1 The market

1.1 How the market works …

In a free market economy, consumer wishes are linked to producer supply through the medium of prices. We express the strength of our desire for particular goods and services by the price which we are willing to pay for them. Thus, prices give firms information about what to produce, and they also provide incentives to get on with producing it. This is because firms are motivated by profits: the revenues they make from selling us goods, minus the costs of producing and marketing them. The revenues are simply the prices they get for the goods, multiplied by the quantities they are able to sell at these prices. The costs are given by the quantity of resources they use up in production, multiplied by the prices firms have to pay to attract these resources away from their next best uses.

The system is a very flexible one. If consumers change their minds about what they want, this will be signalled through a rise in the prices they are willing to pay for their new preferences and a corresponding fall in the prices of the old ones. Spurred by the desire to make greater profits and avoid losses, firms will switch their resource use accordingly.

The free price system can be researched on Wikipedia.