The mechanism of the market consists of three main elements: demand, supply, and prices. The system of prices for goods and services is based on the preferences of buyers and sellers. To develop an effective pricing policy of a company, it is necessary to provide a comprehensive analysis of factors affecting the price level. The main of them is demand for products, state regulation of prices, the costs of production and sales, competition and other factors. Among the many prices (price scale), there is only one for which sellers are willing and are able to buy and sellers are willing to provide a certain number of goods. It is called the equilibrium price. In any price that is above or below equilibrium, there is a gap between supply and demand (Beranek). In the modern theory of price formation, a central place is occupied by the theory of prices, which comprehensively examines the effect that different factors have on the price by changing supply and demand. Price movement in the modern industry is a result of a complex set of factors such as changes in labor productivity and production efficiency, the cyclical nature of reconstruction, the state of the monetary system and balance of payments, the nature of government regulation, etc. In a market economy, the pricing mechanism largely depends on the balance of supply and demand. Heakel considers price “a reflection of supply and demand.” The purpose of the paper consists in studying the relationship between supply, demand, and prices, as well as their interaction. Supply growth has an indirect effect on prices, while an increase in demand has a direct effect on the prices.
Impact of Supply and Demand on Prices
The excess supply of goods will cause lower prices, while the lack (deficit) of them will increase prices. The rise of excess goods causes a reduction in prices. A price that is above the equilibrium price encourages producers to manufacture more but reduces the desire of consumers to buy this product by switching their demand to other goods. As a result, the excess supply of the product occurs in the market. However, this situation cannot continue permanently. The presence of excess goods will encourage producers to lower prices (Beranek). Consequently, the price could fall even below the equilibrium. In accordance with the new process, manufacturers will offer a much smaller quantity, but the number of buyers who are willing to purchase this product will increase. In other words, the demand will exceed supply and a deficit will occur. In turn, competition among buyers will lead to higher prices, but the growth rate will encourage producers to increase the production of goods. This will continue as long as the price does not coincide with the number of goods that producers are willing to produce and sell at the same price (Heakel). This will be the equilibrium price, and the volume of production will be called the equilibrium quantity. In this case, the action has the function of balancing prices. The essence of this feature is that competitive forces of supply and demand are able to reach such a price level at which decisions on the purchase and sale will coincide in time and place. The proposal of goods is a result of the manufacturing process; it reflects the desire and ability of the seller to sell a certain number of goods (services) at a certain price. There are other features in prices: information, organizing, regulating, sanitizing (encouraging the most efficient use of available resources), etc. There are also non-price related factors of demand that consequently influence the price. They include changes in technology. More advanced equipment and technology help to reduce production costs and increase output at the same cost. Another factor is the changes in resource prices. Increased resource prices increase the cost of production and sales, lower revenues and interest of sellers. Changes in taxes also influence prices. Thus, an increased number of taxes reduces supply since it increases costs and reduces the incentives of the manufacturer. Changes in subsidies encourage the growth of the proposal.
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The price depends on the balance of supply and demand. In simple cases, there are changes in demand or supply. In complex cases, supply and demand change simultaneously. First, in some complex cases, while the offer is growing, the demand is reducing. Thus, there is a decrease in the equilibrium price. Secondly, the offer may be reduced while the demand is growing. In this case, there is an increase in the equilibrium price due to the changes in supply and demand. Changing the equilibrium amount may vary. As in the first case, it depends on the balance of supply and demand changes. Thirdly, supply and demand may be growing at the same time. In this case, the equilibrium price affects two opposite trends: an increase in supply in the direction of lowering the price; demand growth in the direction of increasing prices. In case of a reduction of supply and demand, the impact on the equilibrium rate is indefinite. If the volume of supply reduction is over demand reduction, the equilibrium price will rise. If the volume of supply reduction is less than the reduction in demand, the equilibrium price will decrease (Heakel). Equilibrium amount, in any case, will be reduced. Demand shows the number of products that consumers are willing and able to buy at a certain price for a certain time. Demand and price are typically inversely proportional to each other; that is, the bigger the demand, the lower the price. Each price lower than the balance of the price will cause the emergence of a deficit; that is, the quantity demanded will be greater than the offer, which in turn will lead to higher prices. There is a relation between the price and quantity of goods or services to be purchased at each price. All circumstances that change demand but are not related to the price are called non-price factors. They include changing needs and tastes (preferences) of consumers, change in the number of consumers, changes in incomes of consumers, changes in the price of complementary products (automobile gasoline, camera-film) and substitute products (substitutes) (butter-margarine, coat, jacket) and changes in consumer expectations.
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Interaction of supply and demand leads to the establishment of equilibrium (market) price. Equilibrium (market) price is the price at which supply and demand are balanced by the value of the value proposition (Heakel). It is possible to geometrically determine the equilibrium price if one combines the demand and supply curves of the same product. The point of intersection of supply and demand curves gives the equilibrium price (equilibrium price). While supply and demand remain unchanged, the equilibrium price will be constant, and the market will be in balance. Any other price will promote the desire of buyers and sellers to make a difference. The possible ways influencing demand and supply include two options. The first one consists in setting a lower price. As a result, it leads to excess demand, the deficit of goods and the growth of the market price. Thus, excess demand exerts upward pressure on the price. The second option consists of setting a higher price. The supply of goods is greater than customer demand. In this case, manufacturers prefer to reduce the price to match the amount of demand. The oversupply has a downward pressure on the price. These price fluctuations will occur until a price equilibrium level is reached (Heakel). The market mechanism is arranged so that any deviation from the equilibrium position results in the activation of the force that returns the market to equilibrium. However, sometimes the balance is disturbed artificially, through the intervention of the state or as a result of monopolies that are interested in maintaining monopolistically high prices. If demand is the primary, it will cause an increase in the price, as the consumers are willing to pay any price to satisfy their demand. If the demand for some reason is reduced, this will lead to a decrease in prices due to the reduction in the number of people who want to buy this product. Consequently, there is a direct dependence of demand and price: increased demand stimulates an increase in the price and vice versa.
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Not only prices have a strong impact on the volume of supply and demand, but market conditions (supply and demand), in turn, influence the equilibrium (market) price. The most common reason for price fluctuations consists of supply and demand. Demand is a form of manifestation of the needs and interests of consumers in the market. Supply is a form of manifestation of the goals and interests of producers of goods (works, services). Changes in the equilibrium price with changes in market conditions translate into the laws of supply and demand. The market prices are influenced by unsatisfied demand, leading to higher prices, and oversupply that leads to lower prices to the level of equilibrium. Increased demand leads to an increase in the equilibrium price and the number of products sold. A drop in demand leads to the lower equilibrium price and quantity of products sold. Increased offer leads to a lower equilibrium price. On the other hand, reduced supply will cause an increase in the equilibrium price.