In economics, market mechanisms refer to a market working system where the forces of supply and demand determine the price and quantity of goods transacted. This mechanism allows the market to go to a new equilibrium point when disequilibrium occurs.
Market mechanisms are a description of how producers and consumers ultimately agree on prices and quantities. Prices serve as signals for allocating resources.
Producers set prices based on profit considerations. Instead, consumers buy goods based on utility considerations. Both are connected in the market.
The law of supply and demand ensures efficient allocation of resources. The forces of supply and demand help in achieving market equilibrium. In that condition, the market determines the best price and quantity, both for producers and consumers.
But, sometimes, governments try to control economic processes. The government may issue policies such as minimum wages and taxes. Such interventions disrupt market mechanisms from working.
How market mechanisms work
For example, a business produces 60 shirts, and sets the price at IDR 170,000. At the market, the business sells 10 shirts.
Because the sales quantity did not meet expectations, the business reduced the price to IDR 130,000. It turned out that demand was selling well and the other 50 shirts ended up selling quickly. The business finally realized that the right price was IDR 130,000.
In this example, the market mechanism is at work. Businesses responded by lowering initial prices that were too high in response to little interest. The price of IDR 130,000 is the best price at which consumers are willing to buy and producers are willing to sell.
Prices beyond IDR 130,000 are unreasonable for businesses and consumers. If the price of the shirt is IDR 170,000, it is too expensive for the consumer to afford. On the other hand, if the price of the shirt is IDR 120,000, the business will not accept it because it is not profitable.
Effects of external intervention
In economics, the main party that often intervenes in the market is the government. Pro-free market economists do not want government interference. Intervention can lead to economic inefficiency.
The equilibrium price (market price) conveys a lot of information. An increase in prices is a signal for producers to increase production. And for consumers, that’s a signal to reduce demand. The opposite effect occurs when prices fall. .
Therefore, government intervention can disrupt the accuracy of market price information. Two government interventions that can disrupt market prices are:
- Price floors
- Price ceilings
Government intervention is usually for the public good. Private companies may be reluctant to build roads because it is not profitable from a business perspective. Therefore, the government must intervene.