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This is a signal to the supplier to expand their production in order to meet higher demand. Further, in case of excess supply, price factor also plays an important role to eliminate the excess supply. The signalling function of price can be discussed more briefly by using the following diagram.
It can be seen from the Figure-1, as demand for good-Q increases, supplier of the goods can earn higher revenue and profit by selling it at higher price per unit. Thus, increase in market demand leads to expansion of market supply. Further, Figure-2 shows an increase in market supply causes fall in the relative price of good-Q and expansion of the market output along with the market demand curve.
By utilising the signalling function of price, consumers are able to transmit expression of the preference or important information about changing needs and wants, to its customers. When market demand is high, price acts as the motivational factor to increase production, as supplier can earn higher profit by increasing their production. Similarly, when demand is low, it signals suppliers to contract their production. In market mechanism, suppliers actually control their production on the basis of price fluctuation (Mas-Colell et al. 2004).
Price also plays an important role to ration the scarce resources. It helps to allocate the scarce resources in an effective way, when demand in the market over strips the supply. When there is shortage of product in market, the price rises. Thus, only those people, whose willingness to pay is effectively high, purchases the product. It helps to eliminate consumers having low willingness to pay. In this context, it can be cited that, auction plays a crucial part to allocate resources in an appropriate manner and clears the market.
In economics, the term demand increase reflects increase in the ability and willingness on the buyers to buy a good or services at pre-existing
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As for example in an area there is an established Information Technology (IT) company which provides a huge service to the customers in that area and has earned a huge goodwill in that market. This means that the company is a dominant player in that market and posses the price mechanism in its hand i.e., it can charge variable price from time to time for the products it sell and a new IT firm will find it very hard to enter into his market as it will find unprofitable to enter this business.
Market Economy Market economy insinuates the relationship between the quantity of goods in demand, and their pricing according to Altvater (1993). With such factors in consideration, the market will have to shape its demand for the products in the market depending on the prevailing prices.
These two parties decide what to produce and what to purchase. A free market economy is based on the forces of demand and supply with little or minimum government intervention in the form of subsidies, taxes and regulation (Kates, 2011:34). The means of labour are privately owned and this enables parties to according to their own self-interests.
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