In micro-economic theory, the supply and demand model attempts to describe, explain and predict the price and quantity of goods sold in competitive markets. This model assumes that markets are perfectly competitive i.e. there are many buyers or sellers, none of whom have the capacity to influence the price of goods or services on offer. A simple supply and demand model is as shown below. The slope of the demand curve indicates that a greater quantity will be demanded when the price is lower. Similarly, the supply curve shows that as prices rise, firms will produce more goods or offer more or better services. The point where these curves meet is the equilibrium point.
A market is said to be in perfect competition when no producer or consumer has the market power to influence prices. In such a market, prices of goods would instantly shift to the point of equilibrium as illustrated in the supply and demand graph. In competitive market economies, actual prices tend to the equilibrium prices at which demand equals supply. At the point of equilibrium there is no incentive to change either the price or the quantity. (Stiplitz J & Drifill J, 1993, p 73).
Since the price is fixed as the result of interaction of supply and demand, nothing producers can do will aff ...Show more