatoes falls, people won’t particularly want to eat more potatoes. Therefore, if there is an increase in supply of potatoes we get a fall in price, but, only a very small increase in demand. Therefore, this leads to lower revenue for potato farmers.

Diagram for inelastic Demand 

If the low price continues for a long time, farmers may go out of business. As farmers go out of business supply will fall and the price will start to rise.

However, agricultural markets are often volatile, low prices may be followed by high prices the next year. Therefore governments often try to buffer farmers incomes during periods of low prices (this is the rationale behind the CAP)

2. Improved Technology

If low prices are caused by improved technology, firms may not be negatively effected. This is because the lower prices are a result of a reduction in costs. Therefore, their profit margins may be maintained.

3. Falling Demand

Lower prices may also be caused by falling demand. In this case, firms will be encouraged to leave the market because the market is declining and profits will be falling.

By on November 12th, 2007