How a Market Determines the Price of a Product

Sample Answer

How a Market Determines the Price of a Product

Introduction

Markets play a central role in determining the prices of goods and services. Every time a consumer buys a product, the price they pay reflects an interaction between demand and supply. Economists use these two fundamental forces to explain how prices are formed, how they change, and how they influence decisions by consumers and producers.

This report explores how market forces determine prices using clear economic theory and diagrams. It then applies those principles to petrol, one of the most widely used and closely watched products in the global economy. Finally, it discusses possible future changes in petrol prices and their economic impact.

How a Market Determines the Price of a Product

The market price of a product is determined by the interaction of demand and supply.

Demand refers to the quantity of a good that consumers are willing and able to buy at various prices, assuming other factors remain constant. The law of demand states that as the price of a good rises, the quantity demanded falls, and as the price falls, the quantity demanded rises. This inverse relationship gives the downward-sloping demand curve.

Supply, on the other hand, represents the quantity of a good that producers are willing and able to offer for sale at different prices. The law of supply states that as price increases, producers are willing to supply more because higher prices make production more profitable. This creates an upward-sloping supply curve.

The point where these two curves intersect determines the equilibrium price (Pₑ) and equilibrium quantity (Qₑ). At this point, the amount consumers wish to buy equals the amount producers wish to sell.

If the market price is above equilibrium, there is a surplus (excess supply). Producers will reduce prices to clear unsold stock, driving the market back toward equilibrium. If the price is below equilibrium, there is a shortage (excess demand). Consumers will compete for the limited supply, causing prices to rise until the shortage disappears.

Applying Market Theory: The Case of Petrol

Petrol is a useful example because it is a globally traded commodity affected by numerous economic, political, and environmental factors.

Demand for Petrol

The demand for petrol depends largely on transport use, economic activity, and income levels. In developed economies like the UK, petrol demand tends to be price inelastic in the short term because people still need to drive to work or transport goods, even if prices rise. However, over time, consumers can adjust behaviour by using public transport, buying electric cars, or reducing travel.

A fall in income or a recession can shift the demand curve leftward, reducing consumption and lowering price, while economic growth or population increases can shift it rightward, increasing demand and price.

For example, during the COVID-19 pandemic in 2020, lockdowns led to a sudden fall in petrol demand worldwide, pushing prices to record lows. In contrast, as economies reopened in 2021–2022, demand surged, driving prices sharply upward (IEA, 2022).

Supply of Petrol

Petrol supply depends on the availability of crude oil, refining capacity, and global political stability. The largest suppliers of oil are members of OPEC (Organisation of Petroleum Exporting Countries), along with major producers like the United States and Russia.

When oil-producing nations increase production, the supply curve shifts right, leading to lower prices. When they cut output, the supply curve shifts left, pushing prices higher. Production costs, technology, and government policies (such as taxes or subsidies) also influence supply.

For instance, the 2022 Russia-Ukraine conflict caused disruptions in global oil supply, which shifted the supply curve leftward and raised petrol prices in most countries (BBC, 2022).