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September 29, 2020 

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PRICE:

An asset or item voluntarily exchanged in a market transaction for another asset or item. This item or asset is usually, but not necessarily, money. A barter transaction occurs if money is NOT one of the assets or items exchanged. In a standard market diagram, price is displayed on the vertical axis.
Price plays a central role in economics, especially microeconomics and the study of markets. A great deal of economic analysis focuses on explaining prices--why they rise, why they fall, why they achieve the levels they do. In fact, decades ago, microeconomics was commonly termed price theory.

Identifying Price
The standard market model presented in this exhibit, illustrates the role price plays in market exchanges. The quantity of the good exchanged is measured on the horizontal axis and the price of the good is measured on the vertical axis. As the price rises or falls, it causes changes in quantity demanded, a movement only the demand curve D, and changes in quantity supplied, a movement along the supply curve S. The change in the price is what keeps the market in balance.

Two Prices In One

Price is commonly viewed as either the cost of purchasing a product or alternatively as the revenue received from selling a product. Both are essentially correct. The price of a product is something of value that is given up by buyers and received by sellers in exchange for the product. This two-sided exchange results in two key notions of price.
  • Demand Price: On the demand side of a market, the price reflects the willingness and ability of the buyers to purchase a product which is based on the satisfaction received. This is also termed the demand price, which is the maximum price that buyers are willing and able to pay for a product.

  • Supply Price: On the supply side of a market, the price reflects the willingness and ability of the sellers to part with a product which is based on the opportunity cost incurred. This is also termed the supply price, which is the minimum price that sellers are willing and able to receive for a product.

One Equilibrium Price

Equilibrium price results when the demand price and supply price are equal. This equality means that the quantity demanded and the quantity supplied are also equal and that the market has achieved equilibrium. This is commonly termed the market-clearing price because it "clears" the market by eliminating shortages or surpluses.

It is often useful to distinguish between the equilibrium price, which is the price needed to clear the market and achieve equilibrium, and the actual price or the existing price, which is the price that "actually exists" in the market. If the actual price is not equal to the market-clearing equilibrium price, then the market has either a shortage or a surplus.

The Market Balancer

Price plays THE key role in balancing the market forces of demand and supply. If a market is faced with a surplus or a shortage, then the price adjusts to achieve equilibrium.
  • Shortage: If the market is faced with a shortage, in which the quantity demanded is greater than the quantity supplied, then the price rises to restore balance. The higher price causes a decrease in quantity demanded and an increase in quantity supplied, both of which act to eliminate the shortage.

  • Surplus: If the market is faced with a surplus, in which the quantity demanded is less than the quantity supplied, then the price falls to restore balance. The lower price causes an increase in quantity demanded and a decrease in quantity supplied, both of which act to eliminate the surplus.

The Great Allocator

One reason for the economic focus is that prices are essential to the allocation of resources in a market-oriented economy. Like traffic lights, prices direct the movement of resources between consumption and production activities and provide important signals to buyers and sellers.
  • Consumption: A higher price indicates that buyers obtain greater satisfaction of wants and needs from the consumption of a good. At the same time, a higher price discourages some buyers from purchasing the good, redirecting their purchases to other goods. As such, only those buyers gaining the greatest satisfaction end up consuming a good.

  • Production: A higher price indicates that sellers incur a higher opportunity cost in the production of a good. At the same time, a higher price attracts resources away from the production of other goods. As such, producers are induced to allocate their resources to the production of the goods most valued by society.

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Recommended Citation:

PRICE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2020. [Accessed: September 29, 2020].


Check Out These Related Terms...

     | exchange | voluntary exchange | quantity | market demand | market supply | Marshallian cross |


Or For A Little Background...

     | market | competitive market | allocation | economic thinking | scarcity | opportunity cost | satisfaction | value |


And For Further Study...

     | second rule of subjectivity | fourth rule of competition | seven economic rules | incentive | invisible hand | three questions of allocation | market-clearing price | equilibrium price | price level | price floor | price ceiling | elasticity |


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