1.2.6 Price Determination (Micro)

How are prices set in a free market

In a free market economy, prices are determined by the interaction of demand and supply in a market

What is a market

Any place where buyers and sellers come together to trade goods or services.

What type of markets exsist

• Physical markets (e.g. Waterstones)

• Online markets (e.g. eBay)

How is price agreed in a market

Buyers show agreement by purchasing the product.

What if buyers dont agree with the price

They don’t buy, showing consumer choice (consumer sovereignty).

How do sellers respond to buyers

Sellers adjust prices over time based on demand until a balance is reached.

What is equilibrium

The point where demand equals supply.

What happens at equilibrium

• Sellers sell goods at a steady and acceptable rate

• Buyers get maximum satisfaction for the price they pay

Why is equilibrium important

It creates a stable market with no shortages or surpluses.

What is disequilibirum

When demand does not equal supply.

When does disequilibrium happen

When prices are too high or too low.

The two types of disequilibirum

• Excess demand (shortage)

• Excess supply (surplus)

What is excess demand

When demand is greater then supply.

Why does excess demand happen

• Prices are too low

• Demand increases quickly

What problems occur because of excess demand

• Increase in product pricing, as there is more demand then there is supply

• Costumers not being able to afford the good or service anymore

How does the market fix excess demand

• Sellers increase prices

• Demand falls (fewer people buy)

• Supply rises (firms produce more)

• Market returns to equilibrium

What is excess supply

When supply is greater than demand.

Why doe excess supply happen

• Prices are too high

• Demand falls

What problems occur becasue of excess suply

• Unsold goods (surplus)

• Sellers lose money, as they have to reduce the price of their good or service. Less revenue.

How does the market fix excess supply

• Sellers lower prices

• Demand rises (more people buy)

• Supply falls (less is produced)

• Market returns to equilibrium