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 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) 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 (moving curves D or S to the left or the right) will change the equilibrium price.
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