Supply, Demand and Equilibrium Price
According to conventional economic theory market price is fixed by
the following mechanism:
- Demand. The demand curve D illustrates the variation
of a demand Q in relation to the variation of a price P. This function
is often characterized by an inversely proportional curve where demand
drops when the price goes up (and vice-versa). If the price of a
good or service is too high (P1), the demand drops (Q1) while in
the opposite situation (low price; P2) the demand grows (Q2).
- Supply. The supply curve S illustrates a variation of
supply according to a variation of price P. This function is characterized
by a directly proportional curve where supply increases as the price
goes up. Supply grows (Q1 to Q2) when the price increases (P1 to P2)
since profits would be higher.
- Equilibrium Price. The intersection of the demand curve D and the
supply curve S represents the equilibrium price Pe where a quantity
Qe of goods will be sold. Changes in the market in terms of
demand or supply (moving curves D or S to the left or the right) will change the equilibrium price.