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The law of supply and demand states that in a competitive free market, the price for a good will move towards the level where supply and demand for that good are equal.

Supply and demand curves at equilibrium

Main article: Supply and demand

The supply and demand schedules both depend on price. At higher prices, suppliers will wish to sell more, but consumers will wish to buy less. At lower prices, consumers will wish to buy more, but suppliers will be willing to sell less. When the amount that suppliers wish to sell is equal to the amount that consumers wish to buy, the market is at economic equilibrium.

According to the law of supply and demand ; a market will move from a disequilibrium point, where quantity demanded is not equal to quantity supplied, to an equilibrium point.

If the price for a good is at a low level where consumers demand more of the good than producers are prepared to supply, there will be a shortage of the good, and consumers will be willing to pay more for it. The producers will increase the price until it reaches the level where consumers would not buy any more if the price was increased. If the price for a good is at a high level where the suppliers would like to produce more than the consumers will buy, the producers will be willing to lower the price. The price will fall until it reaches the level where consumers would be willing to pay more for the good.

The functioning of the mechanism depends on competition based on price. Suppliers raise the price if a good is in shortage because consumers compete for the good by offering to pay higher prices. Suppliers lower the price if a good is in surplus because other suppliers compete by selling the good at lower prices to get rid of their surplus.

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• Schenk, Robert. The Model of Supply and Demand. Retrieved on 2007-02-08.
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• McCain, Dr. Robert A.. Interactive Demonstration of Equilibrium. Drexel University. Retrieved on 2007-02-08.