Supply, Demand and Equilibrium Price

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 increases (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 supply variation according to a variation of price P. This function is characterized by a directly proportional curve where supply increases as the price increases. 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 regarding demand or supply (moving curves D or S to the left or the right) will change the equilibrium price.