The Market Mechanism – Supply and Demand Chapter 3 The Market Mechanism – Supply and Demand An Introduction To Pricing

The Market Mechanism The demand for a product means the number of units of the product that people are willing to buy at a given market price. The supply of a product means the number of units of the product that producers are willing to make available for sale at a given market price. The price of any product, in the long run, is determined by the interaction of the supply of and the demand for that product.

The Market Mechanism D > S  P S > D  P The price of a product will go up if the demand for it is greater than its supply. D > S  P The price of a product will go down if the supply of it is greater than the demand for it. S > D  P

The Market Mechanism People (consumers) tend to buy more units of a product at a low price than at a high price, as the product gives better value for money at the low price. Therefore, as the price of a product goes up consumers tend to buy fewer units of it and vice versa. This is normally shown on a demand curve, which is a simple graph showing the number of units of a good consumers are willing to purchase at any given price at any given time.

Demand Curve Example of a demand curve showing the demand for a product at €5 and at €3. Price Quantity D €5 €3 10 20

The Market Mechanism As the price of a product goes up, producers tend to increase the supply of it as it becomes more profitable to do so. Therefore, as the price of a product goes up producers tend to supply more units of it and vice versa. This is normally shown on a supply curve, which is a simple graph showing the number of units of a good made available for sale at any given market price at any given time.

Supply Curve Example of a supply curve showing the supply of a product at €5 and at €10. S Price Quantity €10 €5 4 7

The Market Mechanism Therefore, when the number of units of a product available for sale (supply) is equal to the number of units that people want to purchase (demand), price will stabilise. This price is the market price. Therefore, the price of a product is determined by the interaction of the supply of and the demand for it.

The Market Mechanism D2 If the demand for this product increases, it will lead to a new market price. D S Price Quantity €9 €7 6 8

The Market Mechanism and Consumer Surplus An individual consumer may be willing to pay a price higher than the market price rather than do without a product. In this case he or she is receiving a consumer surplus. Thus consumer surplus is the difference between the market price and the higher price a consumer would be willing to pay for a product rather than do without it.

The Market Mechanism Therefore, to understand how prices are determined we must understand the factors that govern the demand for and supply of goods.