How Price is Determined

The price of a good tells us the value of that product in terms of money. A rational consumer will try to get the greatest value for money spent on goods and services. He will therefore weigh and compare the prices of commodities before making a decision to purchase.

Prices in a market economy are determined by the level of demand and the level of supply for each particular product.

The demand for a particular product is the amount that consumers are willing and able to buy at a given price. The law of demand states that when prices are high demand will fall and when prices are low demand rises ceteris paribus (meaning all other things remaining unchanged.).

The supply of a particular commodity is the amount that firms are willing and able to supply at a given price. When prices are high supply will rise and when prices are low supply fall. Suppliers are willing to sell more at higher prices as profits will be high, and unwilling to sell large quantities when prices fall because of low profit margins.

The equilibrium price in a particular market is the price at which consumers and suppliers are willing to trade a certain quantity of a commodity. For example, consumers are willing to buy 55 litres of milk at $3 and suppliers are willing to supply 55 litres at that price. If the price increases to $4 there will be a fall in demand to 30 litres as some consumers are not willing to buy milk at this price.

Illustrating Price Equilibrium

The demand and supply curves are drawn from the demand and supply schedules. Price is measured on the vertical axis and quantity on the horizontal axis.  The demand curve slopes downwards from left to right and the supply curve slopes upwards from left to right.  The intersection of the two curves indicates the equilibrium price and quantity.

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