Theory of Price - Explained
What is the Theory of Price?
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What is Price in Economics?
Price is what a buyer pays for a single unit (or batch) of a specific good or service. Price is a proxy for value.
What is the Theory of Price?
The theory of price is a theory which states that the price for goods and services is determined by economic forces such as supply and demand. According to this theory, the relationship between supply and demand influences price as to whether the prices of goods and services will rise or decline.
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How does the Theory of Price Work?
The theory of price is an economic principle in which demand and supply determine the prices at which goods and services will be traded. When the money paid for goods and services by consumers meet the marginal cost of producing the goods, the optimal market price is realized. The optimal market price is otherwise known as the point of equilibrium between demand and supply. The key points of the theory of price are;
- The theory of price is a study of how economic forces such as demand and supply affect the prices of goods and services in the market.
- According to this theory, the optimal market price for goods and services is reached when the amount of goods supply meet the demands of the consumers and when the price offered by the consumers meet the marginal costs of producing the goods and services.
- Market conditions and forces determine the optimal price of goods and services, this means this price reacts to the market.
- Demand and supply are not static, they fluctuate depending on several factors and this affects the price of goods and services.
The Theory Of Price Deconstructed
Supply and Demand are the core components of price in the theory of price. As a microeconomic principle, the theory of price posits that the adequate price of goods and services realized when supply and demand are factored in. Usually, the objective of the theory of price is to achieve a market optimal price which is the equilibrium between supply and demand. When equilibrium is reached, it means the number of goods supplied meets the demands of the consumers. Equilibrium is a good adjuster of price because market conditions take effect on the prices of goods and services.
Supply and Demand and Their Relation to Price Theory
Supply and demand are two crucial economic forces that cannot be removed from any market. While supply tells us the number or quantity of goods and services available in the market, demand reflects the desires of consumers to purchase the available items. Both supply and demand can fluctuate due to several reasons. For example, the availability of raw materials, availability of needed labor, skilled workers and others can affect supply. Demand, on the other hand, can fluctuate as a result of how affordable products are in the market, the customer's perceived value of available goods, the quality of the goods and other competitor products available in the market. All the above factors affect the price of goods and services available in the market. Equilibrium is only reached when the number of goods supplied meets the number demanded by customers. The price of goods also affects demand and supply, for instance, if a product is expensive, fewer consumers will demand it which will cause an excess in supply.
Real World Example
The purchasing power of consumers is essential when businesses decide on the type of goods and services they want to produce and the quality of those goods. Whether consumers will be able to afford the quality or not is important factor firms consider when manufacturing their products. Also, firms offer products that are of the same quality but of variant features such as color, size, and shape just to meet the desires of the customers. Apple, for instance, manufactures iPhone with different features, sizes, colors, outlook, and models but they all maintain their unique quality.
- Self Interest
- Cost-Benefit Analysis
- Enlightened Self-Interest
- Fisher's Separation Theorem
- Ratchet Effect
- Total Utility (Economics)
- Efficiency Principle
- Expected Utility
- Subjective Theory of Value
- Positional Goods
- Indifference Curve
- Time Preference Theory of Interest
- Marginal Benefit
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Allocative Efficiency
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost