Understanding Price Determination In a market economy, prices are determined by the interaction of supply and demand. This process helps allocate scarce resourc...
In a market economy, prices are determined by the interaction of supply and demand. This process helps allocate scarce resources efficiently and establishes market equilibrium.
Demand represents the quantity of a good or service that consumers are willing and able to buy at various price levels. As prices decrease, quantity demanded tends to increase, and vice versa (the law of demand).
Supply represents the quantity that producers are willing and able to sell at different price levels. As prices increase, quantity supplied tends to rise, and vice versa (the law of supply).
The market equilibrium price is the price at which the quantity demanded equals the quantity supplied. At this point, the market clears, and there is no shortage or surplus.
Problem: In a market for widgets, the demand curve shows that 100 units will be demanded at $5 each, and 50 units at $8 each. The supply curve shows that 50 units will be supplied at $5 each, and 100 units at $8 each. Find the market equilibrium price and quantity.
Solution:
At the equilibrium price, resources are allocated efficiently to those who value them most. Prices act as signals, guiding production and consumption decisions. Any surplus or shortage leads to price adjustments, restoring equilibrium.
However, market failures like externalities, public goods, and imperfect competition can prevent efficient resource allocation. In such cases, government intervention may be necessary.
To learn more, refer to BBC Bitesize on Price Determination and Tutor2U on Price Determination.