interaction of markets

• Free market


  A market free from government intervention where buyers meet suppliers to exchange goods and services
• Equilibrium


  The point where demand equals supply
• Disequilibrium


  Where demand does not equal supply
• Equilibrium represents allocative efficiency as supply perfectly matches consumer demand
• Free market/Price mechanism


  • Has special functions to always return the market to equilibrium
• Functions of the price mechanism

  1. Allocate scarce resources efficiently

  2. Signal excess demand or supply

  3. Incentivize producers to increase or decrease output

  4. Ration scarce resources by encouraging or discouraging consumption
• Excess demand


  Leads to upward pressure on prices
• Higher prices


  Signal excess demand, incentivize increased supply, and ration demand
• Excess supply


  Leads to downward pressure on prices
• Lower prices


  Signal excess supply, incentivize decreased supply, and encourage demand
• The price mechanism always returns the market to equilibrium
• Applying the same principles to shifting demand and supply curves fully explains how free markets work