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In the case of demand
, it takes time for consumers to adjust their buying patterns, although 
demand will often respond more rapidly than supply to changes in price or other demand 
conditions. 
In some markets, responses to changes in price are relatively rapid. In others, response times are much 
longer. In stock markets for example, the supply and demand for company shares respond very rapidly 
to price changes, whereas in the markets for fuel oils or agrichemicals response times are much longer. 
QUESTION 
Quantity supplied
 
What effect will higher grain prices have on the supply curve of a cereal manufacturer who makes 
cereals from grain? 
ANSWER 
The higher price of grain will cause the supply curve to shift leftwards (or upwards). The increase in 
grain prices increase the cereal manufacturer's production costs, making supply at existing prices less 
profitable. 
 
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PART A: THE BUSINESS ORGANISATION, ITS STAKEHOLDERS AND THE EXTERNAL ENVIRONMENT 
 
108
 
 
6
The equilibrium price 
The competitive market process results in an 
equilibrium price
, which is the price at which market 
supply and market demand quantities are in balance. In any market, the equilibrium price will change if 
market demand or supply conditions change.
6.1 Functions of the price mechanism 
People only have a limited income and they must decide what to buy with the money they have. The 
prices of the goods they want will affect their buying decisions. 
Firms' output decisions will be influenced by both demand and supply considerations. 
(a) 
Market demand conditions influence the price that a firm will get for its output. Prices act as 
signals
 
to producers, and changes in prices should stimulate a response from a firm to change its 
production quantities. 
(b) 
Supply is influenced by production costs and profits. The objective of maximising profits provides 
the 
incentive
 
for firms to respond to changes in price or cost by changing their production 
quantities. 
(c) 
When a firm operates efficiently, responding to changes in market prices and controlling its costs, 
it is 
rewarded
with profit. 
Decisions by firms about what industry to operate in and what markets to produce for will be influenced 
by the prices obtainable. Although some firms have been established in one industry for many years, 
others are continually opening up, closing down or switching to new industries and new markets. Over 
time, firms in an industry might also increase or reduce the volume of goods they sell.
Sometimes, however, price will not represent the economic cost of a good or service. For example, price 
may be higher than costs due to 
taxes 
imposed by government. The sales price of cigarettes and alcohol 
is much higher than the cost of producing them, due to the imposition of taxes and duty.
By contrast, a 
subsidy 
may bring about an artificially low price.
However, in the main, we will be looking at price as an indicator of the exchange value of goods and 
services, as determined by the market forces of supply and demand.
6.2 The price mechanism and the equilibrium price 
The