Market mechanism
The interaction of demand and supply, resulting in an equilibrium quantity and price being set by the market.
When demand exceeds supply, market prices are likely to rise.
When supply exceeds demand, market prices are likely to fall.
When demand and supply are equal, market prices are likely to remain stable.
The mechanism described above is a result of the interaction of the demand curve and the supply curve in a given market.
Example 1: Demand exceeds supply
When demand exceeds supply, sellers will run out of stock and realise that they can sell the goods at a higher price.
Sellers will increase their prices accordingly.
This will cause demand to fall.
It will also cause supply to increase.
Demand will continue to fall, and supply will continue to increase, until demand and supply are equal.
At this point prices will in theory be stable, because the previous imbalance of demand and supply has been eliminated.
Example 2: Supply exceeds demand
When supply exceeds demand, sellers will be unable to sell all their stock.
Sellers will have to cut their prices to reduce stock.
This will cause demand to rise.
It will also cause supply to decrease.
Demand will continue to rise, and supply will continue to fall, until demand and supply are equal.
At this point prices will again in theory be stable.
