- Markets
exist when buyers and sellers interact. This interaction determines
market prices and thereby allocates scarce goods and services. In
market economies there is no central planning agency that decides
how many different kinds of sandwiches are provided every day at restaurants
and stores, how many loaves of bread are baked, how many toys are
produced before the holidays, or what the prices will be for sandwiches,
bread, and toys. Most prices in market economies are established by
the interaction of buyers and sellers.
- A
market exists whenever buyers and sellers exchange goods and services.
The market clearing or equilibrium price for a good or a service is
the one price at which quantity supplied equals quantity demanded.
If a price is above the market clearing price, there will be a surplus
(quantity supplied exceeds the quantity demanded). The price will
fall, causing sellers to produce less and buyers to purchase more,
thus eliminating the surplus. If the price is below the market clearing
price, there will exist a shortage (quantity demanded exceeds the
quantity supplied). The price will rise, causing sellers to produce
more and buyers to consume less, thus eliminating the shortage.
- Prices
send signals and provide incentives to buyers and sellers. When supply
or demand changes (the curves shift), market prices adjust, affecting
incentives.
- An
increase in the price of a good or a service encourages people to
look for substitutes, causing the quantity demanded to decrease,
and vice versa. This relationship between price and quantity demanded
is known as the law of demand. This is true as long as other
factors influencing demand do not change.
- An
increase in the price of a good or a service enables producers to
cover more per unit costs, causing the quantity supplied to increase,
and vice-versa. This relationship between price and quantity supplied
is known as the law of supply. It holds true as long as other
factors influencing costs of production and supply do not change.
- Markets
are interrelated; changes in the price of one good or service can
lead to changes in the prices of many other goods and services.
- Demand
for a product changes (the demand curve shifts)when there is a change
in consumer's incomes or preferences, or in the prices of related
goods or services, or in the number of consumers in the market.
- Supply
of a product changes (the supply curve shifts) when there are changes
in either the prices of productive resources used to make the good
or service, the technology used to make the good or service, the profit
opportunities available to producers by selling other goods or services,
or the number of sellers in a market.
- Government-set
and enforced price ceilings set below the equilibrium price and price
floors set above the market clearing price will distort price signals
and incentives to producers and consumers. The price ceilings cause
persistent shortages, while the price floors cause persistent surpluses.
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