In the free market system, the demand and supply work and react together. The price is a key device between them.

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                BA (Hons) Business and Marketing

        (a)

In the free market system, the demand and supply work and react together. The price is a key device between them. The price determines the signalling between the two sides and acts as a balance.

Because there are too many people and the system is too complex, price provides them to try to solve the economic problems such as allocate resources

Forces within market

Free market is where demand and supply meet with each other. Suppliers (firms, individuals) offer their products and services to sell in the market. People who’s aims are demand for the products or services.

The correlation between demand and price is inverse. If the price goes up, demand decrease and if price goes down, the result is, the quantity of demand will increase (P-Q).

The direct relationship between supply and price provides that the higher the price the more quantity product or service produced by suppliers.

The two forces work against each other and it lead to determine the market price, which tends to manage both sides to find the equilibrium (D=S - PeQe).

There is normally no willingness to change this condition.

If there is a changing in demand, the curve will move to the right (D’) or to the left (D’’) –for example, the price of product or the customers taste changes (new trend, new product), their income will go up down. The new equilibrium will be defined depending on people buy more (D’- PhQ2) or less (D’’- PlQ1).

The same two circuimstance can occur with the supply curve. If there something changes will happen – for example, because technology, costs, organisational or efficiency of firm changes or government intervention- supply curve will move. Either right (S’’) where the firm produce more products (Q2) on a lower level compare with the previous price or left (S’) where the quantity (Q1) of price is less but the price (Ph) is higher compare with the previous level.

After in both cases the equilibrium price and quantity will be defined by demand and supply curves where they intersect each other.

 

        Forces between markets

Both demand and supply curves can be changed by influence of other prices in another market. The criterion is, that the two products or services must have complimentary or substitute relationship.

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For instance, if the bread price goes up – (weather fluctuation and poor harvest of wheat-) the supply curve will shift to the left (S’-Q1P1). The change in the price of bread will cause change in another good in another market.

It can be a complimentary good, butter. They relationship is inverse, so the reaction is opposite with the other. People will buy less butter because they consume them together (D’-Q2P2) and the price of butter will decrease.

If there is a substitute relationship between two goods -butter and margarine- one good attract on another. If ...

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