DEMAND AND SUPPLY
How Are Prices Determined?
If an economy runs on the lines of the purely competitive market of free enterprise, then what is produced and the prices at which the products are sold depend upon the choices and decisions made by consumers and producers. It is the price mechanism which makes known to firms what and how much should be produced.
The price mechanism is the process by which prices rise and fall as a result of changes in demand and supply, and thereby acts as a signal to producers to guide them on their production plans. This process is most easily seen in the way in which prices for fruit and vegetables fluctuate according to changes in supply due to seasonal climatic variations and the difficulty of storing a surplus. Sometimes during a good season for citrus fruits so many oranges are produced that there is a glut, and the growers find that the low prices they receive do not cover their costs of transporting the fruit to market; sometimes the fruit-growers allow people to pick all they want, free, or allow the fruit to rot.
If our economy were entirely competitive and there were no restrictions at all, then the market forces, or price mechanism, would operate freely. The only things that would be produced would be those goods for which consumers were willing to pay sufficient to make it worthwhile for the producers to put them on the market. The demand for a product and the price at which it can be sold indicate to the producer the best way to allocate resources in order to make a profit.
When speaking of demand for a commodity, economists mean the quantity which buyers are willing to purchase at a given price over a given period of time. Demand in an economic sense only exists if the consumers have the money to buy the goods and are willing to pay for them. This is then called effective demand, and means a desire to obtain an article accompanied by the ability and willingness to pay for it at the price asked. In economics, when we speak of demand, we are usually referring to effective demand.
