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S6 Economics

Introduction to price Analysis.

PRICE THEORY

This is concerned with the study of prices and is regarded as the basis of economic theory. It is concerned with the economic behaviour of individual consumers, producers and resource owners. It explains the production, allocation and pricing of goods and services. 

PRICE 

Price is the exchange value of a commodity in terms of money. OR: The amount of money that has to be given up in order to obtain a good or service or a factor input. 

MARKET

A market is an arrangement that brings together buyers and sellers to transact business at a particular period of time. It is the total number of buyers and sellers involved in the exchange of a given product at a particular period of time.

 A market is not restricted to an area but it takes place in different ways like on phone, telefaxing, Internet, etc . In the market, buyers and sellers must communicate together and in so doing, they influence the price. 

 A market has the following characteristics:

  • There should be buyers and sellers who participate in the exchange of a commodity.  
  • There should be commodities to exchange
  • There should be a medium of exchange agreed upon and acceptable to all participants.  
  • There should be a price at which commodities are exchanged. 

 

TYPES OF MARKETS:

•  Product/ Commodity Markets ; these are markets in which goods or services are traded.  

•  Resource/ Factor Markets;  these  are  markets  in  which  production resources/factors of production especially labour and capital are traded. 

•  Spot Markets ;  these  are  markets      where  a  commodity  or  a  currency  is  traded  for immediate delivery. 

•  Forward / Future Markets ; these are markets where buyers and sellers make a contract  to  buy  or  sell  commodities  at  a  fixed  date  at  the  price  agreed  upon  in  the contract/agreement. 

•  Free Markets ; these are markets where government exerts no control/ intervention. 

•  Controlled  Market ;  these  are  markets  where  the  government  or  central authorities exerts a degree of control, for example by fixing prices, setting quotas etc. 

•  Perfect  Market ;   this is the market where none of the buyers or sellers have the powers to influence prices in the market by either influencing demand or supply. 

•  Imperfect Markets ; this is where the buyer or seller has the power to influence the price in the market by either influencing demand or supply. 

•  Organised Markets ; these are formal markets, such as a commodity market each dealing in a worldwide commodity, e.g. coffee, sugar, cocoa, rubber, etc. 

 

TYPES OF PRICES 

1.  Normal Price; this is the one which is obtained where supply and demand are equal in the long run period .i.e. The long run equilibrium price. 

2.  Equilibrium Price;  this  is  the  price  at  which  quantity  supplied  equals  quantity demanded. It is determined by the interaction of the market forces of demand and supply. I.e.  it  is  set  or  fixed  at  a  point  of  intersection  of  demand  and  supply  curves  in  a  free enterprise economy. 

 

Illustration of Equilibrium Price 

3.  Reserve  Price ;  this  is  the  price  below  which  a  seller  is  not  willing  to  sell  his/her product. 

 OR. It is the least /lowest possible acceptable price a seller can sell his or her product. 

 

Determinants of Reserve Price 

Expectation of future demand for the product. If the seller expects the demand for the product to rise in future, he/she fixes a high reserve price so that more is sold in future thus earns more profits.  However if the seller expects the demand for the product to fall in future, he sets a lower reserve price so as to sell more currently and earn more profits. 

Durability or Perishability of the product. Durable goods can be kept for a longer period of  time  and  therefore  a  higher  reserve  price  is  fixed  since  the  seller  is  not  afraid  of his/her product getting spoilt. On the other hand for perishable goods a lower reserve price is set because they cannot be kept for long period of time. 

Cash flow requirements in the business. The greater the need for cash in business the lower the reserve price set by the sellers’ products because there is an urgent need for money  in  the  business.  On  the  other  hand  the  less the  need  for  cash  in  business  the higher the reserve price set by the sellers; this is so because there is less urgent need for cash in the business. 

The storage costs in relation to future price. The higher the storage costs, the lower the reserve price set by the seller this is so because the seller wants to sell off the products as fast as possible in order to reduce on the storage cost. On the other hand the lower the storage costs, the higher the reserve price set by the seller because the seller is not in a hurry to sell off his products since the storages costs are manageable 

The length of time it takes before a new supply of goods reaches the market. (Gestation period). The longer the period it takes for a new supply of goods to reach the market the higher the reserve price set by the seller; this is so because the seller scared of new supply of goods outcompeting the old stock. However the shorter the time it takes for new supply of goods to reach the market the lower   the reserve price since the seller wants to get rid of the old stock before the new stock reaches the market.   

The future cost of production. The higher the future cost of production, the lower the reserve price set by the seller, this is because producer would prefer to produce and sell more  when  production  costs  are  low.  On  the  other hand  the  lower    future  cost  of production  the  higher  the  reserve  price,  this  is  because  producer  would  prefer to produce and sell more in future at low costs of production.  

 

DETERMINANTS OF MARKET PRICE.

Through Haggling/Bargaining; this is where a seller and a buyer carry out negotiations over the price until the two parties reach an agreeable price. Bargaining depends on the skills of a buyer and the seller. If the buyer has got more bargaining skills, then the price will be in his/her favour and if the buyer has got more bargaining skills, then the price will be in his /her favour depending on the bargaining zone. 

Through Auctioning/Bidding/tendering. This is where a seller offers a product for sale and calls for bids (price offers) and the highest bidder takes the commodity. This is common in fund raising functions and sale of government property. 

Through the market forces of demand and supply; this applies for transactions in a free market situation whereby the price is determined by the free interplay of the market forces of demand and supply. The point of intersection is where the price is reconciled. 

Sale by treaties/agreements; this is where buyers and sellers come together to fix the price of a given commodity e.g. the price of coffee is usually fixed by the international coffee agreement. 

Price leadership; this is where a dominant or low cost firm sets up a profit maximising price and other firms follow it. 

Government policy of price legislations; this is where the government fixes the price for the commodity through price control policy. It can either be a minimum price fixed above the equilibrium to protect the producers or fix a maximum price  below the equilibrium to protect the consumers.

Offers at fixed price by individuals, government, institutions, this is where a seller sets a price for his/her commodity and the buyer has to buy that commodity at that price e.g. price  in the supermarkets, government fixing wages of civil servants. 

Collusion/cartel  arrangements;  this  is  where  different  firms  producing  a  similar commodity come together and agree on the price to charge for their product.  

Resale  price  maintenance;  this  is  a  practice  where  producers  fix  prices  at  which  their products should be sold to the final consumers

OR; This is a system where producers insist on fixing prices at which their products should be sold up to the retail level.  

This  is  commonly  used  in  the  newspapers  industry  where  manufactures  fix  prices  at  which consumers should buy these commodities. 

 

ADVATANGES/MERITS OF RESALE PRICE MAINTENANCE; 

•  It helps to protect consumers from exploitation by middlemen. 

•  It helps to reduce competition especially between small scale and large scale retailers. 

•  Helps to maintain price stability. 

•  Business profits are easy to compute. 

•  Helps the seller to increase his profits through increased sales. 

•  It saves time since there is no need for bargaining. 

 

 FUNCTIONS OF PRICE IN THE MARKET 

Measuring the value of commodities; the worth of commodities is expressed in terms of money. Guiding producers on what to produce.  Producers normally go for commodities which fetch high prices. 

Guiding  consumers    in  making  consumption  decisions/plans.  Consumers  put  into consideration  the  prices attached  to  the  various  needs/wants  before  buying  goods  and services.

Determining income distribution i.e. producers who sell their goods at higher prices earn more income than those who sell at low prices. 

Guiding producers on how to produce /determining the technique of production to use i.e. producers  normally  go  for  an  affordable  method  of  production  in  order  to  minimise  the cost of production so as to maximise profits.

Guiding  producers  on  where  to  produce/  choosing  the  best  location  for  the  business. Producers  always  set up  firms  in  those  areas  which  have  attractive  markets  and  where consumers can afford to pay high prices for their goods so as to maximise profits. 

Guiding the producer on deciding for whom to produce/ providing automatic adjustments between demand and supply. 

Discussion

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