Theory Of Price

What is the 'Theory Of Price'

The theory of price is an economic theory that contends that the price for any specific good/service is based on the relationship between the forces of supply and demand. The theory of price says that the point at which the benefit gained from those who demand the entity meets the seller's marginal costs is the most optimal market price for the good/service.

BREAKING DOWN 'Theory Of Price'

The theory of price, also known as price theory, is a microeconomics principle that involves the analysis of supply and demand in determining an appropriate price point for a good or service. The goal is to achieve equilibrium in which the quantities of goods or services provided match the corresponding market's desire and ability to acquire the good or service. This concept allows for price adjustments as market conditions change.

For example, suppose that market forces determine that it costs $5 for a widget. This suggests that widget buyers are willing to forgo the utility in $5 in order to possess the widget and that the widget seller perceives that $5 is a fair price in exchange for giving up the widget. This simple theory of determining prices is one of the core principles underlying economic theory.

Understanding Supply and Demand and the Relation to Price Theory

Supply denotes the amount of products or services the market is able to provide. This can include tangible goods, such as automobiles, or intangibles, such as the ability to have an appointment with a skilled service provider. In each instance, the available supply is finite in 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 the item, be it tangible or intangible. At any point in time, there is also only a finite number of potential consumers available. Demand may fluctuate depending on a variety of factors, such as whether an improved version of a product is available or if a service is no longer needed. Demand can also be impacted by an item's perceived value, or affordability, by the consumer market.

In order to achieve equilibrium, the goal is to locate a price point that allows the number of items available, referred to as the supply, to be reasonably covered by potential customers. Should a price be too high, customers may avoid the good or service, resulting in excess supply. In contrast, should a price be too low, demand may significantly outweigh the available supply. Economist use price theory in an attempt to find the selling price that allows the supply and demand to be as close to equal as possible.

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