The price mechanism is a term used to refer to how changes in prices act as a signal to suppliers to allocate resources as a response to consumer demand. The way these resources are allocated in a free market where there is no government intervention, makes it seem as if were an invisible hand moving the resources around. The term "invisible hand' was first used by Adam Smiths in "The Wealth of Nations".
For example, in a certain market if we take all factors to be fixed then the price of a given good will be such as that the quantity of intended supply is equal to the quantity of intended demand. This price is called the equilibrium price, and is not affected as long as the market for the product is not disturbed by an outside factor.
However, when an exterior factor affects the market causing the demand for the product to increase, the equilibrium at price P will be affected, as the demand curve will shift as illustrated in the diagram below to the right from DD to D1D1:.
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This will cause a shortage in the supply at price P, shown by the dotted line, this shortage will cause the suppliers to increase the price of the good to P1. To reach to a new equilibrium the supply will extend along the supply curve, because the suppliers will be more willing to supply at the new higher price, until the new equilibrium is achieved at P1 when the quantity supplied meets the quantity demanded at Q1. .
On the other hand if an exterior factor caused the demand of the good to decrease the demand curve will shift to the left from DD to D1D1:.
This will cause a surplus in the supply, shown in the diagram as the horizontal bold line between the two curves at the original price P. This surplus will lead in it's turn to a decrease in the price to P1, as the suppliers would have to lower their prices in order to clear their stocks. As the price decreases the supply will contract, because at the new lower price the suppliers will be less willing to supply their good, and so the market will reach to a new equilibrium price of P1 where the quantity supplied = quantity demanded = Q1.
