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Introduction:
Price is relative; it is not a fxed thing. A companys ability to set price is based
on many things, customer demand, availability of the product, the uniqueness
of the product, the perceived quality of the product, ho hard is the product to
duplicate, control of ra materials, customer education of your product, etc. !f
your product is a monopoly then pricing poer rests ith the producer, if the
product is a commodity then pricing poer rests ith the consumer.
Market Mechanism:
"he mar#et mechanism is the process by hich buyers and sellers acting in
their on interest establish a mar#et price and determine the quantity of a
goods exchange in a mar#et.
$ar#et mechanism means the mechanism by hich the forces of
demand and supply determine prices and quantities of goods and
services o%ered for sales in a free mar#et.
&roadly, the mar#et mechanism is an economic term that refers to the manner
in hich consumers and producers ultimately determine the price of the goods
that are produced. Producers ill respond to ho many goods are being
purchased by consumers by setting the price and consumers ill then react to
that price. "his process is tied into the las of supply and demand, and the
mar#et mechanism helps to provide an equilibrium point at hich the price
sustains both sides.
"he price mechanism plays three important functions in a mar#et:
1. Signaling function
'. Transmission of preferences
(. Rationing function
How Price is Determined:
"he price of a good tells us the value of that product in terms of money. A
rational consumer ill try to get the greatest value for money spent on goods
and services. )e ill therefore eigh and compare the prices of commodities
before ma#ing a decision to purchase.
Prices in a mar#et economy are determined by the level of demand and
the level of supply for each particular product.
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"he demand for a particular product is the amount that consumers are
illing and able to buy at a given price. "he la of demand states that
hen prices are high demand ill fall and hen prices are lo demand
rises ceteris paribus *meaning all other things remaining unchanged.+.
"he supply of a particular commodity is the amount that frms are
illing and able to supply at a given price. ,hen prices are high supply
ill rise and hen prices are lo supply fall. -uppliers are illing to sell
more at higher prices as profts ill be high, and unilling to sell large
quantities hen prices fall because of lo proft margins.
"he equilibrium price in a particular mar#et is the price at hich
consumers and suppliers are illing to trade a certain quantity of a
commodity.
Determination of price with Example:
.emand and supply schedule of ,ater melon
!"
Possi#le
priceTk$
$ per
unit"
%"
&uantit'
demande
d unit"
("
&uantit'
supplied
unit"
)"
State of
market
*"
Pressure on
price
A /0 10 1(0 -urplus .onar
d
& 20 100 1'0 -urplus .onar
d
3 40 110 110 5quilibrium
. (0 1'0 100 -hortage 6pard
5 '0 1(0 10 -hortage 6pard
Ta#le: E+uili#rium price where +uantit' demanded e+uals +uantit'
supplied
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7rom table, at "#. /0 producer ould li#e to sell 1(0 units here demanders
ant to buy only 10 units. "he amount supplied at "#. /0 exceeds the amount
demanded, and stoc#s of ,ater melon pile up in the mar#et.
At "#. (0 consumption exceeds production. ,ater melon begins to
disappear from the stores at that price. As people loo#ing around to fnd
their desired ,ater melons, they ill tend to bid up price of ,ater
melons, as shon in column *2+ of table.
,e could try other prices, but e can easily see that the equilibrium
price is "#. 40 or ro 3. At "#. 40 consumers desired demand exactly
equals producers desired production, each of hich is 110 units. 8nly at
"#. 40 ill consumers and suppliers both be ma#ing consistent
decisions.

!f intended supply 9 intended demand, price ill fall
!f intended supply : intended demand, price ill rise
!f intended supply ; intended demand *equilibrium+
"he demand and supply curves are dran from the demand and supply
schedules. Price is measured on the vertical axis and quantity on the
hori<ontal axis. "he demand curve slopes donards from left to right and
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the supply curve slopes upards from left to right. "he intersection of the to
curves indicates the equilibrium price and quantity.
-tart ith initial high price of "#. /0 per unit, shon at the top of the
price axis. At that price, suppliers ant to sell more than demanders
ant to buy. "he result is surplus, or excess of quantity supplied over
quantity demanded. "he arros along the curves sho the direction
that price tends to move hen a mar#et is in surplus.
At a lo price of "#. (0 per unit, the mar#et shos shortage or excess of
quantity demanded over quantities supplied hich are shon in this
fgure =shortage>. 6nder conditions of shortage, the competition among
buyers for limited goods causes the price rises, hich are shon in the
fgure by the arros pointing upard.
,e no see that the balance or equilibrium of supply and demand comes at
point 3, here the supply and demand curves intersect. At point 3, here the
prices is "#. 40 per ,ater melon and the quantity is 110 units, the quantities
demanded and supplied are equal? there are no shortages of surpluses; there
is no tendency for price to rise or fail. At point 3 only at point, the forces of
supply and demand are in balance and the price has settled at a sustainable
level. "he equilibrium price and quantity come here the amount illingly
supplied equals the amount illingly demanded.
,onclusion:
Price provides the incentive to both the consumer and producer. )igh prices
encouraged more production by the producers, but less consumption by the
consumers. @o prices discourage production by the producer, and
encouraged consumption by the consumers. &oth incentives push the price to
balance the forces of consumption *demand+ and production *supply+.
5conomists call this balance? equilibrium. "his natural mechanism requires no
external institution for direction, or any altruists motivation by either the
consumers or the producers. . "he mar#et mechanisms eAciency outcome is
alays located on the production possibility curves frontier, here all
resources are fully utili<ed.
Reference:
1
5conomics by -amuelson
$icroeconomics by $d. Abdullah
Pricing policies B procedures by Cessim )anna
3lass lecture
,i#ipedia
Psychological aspects of price by Paula &ennett
5conomic and fnancial analysis by $r. )a<litt
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