Demand and Supply in Free Market Systems

Demand and Supply in Free Market Systems - Afrika Kesho

 

In this segment, we will be discussing the factors behind price determination in free market systems. The prices for certain goods or services in a free market system are determined by what buyers think the good/service to be priced at and what suppliers think is the appropriate price for the good/service; government has little to no control over these market systems.

First, we will introduce the first two factors, demand and supply.

Demand is the desire by consumers for a certain product or service that is offered in the market. For example, if an investor decides to invest some of his wealth in the gold market, the investor will bid to purchase a certain mass of gold, for a certain price.

Say for example the investor has performed technical analysis known as chartism, on the price history of gold per ounce. He discovered that an ounce of gold should be priced at $1600 per ounce whereas the current price in the market is $1580; this investor believes that the commodity is under-priced and hence would purchase it at $1580 per ounce and if his philosophy is correct, would strike a $20 profit per ounce if the price of gold increases to $1600 per ounce overtime and thus sells it, but that is a discussion for another article. This is in essence what demand is.

In a free market system, various investors who want to purchase the gold will bid to purchase an ounce of gold at different prices and suppose that all these prices can be captured collectively through a mathematical function that will be introduced later.

Supply is the action of providing what is required by consumers in a specific market in the market, this action is initiated by suppliers. For example, companies that specialize in extracting gold from the gold ore mined in Africa will offer the ounce of gold in the market for $1575, after having incorporated all its transactional costs and other incurred costs.

Other companies will then offer to sell an ounce of gold at different prices and thus these different prices can also be captured through a mathematical function, known as the supply function.

For simplicity purposes, let’s assume that the quantity (ounce) of gold varies with the price attached to it;  in this market sellers and buyers will come together to determine what the price of gold should be, dependent on the quantity demanded.

The principle of demand is that the more quantity of gold is demanded, the greater the price of the gold, measured in ounce, is supposed to be.

Similarly, sellers of gold will also come to the market to sell gold at different prices through the Principle of Supply, the more quantity of gold supplied in the market by sellers, the lower the price of the quantity sold should be.

In free market systems, price determination is all about what how many buyers and sellers interact in an open session of bidding and offering prices for different quantities. They reach a point where for an agreed quantity in ounce, buyers and sellers are willing to exchange the gold of quantity for an agreed Price, this is referred to as market equilibrium.

To make more sense of market equilibrium, suppose that we have only 2 stakeholders in the gold market, where there is a combination of prices and quantities an investor is bidding for in this market as well as a combination of prices and quantities Company X is willing to supply or sell in the market. Where both parties reach an agreement; the investor is willing to buy ounces from Company X at a certain price and Company X is then willing to sell to the investor at a price for the agreed quantity.

In the next article, we will introduce government intervention tools or controls in this market and how it affects the interaction between buyers and suppliers.

 

This article was written by Realeboha Molaba.

You can contact Realeboha Molaba by clicking on the social media buttons below, or by emailing him on: relebz.quinton@gmail.com

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