Strange help needed

A strange thought, please help me with this one.

Now, we know that in ceteris paribus condition with the rise in price of the commodity, the demand decreases. So, no supplier would want to see the demand for his commodity decreasing so he/she would decrease his/her supply. But in ceteris paribus condition, the supply of a commodity increases with the increase in price because it becomes comparatively more attractive to sell. Both these statements are contradicting each other but only one can be true. It seems like then there is some flaw in the definition of ceteris paribus I am making but what is it? I am not able to find any so please help. There is nothing like, "It is subjective" because then that too would be a determinant which is neglected in ceteris paribus condition.

Definition of ceteris paribus:- All the other determinants except own price of rhe commodity is kept constant.

#QuantitativeFinance

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Comments

I'm going to try Raghuram Rajan's Dosanomics, so this might be cringe-y. I'm also using basic assumptions like there is perfect competition and the there are multiple suppliers and buyers.

So, no supplier would want to see the demand for his commodity decreasing so he/she would decrease his/her supply.

There are two points you need to consider here.

When a Dosa seller enters the market, what is his primary motive? Does he really care if everyone in the world are Dosa fans, or almost everyone hates Dosas, as long as he has customers? Sure the first scenario might be beneficial to him, but is his primary motive to make everyone in the world Dosa fans?
There a lot of people who sell Dosas. So any individual Dosa seller's contribution to the market is pretty negligible. If he cuts his supply, the total supply of Dosas will effectively be the same. So will a Dosa seller cut his supply in an attempt to reduce supply? Any decision the Dosa Seller will take is to serve his primary motive.

So anyway, if I wasn't able to get point across, my basic argument is that 1. Firms are profit maximizing, not demand maximizing. 2. Firms do not attempt to change global supply and demand since they can't.

It's also easy to see why an increase in price results in an increase in supply by firms.

Suppose there is a Dosa seller Ram. It costs him Rs 3 to make a Dosa and he earns Rs 5 per Dosa. He also can only make 50 Dosas per day, so his total profit is Rs 50(5-3) = 100 per day.

He could make 50 more Dosas per day by hiring another person Shyam to help him make Dosas, but he takes Rs 150 as wages. So if Ram hires Shyam, his profit would only be 100(5-3) - 150 = 50 per day. So he does not hire Shyam. And the total number of Dosas he makes is 50.

But if the price suddenly rises to Rs 10, then Ram can afford to hire Shyam since his profit if he hires Shyam is Rs 100(10 - 3) - 150 = Rs 550, and without Shyam is only Rs 50(10 - 3) = Rs 350. So therefore, the total number of Dosas, he makes now is 100.

Siddhartha Srivastava - 5 years ago

Nice clear explanation and nice argument with examples (+1) but there is still some confusion :- Are all firms profit maximising. Usually it is and this is a determinant of demand and in ceteris paribus condition all other determinants except price are kept constant so maybe it has to be defined it the definition that it is valid for all "profit-maximising" firms and not "welfare-maximising" firms like a government of a socialist economy.

Ashish Menon - 5 years ago

@Abhay Tiwari @Rohit Udaiwal @Jason Chrysoprase anyone?

Ashish Menon - 5 years ago

@Sambhrant Sachan @Hung Woei Neoh @Samara Simha Reddy anyone?

Ashish Menon - 5 years ago

I'm not good at Quantitative Fianance, i even don't know what is ceteris paribus, but that must have something to do with demand and supply.

Jason Chrysoprase - 5 years ago

same situation here , i suck at quantitative finance :( .

Sabhrant Sachan - 5 years ago

@Sabhrant Sachan – Nah, not like that bt this is a bit of logical question so I asked. :/ I have learnt QF in my lower grades so I like it. XD

Ashish Menon - 5 years ago

@Ashish Menon – Based on what I learned from economics:

The law of demand: All else equal, when the price of a good increases, the quantity demanded decreases.

Note that quantity demanded is different from demand. Quantity demanded refers to the quantity people are willing and able to buy at a particular price level. Demand is all the different quantities demanded at different price levels. In simpler terms, quantity demanded refers to a point on the demand curve. Demand on the other hand refers to the entire demand curve.

The same thing applies to supply, quantity supplied and law of supply.

Now, imagine if the price of a good increases. The quantity supplied will increase because it is more profitable to sell the goods now. However, the quantity demanded will decrease because, well, you understand why. Then, you will have this situation:

where suppliers produce more goods than what consumers are willing and able to buy.

This leads to a surplus, which is noted as $Q_2 - Q_1$ in the graph above.

When suppliers have a surplus, it leads to losses and so on, which causes the suppliers to reduce the price of that good, pushing the price back to the equilibrium.

This is an example of how the invisible hand in the market balances things out.

Note: This is a simple, basic analysis based on what I've learned in my introductory courses for Macroeconomics and Microeconomics.

Hung Woei Neoh - 5 years ago

@Hung Woei Neoh – Ok, so your point is that when price of a commodity increases supply increases and you assume that production would increase and due ro excess production, the cost would decrease and thus demand would increase. But that is an exception of the general law of demand :/ Ceteris paribus is of no use in exceptions, right?

Ashish Menon - 5 years ago

@Ashish Menon – Nope. First, quantity supplied will increase. This is different from supply increasing. If supply increases, the entire graph moves to the right. Now, it's only moving to a different point on the graph.

Next, based on economic theories, rational people think at the margin and they respond to incentives. Now, we are assuming that all else are equal. This means that cost of productions remain the same. When the price increases, the profit maximization point on the cost curve shifts to a point where the quantity is higher (this would be easier to understand if you study Microeconomics and learn Costs of Production). As rational people, we compare marginal benefits against marginal costs, and make changes if marginal benefits are higher than marginal costs. In this case, increasing the production increases marginal benefits (profit), therefore suppliers increase the quantity supplied.

Now, when this happens, people naturally will buy less. The quantity demanded reduces. Which leads to the surplus mentioned above. This causes prices to drop, and the quantity supplied and demanded will be eventually pushed back to the equilibrium.

Of course, this analysis is based on the assumption that firm planners and executives are rational people who make decisions based on these theories. I only took introductory courses, so I can only work with these assumptions.

There is an entire field of economics called "Behavioral Economics" which analyzes situations where people pick the "less rational" decisions and why they do so.

Lastly, I just noticed this: if you don't want demand to drop, you reduce the price, not the supply.

Hung Woei Neoh - 5 years ago

@Hung Woei Neoh – Yes that is correct demand curve shifts ro the right if any other determinant other than own price changes. Lol you are going for cardinal and marginal analysis of the demand curve, I just ask logically XD Anyways nice explanation. Maybe the flaw is in the determinants section and not in ceteris paribus section.

Ashish Menon - 5 years ago

@Ashish Menon – Nah, I think I just didn't focus on what you were asking. And this is everything I've learned from my introductory courses.

And I think it's the logic you used. To avoid quantity demanded from dropping, firms will reduce prices. The price level affects the quantity demanded. The quantity supplied will affect the price level, which then affects the quantity demanded

Hung Woei Neoh - 5 years ago

@Hung Woei Neoh – But I have learnt that with the increase it price it becime relatively mpre attactive to sell so the supply increases. :/

Ashish Menon - 5 years ago

@Ashish Menon – Exactly. Since when price increases, firms can earn more profits. Therefore, firms will increase quantity supplied. It's the most rational thing to do.

Hung Woei Neoh - 5 years ago

@Hung Woei Neoh – But this contradicts to the first statement :/

Ashish Menon - 5 years ago

@Ashish Menon – I don't think suppliers are really concerned about that. After all, who knows, people might still buy, and you might just earn more.

Note: I am not really certain about this. After all, I'm not majoring in finance or economics

Hung Woei Neoh - 5 years ago

@Hung Woei Neoh – Haha thats no issue, its just a logical doubt. I just applied the rules i learnt and asked. Maybe it is true that suppliers are not concerned about that

Ashish Menon - 5 years ago

@Ashish Menon – Umm, after you solve this, you wanna try my geometry problem?

Jason Chrysoprase - 5 years ago

@Jason Chrysoprase – Yeah sure

Ashish Menon - 5 years ago

@Ashish Menon – Well, LOL, i don't like it XD

Jason Chrysoprase - 5 years ago

@Jason Chrysoprase – Well, your passion. I love share markets and want to know more XD.

Ashish Menon - 5 years ago

Many things will afect demand of a customer right. Now if we keep all those factors constant except he price of the good, then the condition is described as ceteris paribus condition.

Ashish Menon - 5 years ago

Math	Appears as
Remember to wrap math in `\(` ... `\)` or `\[` ... `\]` to ensure proper formatting.
`2 \times 3`	$2 \times 3$
`2^{34}`	$2^{34}$
`a_{i-1}`	$a_{i-1}$
`\frac{2}{3}`	$\frac{2}{3}$
`\sqrt{2}`	$\sqrt{2}$
`\sum_{i=1}^3`	$\sum_{i=1}^3$
`\sin \theta`	$\sin \theta$
`\boxed{123}`	$\boxed{123}$