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In a free market, the 
price mechanism 
signals demand and supply conditions to producers and 
consumers. It therefore determines the activities of both producers and consumers, influencing the levels 
of demand for and the supply of goods. 

 
The position of the 
demand curve 
is determined by the demand conditions, which include consumers' 
tastes and preferences, and consumers' incomes. 

 
Elasticity, in general, refers to the relationship between two variables. Price elasticity of demand explains 
the relationship between 
change in quantity demanded 
and 
changes in price
. 

 
Income elasticity of demand 
measures the responsiveness of demand to changes in household income. 
Cross elasticity of demand 
is determined by the availability of substitute (competitors') products. 

 
The 
supply curve 
shows the quantity of a good which would be supplied by producers at a given 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. 

 
The 
price mechanism
brings demand and supply into equilibrium, and the 
equilibrium price 
for a good 
is the price at which the volume demanded by consumers and the volume that firms would be willing to 
supply is the same. This is also known as the 
market clearing price
, since at this price there will be 
neither surplus nor shortage in the market. 

 
The effects of 
demand and supply 
conditions on markets can be analysed by studying the behaviour of 
both demand and supply curves. 
