Market mechanisms

Market mechanisms
See also


Market mechanism is a process through which market economy functions. A market economy functions through the market forces of demand and supply. The demand and supply forces interact to determine the price of goods and services. Thus, a price system is generated. Prices perform two functions in the market system. First, prices serve as signals for the producers to decide "what to produce" and for the consumers to decide "what to consume" and "how much consume". Secondly, prices force the demand and supply conditions to adjust themselves to the prevailing prices [1].

Functions of the market mechanism

Market mechanisms answers the questions that come from the market [2] [3] [4] :

  • What to produce? - the goods and services that are produced in a market economy are determined by customer demand. The mechanisms through which individual values and interests are aggregated to make "consumer demand" is basewd on purchases. The consumer is "sovereign" in a free enterprise economy. Each penny a consumer spends on a commodity is treated as vote for producing that commodity. Continuing demand is a continuous process of voting. Increasing demand for a good causes increase in its price. Rise in price increases profit margin. The profit- seeking producers will concentrate on the production of this commodity, If they produce a commodity that is not in demand, it will go waste and their profit motive will be defeated.
  • How to produce? - is the question of choice of technology. Here technology means the technical combination of labour and capital. The proportion of labour and capital used to produce a commodity is also determined by the market forces, the supply of a demand for labour and capital. Firms produce for making profit and try to maximize it. It requires, among other things, minimizing cost of production. Cost can be minimized by using a factor combination that minimizes production cost. If labour is cheaper than capital then more of labour and less of capital is used to produce a commodity. On the contrary, if capital is cheaper or more productive, more of capital and less of labour is used. In fact, cost-minimizing firms combine labour and capital in such a proportion that minimizes the cost of production for a given output.
  • How much to produce? - market system forces - demand and supply- determine the quantity of a commodity that firms have to produce, given their objective of profit maximization. If the firms produce less than the quantity demanded, they leave out the prospect of selling more and making more profit. If firms produce more than quantity demanded, supply exceeds the demand. As a results, the price of their product goes down. Decrease in price reduces the profit margin (given the cost) or may even result in losses. So the firms cut down their production to match with market demand.

Equilibrium price on the market

The market equilibrium is found at the point at which the market supply and market demand curves intersect. The price at the intersection of the market supply curve and the market demand curve is called the equilibrium price, and the quantity is called equilibrium quantity. At the equilibrium price, the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce [5].

References

Footnotes

  1. Dwivedi D.N. (2008)
  2. Dwivedi D.N. (2016)
  3. Avant D.D. (2005)
  4. Walsh K. (1995)
  5. Sexton R.L. (2014)

Author: Aldona Pająk