How to Understand Price - Essay Example

PRICE Introduction Price is a term that is commonly used in the business and economic world. In these two fields, price is used to mean the numerical value that is assigned to a good, service or an asset. This numerical value is tied to the monetary values of the good or services. Price is an important concept to microeconomics and it is one of the important variables that are considered in the allocation of resources for the operation of the business. When price is considered in terms of the allocation of resources then it is referred to in terms of the price theory. Price is also very import in marketing. It is one of the four variables that are considered when coming up with marketing strategy. In the marketing mix, price is the utmost factor which determines how the commodity is accepted in the market and in which market segment that product will have to be sold. It is also used by business when they are developing the marketing plan for the products. Understand price In our ordinary life we use the term price in order to refer to the amount or the quantity of payment that is made in order to acquire something. In this regard it is taken as a form of compensation that is given in exchange for something. When not referring to the economical terms, price has the same meaning of the compensating for something that has been acquired. When a criminal is arrested and incarcerated, we usually say that one has paid the price of the crime. This implies that the criminal has been compensated for the crime that has been committed. Therefore it is an exchange that is used to settle a debt. But in the economic world, price is used to refer to the exchange ratio for goods or services. It is the amount that is given in order to acquirer something which means it is an exchange reaction that is equal to what is being acquired. In this case we should not only be referring to the price in terms of the monetary exchange but it can also mean the value that is equal to something. For example when use din barter trade it would be an exchange ratio that equates the product or service that are being exchanged. In this case if we take that we have two goods x and y, the price of commodity x will be the ration y/x and in the same manner the price of y will be the ration x/y. (Buiter, 1999) However this concept has not been used always to refer to the price and there are old confusion that still compound the concept. In this case we can take that the value of a commodity of are services to be equated to the quantity countered using a common unit of values which may even have been based on imagination. This is usually done in order to compare different goods and services. This is the unit value of something. But most of the time, we usually confuse the unit value of something with price based on the fact that market values is usually counted as the quantity of a commodity which is multiplied by the nominal price of the commodity. The theory of price The theory of price was constructed in order to show how the price of goods and services is arrived at in the market. The price theory asserts that the market price of a commodity is usually based on two opposing considerations. As we have said about if we base the market price on the unit value of the product, this may not be true because the unit value may be created on imaginations. Therefore the theory of price presents factors that prevail in the market and which help to determent the common stand in the market. In this case the buyer and the seller are the two people who are involved in the whole process. It is the willingness of the buyer to buy a product or a service and the willingness of the seller to dispose that product or service that will determine the price at which they will arrive in. Therefore setting of the market price is an interactive process that involves the buyer and the seller. Therefore on one side stands the demand factor while which is based on marginal utility of the product while on the other side there is the supplier who based the willingness to acquire the product on the marginal cost of the product or services. It is the interaction of demand and supply in the market that eventually determines the price and which the market price will be set. An equally price is the price which is arrived at considering the two factor of demand and supply. It is supposed to be set in a way that it is at once side equal to the marginal utility which in this case will be counted in units of income on the buyer side and on the other side equal to the marginal cost to take care of the seller. This has been the main concept that has been used in setting up the price theory. It is a concept that had been accepted by almost all the economist although it has been facing a challenge from some economist. Under the postulation of the above concept it follows that the forces of demand and supply determines the price of a commodity or service in the market. On the contrary if the demand of the commodity is low, then the price is expected to be low. This would be the case if we don't take the aspect of supply into consideration. When the supply of the commodity is high in the market, the price of that commodity is supposed to be low and vice versa. But if we take the interaction of the two factors we will find that demand and supply interact to set an equilibrium price. The demand of the commodity may be high but the supply may be high as well and therefore there will be no significant change that will be made on the price. On the other hand the supply of the commodity may be high and the demand may be low and therefore the price of the commodity will be low as well. But when the demand is high and the supply is low, the price of the commodity is expected to rise. Let us construct a diagrammatic relationship between the two concepts. Price Demand curve X1 X X X2 Supply curve Y1 Y Y2 Amount The above graph can be used to explain the price theory. It shows how the price is set in the market using the relationship between the force of the demand and supply. From the graph we can see that the interaction between demand and supply is import in determining the price and the amount of a commodity that will be supplied in the market. X1 represents the price of a commodity when the demand in the market is high and supply is low. This shows that when the demand is high in the market and the supply is low, then the price of the commodity is high. In this case there will a low supply of the commodity in the market while the demand will be very high On the contrary X2 represents the price of the same commodity in the market when the demand is low and the supply is high. In this case there will be an oversupply of the product in the market and therefore there will be increase of the needs of the consumers. Therefore the price goes down as the supply tries to dispose the excess products that they have. When the market is allowed or peerage free in without controls, the force of demand and supply interacts with one another in such a way that there is common agreement that is attained. The demand of the product comes to terms with the supply in the market and therefore the final price is determined. In this case our X will show the equilibrium price that will be arrived at in the market using the force of supply and demand. This is the price that is acceptable to all players in the process. However there are other factors that have been shown to interview with this process. An example of the factor that has affected with the determination of the market price especially in the world arena has been the interference of the governed to impose quotas, tariffs and subsidies. Quotas are usually imposed in the market in order to determine the amount of the commodity or service that will have to be supplied in the market. In this regard quotas tend to lead to high or low prices of the commodity in the market. Tariffs tend to impose unnecessary restrictions in the market and many ends up raising the price of the commodity. Tariffs are used in order to protect the domestic market and the infant industries that are growing. However they are common in the international market but their effect may spill over to the domestic market especially when the products that are sold in both markets follow the same chain of production. On the other hand subsidies have an effect of lowering the market price of the commodity and undermining the force of demand and supply in the market. What happen is that the government sets up the accepted market price of products especially agricultural products. When the price of that commodity falls below the market price due to the force of demand and supply, the government compensates the suppliers by paying the loss and ensures that they get the market price. This encourages the producer to product more because they are not running at any loss. At the need to supply increase in the market and the reset of the products has to be disposed off especially in the internal market. This lowers the price of the commodity in the market as some producers who cannot access subsidies will make huge losses. The issue of subsidies to be a controversy one especially when the world is pushing for the need to have a free trade system in which all the countries in the world are given an equal chance to participate in trade. (Christorper, 2004) Relative and normal price of products in the market There is a difference between the relative and the normal price of commodities in the market. Relative price can be taken as the real price of the commodity or the exchange ratio of the product in the market. Normal price is taken as the price that is quoted in money while the real price or the relative price is taken to be the exchange ratio between goods and services regardless of their money vale. However the distinction between the two terms comes out when we are refereeing to the rate of inflation. When the price of goods and service are all quoted in regard to the monetary units and this price in the money values changes, there may not be a big change in the money units. On the other hand if the price of goods and services are all quoted in terms of money and they change in the same proportions, the relative or the real price will remain to be the same. It has been shown that the difference between the two is a hindrance of a major confusion. In literal terms, the proportion of change in the normal price of goods and services does not affect the real price and therefore it should not affect the force of demand and supply and in advance it should not have an effect on output. Price theories There are number of price theory that has been used to explain to the force of supply and demand and the setting of the equilibrium price in the market. Let us review some of those theories. Marxian price theory This theory distinguishes between the real and the ideal price of the commit in the market. In this case the real price is the actual market price which is realized through trade. On the other hand the ideal piece is a hypothetical price which is realized if certain conditions apply in the market. Most of these equilibrium prices are taken to be hypothetical prices not realized in reality and therefore they have a limited use. This theory postulates that while the labor-product has an economic value in the market, there are few of them that actually have a real value. (Simon, 1982) However this theory was credited on the following ground: It was not based on the substantive realistic theories of that govern economic exchange of goods and service. It assumed more the factor that is involved in the exchanges process. The theory also assumes that price of a good and service can be attracted to all of them in the same way. It was also criticized on the ground that it assumed that equilibrium prices will exist in the market and it fails to distinguish between the actual market price, administered prices and ideal price in the market. It discounted the real price theory from the reality economic high in the use of price in the market. It is also unable to provide an explanation of the relations that exist between price and the economic value of goods and services. Australian theory The developing of this theory was based on the criticism that was advanced to the Marxian theory of price. According to the neoclassical economist Adam Smith, there is water-diamond paradox which shows that diamond is likely to fetch a very high price in the market compared to water while water is actually essential for life of the people. However this was explained through the marginal utility in the Australia school of economics. According to this theory there is the interaction of the force of demand and supply with the human subject to determent final price of the goods and service in the market. In this regard marginalized economic helped to bring the human factor of bargain tool which has been influencing the way price is set in the market. (Makoto and Costas, 2001) This theory shows that it is not only the force of demand and supply that influence the price of the commodity in the market. This however applies to some goods in the market while others will come with fixed price. This theory showed that with the entry of bargain tool in the market supplier are likely to set their price a bit high in order to give a space for the bargains to take place. Bargain has become an important tool in marketing and buying especially when the level of competition is interested in the market. It is a method o f attracting consumers to buy goods or service but at the end it has an effect on the overall price of the commodity in the market. Therefore we can say that Australian theory has taken into consideration the recent changes that have been taking place in the price determination theories. It has taken into consideration the trends that have changing the traditional forces of demand and supply which is change price determination mechanism. References Simon, C. (1982): Marx, marginalize, and modern sociology: - from Adam Smith to Max Weber: London: The Macmillan Press Makoto, I. & Costas, L. (2001): Political Economy of Money and Finance; Cambridge University Buiter, W. (1999): Fiscal theory of price. University of Cambridge Christopher, S. (2004): Determination of price. Oxford University Read More