Question

The price system is based on (LO2) a) government regulation (i.e., the government sets most prices) b) the individual whim of the businessperson who sets it c) the feelings of the individual buyer d) supply and demand

Short answer

The price system is based on supply and demand, which determines the prices of goods and services in the market through the interaction between the quantity and willingness of producers and buyers to trade. The correct answer is d) supply and demand.

Step-by-step solution

Understand the options

First, let's understand the meaning behind each option in the context of the price system: a) Government regulation: This means that the government itself determines the prices of products and services in the market. b) Individual whim of the businessperson who sets it: This means that the businessperson, without any specific considerations or fundamental principles, determines the price of the products they are selling. c) Feelings of the individual buyer: This implies that the sentiment or emotions of the buyer profoundly affect and determine the prices of goods and services. d) Supply and demand: This states that the interaction between the quantity and willingness of producers and buyers to trade goods and services determines the prices for those goods and services in the market.

Identify the correct answer

Now that we understand the meaning of each option, we can identify which one is the basis for the price system. In a market economy, the price of a product is determined by the interaction of supply and demand, which causes the price to adjust until an equilibrium is reached. Therefore, the correct answer is: d) supply and demand

Key concepts

Supply and Demand

Supply and demand are the core components of a market economy. These forces interact to determine the prices of goods and services. Think of supply as how much of a product is available, while demand reflects how much people want a product.

When demand is high, but supply is low, prices will rise. This encourages producers to increase supply, reaching a balance over time. Conversely, if supply outstrips demand, prices tend to fall.

This price adjustment continues until market equilibrium is achieved. In equilibrium, the quantity of goods producers are willing to supply equals what consumers want to buy.

• High Demand + Low Supply = Rising Prices
• High Supply + Low Demand = Falling Prices

Market Economy

A market economy is a system where economic decisions and pricing of goods and services are guided by the interactions of citizens and businesses. In contrast to a centrally planned economy, a market economy relies on the voluntary trade between buyers and sellers.

Businesses compete to offer better products at attractive prices, continually encouraging innovation and efficiency. This competition ensures consumers get good value for their money.

A key feature of a market economy is the decentralized decision-making process, allowing the forces of supply and demand to set prices naturally without government intervention.

• Decentralized Decision Making: Individuals have the freedom to make choices regarding their economic activities.
• Competition: Drives improvements in quality and innovation.

Government Regulation

Government regulation involves rules that influence how businesses operate in the economy. While a market economy largely relies on supply and demand, regulations are sometimes necessary to ensure fairness and safety.

For example, governments may impose regulations to prevent monopolies, safeguard consumer rights, or ensure environmental protection. These rules help maintain a balance, ensuring the market remains competitive and fair.

Regulations can vary greatly depending on the country, industry, and specific needs of the economy:

• Anti-Monopoly Laws: Prevent companies from dominating the market unfairly.
• Consumer Protection: Ensures that the rights of consumers are upheld.