<ul><li>"… he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." Adam Smith, Wealth of Nation </li></ul><ul><li>Invisible Hand: </li></ul><ul><li>If the only forces working in the market are demand and supply, buyers and sellers behave as if their actions are coordinated by an unobservable factor (even if they are ignorant of the demand and supply rules) and equilibrium is reached. </li></ul><ul><li>This unseen coordinating factor is called the "Invisible Hand" and is actually the "Price Mechanism" which aggregates the information of all market participants. Economics usually assumes that market participants have perfect information or at least behave as if they have perfect information. </li></ul>
Law of D emand <ul><li>Price and quantity demanded move in opposite directions, ceteris paribus (holding everything else constant) . A decrease in price leads to an increase in quantity demanded. Likewise, an increase in price causes quantity demanded to fall. </li></ul><ul><li>When this relationship between price and quantity demanded is graphed, it is called the demand curve. </li></ul>
The total effect of a price change is actually a combin ation of two different effects: <ul><li>1) Income effect: As the price of a commodity rises, it may be considered as if the income of the consumer has declined. Therefore, the income effect of a change in price tells us that as price rises quantity demanded would fall. </li></ul>
<ul><li>2) Substitution effect: As the price of a commodity rises, it becomes relatively more expensive than the substitute goods. Hence, consumers substitute in the alternative product in for the good whose price has risen. Therefore, the substitution effect of a change in price also tells us that as price rises the quantity demanded would fall. </li></ul>
Law of S upply <ul><li>Price and quantity supplied move in the same direction. A decrease in price leads to a decline in quantity supplied, Ceteris Paribus. Whereas, an increase in price causes the quantity supplied to rise. </li></ul><ul><li>When this relationship between price and quantity supplied is graphed, it is called the supply curve. </li></ul>
Equilibrium in the M arket <ul><li>Equilibrium occurs at the point where the demand curve intersects the supply curve. At this point the price is such that the quantity supplied is exactly equal to the quantity demanded. In other words, the market clears. Changes in other conditions may cause the market to come to equilibrium at a different point. </li></ul>
How Supply and Demand Determine Commodities Market Prices <ul><li>Price is derived by the interaction of supply and demand. The resultant market price is dependant upon both of these fundamental components of a market. </li></ul><ul><li>An exchange of goods or services will occur whenever buyers and sellers can agree on a price. When an exchange occurs, the agreed upon price is called the "equilibrium price", or a "market clearing price." This can be graphically illustrated as follows: </li></ul>
<ul><li>A market price is not a fair price to all participants in the marketplace. It does not guarantee total satisfaction on the part of both buyer and seller or all buyers and all sellers. </li></ul><ul><li>This will depend on their individual competitive positions within the market. Buyers will attempt to maximize their individual well being within certain competitive constraints. </li></ul><ul><li>Too low a price will result in excess profits for the buyer attracting competition. Likewise sellers are also considered to be profit maximizers. </li></ul>
“ With Great Power comes Great Responsibility”
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