Certification in Supplier Diversity Practice Exam

In a free market economy, how is price determined?

1. By administrative decisions of government

2. By negotiations between competitors

3. Primarily by supply and demand

4. By fixed regulations across industries

The correct answer is: Primarily by supply and demand

In a free market economy, price is primarily determined by the forces of supply and demand. This fundamental economic principle states that the price of a good or service is established where the quantity supplied by producers equals the quantity demanded by consumers. When demand for a product increases, prices tend to rise, prompting suppliers to produce more to meet that demand. Conversely, if demand decreases, prices typically fall, leading to a reduction in supply as producers adjust to the new market conditions. This dynamic interaction allows for flexibility in pricing based on consumer behavior and resource availability, which is a hallmark of a free market system. By enabling prices to fluctuate based on these natural market forces, a free market encourages innovation and efficiency, as producers seek to attract consumers while managing their costs. This process contrasts sharply with other methods of price determination, such as government regulation or fixed pricing, which can stifle competition and lead to inefficiencies in the market.