Price Determination & Equilibrium
Price Determination
- In a free market economy, prices are determined by the interaction of demand and supply in a market
- A market is any place that brings buyers and sellers together
- Markets can be physical (e.g. Waterstones) or virtual (e.g. eBay)
- Buyers and sellers meet to trade at an agreed price
- Buyers agree the price by purchasing the good/service
- If they do not agree on the price then they do not purchase the good/service and are exercising their consumer sovereignty
- Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties
- At the equilibrium price, sellers will be satisfied with the rate/quantity of sales
- At the equilibrium price, the utility/price combination is maximised for the buyers
Equilibrium
- Equilibrium in a market occurs when demand = supply
- At this point the price is called the market clearing price
- This is the price at which sellers are clearing their stock at an acceptable rate
A graph showing a market in equilibrium with a market clearing price at P and quantity at Q
- Any price above or below P creates disequilibrium in this market
- Disequilibrium occurs whenever there is excess demand or supply in a market
- Disequilibrium occurs whenever there is excess demand or supply in a market