The term market mechanism is a term used to describe the manner in which the producers and consumers eventually determine the price of the goods that are produced. Producers usually set a price to respond to how many goods are being purchased, and consumers, on the other hand, react to that price.

This process is usually connected to the laws of demand and supply, and the market mechanism assists in providing balance, in which the price sustains both the producers and customers. At times, the government can try to control the economic process with the aim of pushing the market in a certain direction, and this interrupts the market mechanism.

A market mechanism can exist in either:

  • Free market economy – where all the resources are given to the private sector, that is, individuals, groups of individuals and households.
  • Planned economy – the public sector, that is, both the local and central government owns the public sector.
  • Mixed economy – all the resources are distributed to both the public and private sectors.

Both free and planned economies are typically theoretical, while the mixed economy is the most common. Economists are always trying to study the buying and selling habits in a specific market. By examining the buying and selling habits on a smaller scale, the economists believe that they can make assumptions concerning economic habits on a larger scale, like the economy of a country. Other economists believe that the market requires some external stimulation for it to perform efficiently. Some feel that the market mechanism offers the most efficient model of a market’s production and consumption.

How market mechanism works

Imagine that a company in the US produces a batch of 50 shirts, and sets the price of each shirt at $150. Once the shirts go to the market, only 10 are sold. The company responds to this by reducing the price to $90, and the remain 40 shirts are bought quickly. In response to this, the company increases the price to $120, and the sales start to match the production levels.

In this scenario, the market mechanism decided that $120 was the perfect price for the shirts, and this was the balancing point in which the production and consumption came together. The company reduced the price to increase buying and then increased the prices after more production was stimulated. This is a perfect example of the law of supply and demand, and free markets operate this way, without any external stimulation.