Price mechanism

In economics, a price mechanism is the manner in which the prices of commodities affect the demand and supply of goods and services. A price mechanism affects both buyers and sellers who negotiate prices of goods or services. A price mechanism or market-based mechanism comprises a wide variety of ways to match up buyers and sellers.

An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in a trade, the purchaser will announce a price he is willing to pay (the bid price) and seller will announce a price he is willing to accept (the ask price).

The primary advantage of such a method is that conditions are laid out in advance and transactions can proceed with no further permission or authorization from any participant. When any bid and ask pair are compatible, a transaction occurs, in most cases automatically.

Under a price mechanism, if there is an increase in demand, then prices will go higher causing a movement along the supply curve.

For example, the oil crisis of the 1970s caused more nations to start producing their own oil due to dramatic price increases of oil. Since more nations started to produce oil, the short-run supply curve shifted more to the right meaning there was more supply of oil.

A price mechanism affects every economic situation in the long term. Another example of the effects of a price mechanism in the long run involves fuel for cars. If fuel becomes more expensive, then the demand for fuel would not decrease fast but eventually companies will start to produce alternatives such as biodiesel fuel and electrical cars. A price mechanism is a system by which the allocation of resources and distribution of goods and services are made on the basis of relative market price.

When trading in a , a person who has shares to sell may not wish to sell them at the current market price (quote). Likewise, a person who wishes to buy shares may not wish to pay the current market price either. Some negotiation is necessary in order for a transaction to occur.

The negotiation often comes in the form of adjusting the bid prices and the ask prices as the value of the share goes up and down. For example, if the share is worth $10, a buyer may "bid" $9.97 (3 cents less), and a seller may ask for $10.02 (2 cents more). If the value of the stock goes down, a seller may be forced to reduce his asking price. Conversely, if the value of the stock goes up, a buyer may be forced to increase his bidding price.

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Wikipedia