In a market economy, the allocation of scarce resources is primarily driven by the interaction of buyers and sellers. This interaction determines the prices of goods and services, which in turn signal how resources should be used.
Roles of Buyers
Buyers are individuals or businesses who purchase goods and services. Their decisions are based on their wants, needs, and the prices they are willing to pay.
Demand: Buyers express their willingness and ability to purchase a good or service at different prices. The demand curve shows the inverse relationship between price and quantity demanded (as price increases, quantity demanded decreases).
Consumer Sovereignty: The collective choices of consumers significantly influence what goods and services are produced. Businesses respond to consumer demand to maximize profits.
Price Sensitivity: Buyers' willingness to change their consumption in response to price changes is known as price sensitivity.
Roles of Sellers
Sellers are individuals or businesses who offer goods and services for sale. Their decisions are influenced by the prices they can receive and the costs of production.
Supply: Sellers express their willingness and ability to offer a good or service for sale at different prices. The supply curve typically shows a direct relationship between price and quantity supplied (as price increases, quantity supplied increases).
Profit Maximization: Sellers aim to maximize their profits by producing and selling goods and services at prices that cover their costs and generate a surplus.
Competition: The number of sellers in a market influences the price and quantity of goods and services offered.
Interaction of Buyers and Sellers
The interaction of buyers and sellers in the market leads to the determination of market equilibrium. This occurs where the quantity demanded equals the quantity supplied.
Price Level
Quantity Demanded
Quantity Supplied
Market Equilibrium
High
Low
High
Shortage
Medium
Medium
Medium
Equilibrium
Low
High
Low
Surplus
At the market equilibrium price, the quantity of goods and services that buyers want to purchase is equal to the quantity that sellers are willing to supply. This price is known as the equilibrium price, and the corresponding quantity is the equilibrium quantity.
Changes in factors affecting demand or supply will lead to shifts in the demand and supply curves, resulting in new equilibrium prices and quantities.
Suggested diagram: A standard supply and demand curve illustrating the concept of market equilibrium.
Factors Affecting Demand and Supply
Several factors can influence the demand and supply curves:
Factors Affecting Demand:
Income: Changes in consumer income can affect the demand for normal and inferior goods.
Prices of Related Goods: The prices of substitute and complementary goods can impact demand.
Consumer Tastes and Preferences: Changes in consumer tastes can shift demand.
Expectations: Expectations about future prices or income can influence current demand.
Population: A larger population generally leads to higher demand.
Factors Affecting Supply:
Cost of Production: Changes in the cost of inputs (e.g., wages, raw materials) affect supply.
Technology: Improvements in technology can increase supply.
Expectations: Expectations about future prices can influence current supply.
Number of Sellers: More sellers in the market increase supply.
Government Policies: Taxes and subsidies can affect supply.