Suppose the price in a perfectly competitive product market increases.  What could have caused the market price to increase? 

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pohnpei397's profile pic

Posted on (Answer #1)

Prices in a market economy are determined by a combination of supply and demand.  An increase in the price of a product can be caused by an increase in demand or a decrease in supply.  Let us look at some examples of how this can happen.

One thing that can make demand increase is a change in consumer tastes.  Let us say that consumers start to think that ethanol is good for the environment.  They demand more of it.  Since ethanol is made of corn, the price of corn goes up.  This happened because the demand for corn rose.

A second thing that can make demand rise is an increase in consumer income.  Let us say that we are looking at the market for corn in a developing country.  If consumer incomes rise, people will tend to demand more meat.  Much of this meat comes from animals that eat corn.  The increased income leads to more demand for corn and the price of corn rises.

One thing that can make supply decrease is this particular instance is a bad harvest.  Imagine that there is a terrible drought in corn growing regions.  This means that less corn can be produced.  Supply drops and the price of corn rises.

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