How Prices are Determined in a Market In a market economy, prices are determined by the interaction of supply and demand. This price determination process ensur...
In a market economy, prices are determined by the interaction of supply and demand. This price determination process ensures efficient allocation of resources and establishes market equilibrium.
Supply refers to the amount of a good or service that producers are willing and able to sell at various price levels over a given period. Demand represents the quantity that consumers are willing and able to purchase at different prices.
The law of supply states that, all else being equal, as the price of a good rises, the quantity supplied increases, and vice versa. The law of demand posits that as the price of a good falls, the quantity demanded rises, and vice versa.
Market equilibrium occurs when the supply and demand curves intersect, establishing the equilibrium price and equilibrium quantity. At this point, the quantity supplied equals the quantity demanded.
Problem: In a market, the supply curve is Qs = 20 + 2P, and the demand curve is Qd = 80 - 4P. Find the equilibrium price and quantity.
Solution:
At the equilibrium price and quantity, resources are allocated efficiently. Consumers purchase the quantity they demand at the market price, and producers supply the quantity that maximizes their profits.
Any deviation from equilibrium creates shortages or surpluses, signaling the need for price adjustments. Market forces seek to restore equilibrium, ensuring efficient allocation of resources.
However, market failures such as externalities, public goods, and imperfect competition can lead to inefficient allocation. Government intervention through taxes, subsidies, or regulations may be necessary to correct these inefficiencies.