Theory of price definition
What is the theory of price?
Price theory is an economic theory that states that the price of any specific good or service is based on the relationship between its supply and demand. Price theory postulates that the point at which the benefit derived from those who demand the entity meets the marginal costs of the seller is the most optimal market price for that good or service.
Key points to remember
- Price theory is an economic theory that states that the price of any specific good or service is based on the relationship between its supply and demand.
- The optimal market price, or equilibrium, is the point at which the total number of available items can be reasonably consumed by potential customers.
- Supply can be affected by the availability of raw materials; demand can fluctuate based on competing products, the perceived value of an item, or its affordability to the consumer market.
Understanding the theory of price
Price theory – also called “price theory” – is a microeconomic principle that uses the concept of supply and demand to determine the appropriate price for a given good or service.
The aim is to achieve equilibrium where the quantity of goods or services provided corresponds to the demand of the corresponding market and its capacity to acquire the good or service. The concept of price theory allows for price adjustments as market conditions change.
Relationship between supply and demand and price theory
Supply refers to the number of products or services that the market can provide. This includes both tangible goods, such as automobiles, and intangible goods, such as the ability to make an appointment with a qualified service provider. In each case, the available offer is of a limited nature. There are only a certain number of automobiles available and only a certain number of appointments available at any given time.
Demand applies to the market’s desire for tangible or intangible goods. At any given time, there is also only a limited number of potential consumers available. Demand can fluctuate depending on a variety of factors, such as whether an improved version of a product is available or whether a service is no longer required. Demand can also be affected by the perceived value of an item by the consumer market.
Equilibrium occurs when the total number of items available – the supply – is consumed by potential customers. If a price is too high, customers may avoid the product or service. This would result in an oversupply.
On the other hand, if a price is too low, the demand can greatly exceed the available supply. Economists use price theory to find the selling price that brings supply and demand as close as possible to equilibrium.
Example of price theory
Companies often differentiate their product lines vertically rather than horizontally, given the differential willingness of consumers to pay for quality. According to an article published in Marketing Science with research by Michaela Draganska of Drexel University and Dipak C. Jain of INSEAD, many companies offer products that vary in characteristics, such as color or flavor, but do not vary in quality.
For example, Apple, Inc. offers different models of MacBook Pro with varying prices and capacities. Each laptop is also available in a variety of colors which are the same price. The study found that using uniform prices for all products in a product line is the best pricing policy. For example, if Apple were to charge a higher price for a silver MacBook Pro compared to a space gray MacBook Pro, the demand for the silver model could drop and the supply of the silver model would increase. At this point, Apple might be forced to lower the price of this model.