Markets, Equilibrium, and Prices

How do you know when the price is “right”?


In a free market, demand and supply automatically move prices to equilibrium, the point at which quantity demanded equals quantity supplied.

What happens when demand meets supply? Demand and supply interact to drive prices for goods and services to the equilibrium level. On a graph, this equilibrium point is found at the intersection of the demand and supply curves. The equilibrium price, also known as the market-clearing price, may be thought of as the “right” price.

What happens when the price isn’t “right"? Disequilibrium occurs when prices are set above or below the equilibrium price. When prices are too low, excess demand leads to shortages. When prices are too high, excess supply leads to surpluses.

How do shifts in supply or demand affect markets? Many kinds of events can cause demand and supply curves to shift to the right or left. Markets adjust to such changed conditions by seeking a new equilibrium point.

What role do prices play in a modern mixed economy? Prices convey information to consumers and producers as to what to buy and produce. Prices motivate workers and firms to enter markets, and they help markets respond to changing conditions. They guide resources to their most efficient uses.

How does government intervention affect markets? Governments sometimes implement price controls when prices are considered unfairly high for consumers or unfairly low for producers. Price floors, such as minimum wage laws, prevent prices from going too low, but lead to excess supply. Price ceilings, such as rent control laws, prevent prices from going too high, but lead to shortages