Price Determination

A. Scarcity and Pricing

• Good and services are considered scarce, when they’re not free. Either they need to be bought or replaced with another resource of equal value.
• Not all things come with a price tag. Resources such as water and air are considered to be free.
• Almost all resources are scarce resources. Almost all goods and services are scarce goods and services.
• Such scarcity therefore brings about price in goods and services. Price measures the value of a given commodity.
• The prices are determined by the Price Mechanism. It has two components: Supply and Demand

B. Demand

• Demand is the behavior of buyers towards certain goods and services.
• Such behavior is determined in the price change and quantity demanded of the product.
• There is an inverse relationship between price and quantity demand. When price increases, demand decreases and when price decreases, demands increases. (see chart)
• The chart shows the behavior of buyers towards different price levels.
• If the price decreases, many people will be able to afford it, thus raising demand, but if the price increases, few people will be able to afford it and so the demand drops.

C. Supply

• On the other hand, Supply is the behavior of the suppliers of resources and commodities.
• It is determined by price and quantity supplied of the product.
• The relationship between price and supply is direct. Therefore, when the prices go up, so will the supply and vice versa. (see chart)
• The chart shows the behavior of suppliers at different price levels.
• At higher prices, suppliers are willing to produce more goods in search of higher profit.

D. Price Determination

• Price is controlled by these two market forces, so prices, demand, and quantities vary from time to time, but there’s one position in which the price, both satisfies supply and demand. This is called Price Equilibrium.
• In state of excess demand, there’s not enough supply to satisfy the needs of the people. In order to increase the supply and meet the demand, suppliers will need more profit. Therefore prices go up to produce more of the product.
• In contrast, the state of excess supply, there’s a bulging surplus of supply compared to the little demand. In such situation, sellers are pressured to capture the small market, in order to maximize their profits. They’ll be forced to bring down the price in order to attract more buyers.

E. Factors Affecting Shifts in Price

• (Demand) There’s an unstable flux of salaries in society. The people will have more or less money to buy products.
• (Demand) A change of price in substitute commodity occurs. A substitute commodity is a product that satisfies similar needs as the original commodity. (e.g. beef for pork)
• (Demand) A rise or falls of the price of complementary commodities happen. Complementary commodities are products used jointly with the original commodity. (e.g. Original Commodity: cars & Complementary Commodities: gasoline)
• (Demand) There is an increase/decrease in population.
• (Demand) A redistribution of income to or away from certain people who favor a kind of commodity happens. For instance, people from Town X like pizza, so their income will determine the demand for pizza.
• (Supply) There’s change in the desire of producers to supply more or less.
• (Supply) Prices of substitute commodities change.
• (Supply) Prices of resources (land, labor, and capital) change.
• (Supply) Improvements or deterioration in technology is done. If technology improves the production of Brand X, then more of Brand X will be made.

F. Application of Price Determination

• In the theory of Price Determination, it is assumed that the market is in Perfect Competition. Under such situation, all buyers and sellers aren’t in a position to dictate the price and demand of products.
• Unfortunately, in reality, Perfect Competition is very rare. Big corporations, legislators, and trade unions control most prices.
• Although quite limited in nature, it can still give a pretty good picture of the developmental situation. Its limitations should be kept in check.
• (see also Causes: Supply and Demand)

Further Reading

• Economics lesson plans were based and adopted from Fr. Roberto Yap's economics notes found in the Tulong Dunong Sourcebook and Michael P. Todaro: Economics for a Developing World