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# price determination

## Mentioned in These Terms

❶This view of the price determination process is fine as long as it is recognized by the user that this traditional illustration of the price determination process implicitly assumes that the market value of the measurement good is constant. Which will be a vertical straight line MS, when OM is the quantity of fish available on that day?

## A New Perspective on Money and Inflation

For example, in order to measure the height of a tree in an absolute sense, we need a standard unit of measurement for height, such as inches. Standard units of measurement have two critical properties. First, they must possess the property that they are used to measure. Second, they must be invariable in that property. There is a third property common to most standard units: We made it up.

This is true of the market value of goods. No good possesses the quality of invariable market value. This is also true of money currencies. No currency possesses the property of invariable market value. So, how do we measure market value in the absolute? We need to create a standard unit for the measure of market value.

Since no standard unit for the measurement of market value exists in nature, we need to make one up. Adopting this standard unit for the measurement of market value is important because it allows us to demonstrate two critical points.

First, it allows us to illustrate how the price of a primary good, in terms of a measurement good, is a relative expression of the market value of both the primary good and the measurement good. Consider our earlier example, the price of apples in banana terms. We can now measure the market value of apples in the absolute and denote this as V A.

Furthermore, we can separately measure the market value of bananas using our new standard unit and denote the absolute market value of bananas as V B. For example, if the market value of an apple is twice that of a banana, then the price of apples, in banana terms, is two bananas. Mathematically, the ratio of quantities exchange, the quantity of bananas Q B for a quantity of apples Q A , is simply the reciprocal of the ratio of the two absolute market values.

The slide above implies that the price of apples, in banana terms, simply depends upon the market value of apples relative to the market value of bananas. All else remaining equal, if the market value of apples V A rises, then the price of apples will rise. Conversely, if the market value of bananas V B rises, then the price of apples, in banana terms, will fall. We can extend this to a money-based economy. All else equal, if the market value of money rises, then prices will fall.

If the market value of money falls, then, all else equal, prices will rise. The second important use for our standard unit for the measurement of market value is that it allows us to demonstrate how every price can be illustrated as a function of two sets of supply and demand. As discussed, the price of apples, in banana terms, depends upon both the market value of apples V A and the market value of bananas V B.

How is the market value of a good determined? The market value of apples V A is determined by supply and demand for apples. The market value of bananas V B is determined by supply and demand for bananas. The price of apples, in banana terms, is a relative expression or a ratio of these two market values. Therefore, the price of apples, in banana terms, is determined by two sets of supply and demand. For example, an increase in supply of bananas will lower the market value of bananas V B.

If nothing changes in the market for apples the market value of apples V A is constant , then the price of apples, in banana terms, will rise as a result of an increase in supply of bananas. We can extend this paradigm to the determination of money prices by simply replacing one measurement good bananas with another measurement good money. The price of apples, in money terms, is determined by both supply and demand for apples and supply and demand for money.

It should be noted that this concept sits in stark contrast to traditional Keynesian theory. The view of The Money Enigma is that this is wrong.

In order for prices to be expressed in money terms, money must possess the property of market value. Supply and demand for money determines the market value of money. This theory of price determination can be neatly reconciled with the traditional illustration of supply and demand taught in economics textbooks. The traditional view is that the price of a good is determined by supply and demand for that good.

This view of the price determination process is fine as long as it is recognized by the user that this traditional illustration of the price determination process implicitly assumes that the market value of the measurement good is constant. Rather than using a theoretical invariable measure of market value units of economic value we can simply use an assumed invariable measure of market value the market value of bananas. However, this traditional view of supply and demand provides most students with a very one-sided view of the price determination process.

The current mainstream view that price is a function of one set of supply and demand is a primary source of many misconceptions in economics, most notably, the poorly conceived notion that supply and demand for money determines the interest rate.

If you would like to learn more about these theories then please visit the Price Determination section of The Money Enigma. The view of The Money Enigma is that current microeconomic models of price determination provide a limited and very one-sided view of the price determination process. For example, the traditional view is that the price of apples is determined by supply and demand for apples.

However, in every transaction, there are two goods that are exchanged. For example, in a barter economy, we might exchange two bananas for one apple. So, does the price of this trade the ratio of bananas for apples depend upon supply and demand for apples or supply and demand for bananas? In a money-based transaction, we exchange one good the primary good for money the measurement good. The objective of exit fees is to deter premature exit.

Regulatory authorities, around the globe, have often expressed their discontent with the practice of exit fees as it has the potential to be anti-competitive and restricts consumers' abilities to switch freely, but the practice has not been proscribed. Experience curve pricing occurs when a manufacturer prices a product or service at a low rate in order to obtain volume and with the expectation that the cost of production will decrease with the acquisition of manufacturing experience.

This approach which is often used in the pricing of high technology products and services, is based on the insight that manufacturers learn to trim production costs over time in a phenomenon known as experience effects. Geographic pricing occurs when different prices are charged in different geographic markets for an identical product. Guaranteed pricing is a variant of contingency pricing.

It refers to the practice of including an undertaking or promise that certain results or outcomes will be achieved. In the event that the result is not achieved, the client does not pay for the service. High-low pricing refers to the practice of offering goods at a high price for a period of time, followed by offering the same goods at a low price for a predetermined time. This practice is widely used by chain stores selling homewares. The main disadvantage of the high-low tactic is that consumers tend to become aware of the price cycles and time their purchases to coincide with a low-price cycle.

Honeymoon Pricing refers to the practice of using a low introductory price with subsequent price increases once relationship is established. The objective of honeymoon pricing is to "lock" customers into a long-term association with the vendor. This approach is widely used in situations where customer switching costs are relatively high such as in home loans and financial investsments.

A loss leader is a product that has a price set below the operating margin. Loss leadering is widely used in supermarkets and budget-priced retail outlets where the store as a means of generating store traffic. The low price is widely promoted and the store is prepared to take a small loss on an individual item, with an expectation that it will recoup that loss when customers purchase other higher priced-higher margin items.

In service industries, loss leadering may refer to the practice of charging a reduced price on the first order as an inducement and with anticipation of charging higher prices on subsequent orders.

Offset pricing also known as diversionary pricing is the service industry's equivalent of loss leadering. A service may price one component of the offer at a very low price with an expectation that it can recoup any losses by cross-selling additional services. For example, a carpet steam cleaning service may charge a very low basic price for the first three rooms, but charges higher prices for additional rooms, furniture and curtain cleaning. The operator may also try to cross-sell the client on additional services such as spot-cleaning products, or stain-resistant treatments for fabrics and carpets.

Parity pricing refers to the process of pricing a product at or near a rival's price in order to remain competitive. Price bundling also known as product bundling occurs where two or more products or services are priced as a package with a single price. There are several types of bundles: The prices of the bundle is typically less than when the two items are purchased separately. Peak and off-peak pricing is a form of price discrimination where the price variation is due to some type of seasonal factor.

The objective of peak and off peak pricing is to use prices to even out peaks and troughs in demand. Peak and off-peak pricing is widely used in tourism, travel and also in utilities such as electricity providers. Peak pricing has caught the public's imagination since the ride-sharing service provider, Uber, commenced using surge pricing and has sought to patent the technologies that support this approach. Price discrimination is also known as variable pricing or differential pricing. Price lining is the use of a limited number of prices for all product offered by a business.

Price lining is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. In price lining, the price remains constant but quality or extent of product or service adjusted to reflect changes in cost. The underlying rationale of this tactic is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

Price lining continues to be widely used in department stores where customers often note racks of garments or accessories priced at predetermined price points e. Penetration pricing is an approach that can be considered at the time of market entry. In this approach, the price of a product is initially set low in an effort to penetrate the market quickly.

Low prices and low margins also act as a deterrent, preventing potential rivals from entering the market since they would have to undercut the low margins to gain a foothold.

Prestige pricing is also known as premium pricing and occasionally luxury pricing or high price maintenance refers to the deliberate pursuit of a high price posture to create an image of quality. Price signalling is where the price is used as an indicator of some other attribute. For example, some travel resorts promote that when two adults make a booking, the kids stay for free. This type of pricing is designed to signal that the resort is a family friendly operation.

Price skimming , also known as skim-the-cream pricing is a tactic that might be considered at market entry. The objective is to charge relatively high prices in order to recoup the cost of product development early in the life-cycle and before competitors enter the market. Promotional pricing is a temporary measure that involves setting prices at levels lower than normally charged for a good or service.

Promotional pricing is sometimes a reaction to unforeseen circumstances, as when a downturn in demand leaves a company with excess stocks; or when competitive activity is making inroads into market share or profits.

Two-part pricing is a variant of captive-market pricing used in service industries. Two part pricing breaks the actual price into two parts; a fixed service fee plus a variable consumption rate.

Two- part pricing tactics are widely used by utility companies such as electricity, gas and water and services where there is a quasi- membership type relationship, credit cards where an annual fee is charged and theme parks where an entrance fee is charged for admission while the customer pays for rides and extras. One part of the price represents a membership fee or joining fee, while the second part represents the usage component.

Psychological pricing is a range of tactics designed to have a positive psychological impact. Psychological pricing is widely used in a variety of retail settings.

Premium pricing also called prestige pricing [30] is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. The high pricing of a premium product is used to enhance and reinforce a product's luxury image. Examples of companies which partake in premium pricing in the marketplace include Rolex and Bentley.

As well as brand, product attributes such as eco-labelling and provenance e. A component of such premiums may reflect the increased cost of production. People will buy a premium priced product because:. People have generally become wealthier, therefore the mass marketing phenomenon of luxury has simply become a part of everyday life, and no longer reserved for the elite. This phenomenon enables premium pricing opportunities for marketers in luxury markets.

Examples of this can be seen with items such as clothing and electronics. Charging a premium price for a product also makes it more inaccessible and helps it gain an exclusive appeal. Luxury brands such as Louis Vuitton and Gucci are more than just clothing and become more of a status symbol.

Prestige goods are usually sold by companies that have a monopoly on the market and hold competitive advantage. Due to a firm having great market power they are able to charge at a premium for goods, and are able to spend a larger sum on promotion and advertising.

People associate high priced items with success. Marketers understand this concept, and price items at a premium to create the illusion of exclusivity and high quality. Consumers are likely to purchase a product at a higher price than a similar product as they crave the status, and feeling of superiority as being part of a minority that can in fact afford the said product. A price premium can also be charged to consumers when purchasing eco-labelled products.

Market based incentives are given in order to encourage people to practice their business in an eco-friendly way in regard to the environment. Pressure from environmental groups have caused the implementation of Associations such as these, rather than consumers demanding it. This means that producers have some sort of incentive for suppling goods worthy of eco-labelling standard. Usually more costs are incurred when practicing sustainable business, and charging at a premium is a way businesses can recover extra costs.

Demand-based pricing , also known as dynamic pricing , is a pricing method that uses consumer demand - based on perceived value - as the central element.

These include price skimming , price discrimination and yield management , price points , psychological pricing , bundle pricing , penetration pricing , price lining, value-based pricing , geo and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.

Price modeling using econometric techniques can help measure price elasticity , and computer based modeling tools will often facilitate simulations of different prices and the outcome on sales and profit.

More sophisticated tools help determine price at the SKU level across a portfolio of products. Uber's pricing policy is an example of demand-based dynamic pricing. It uses an automated algorithm to increase prices to "surge price" levels, responding rapidly to changes of supply and demand in the market. By responding in realtime, an equilibrium between demand and supply of drivers can be approached.

The practice has often caused passengers to become upset and invited criticism when it happens as a result of holidays, inclement weather, natural disasters or other factors. There's 70 years of conditioning around the fixed price of taxis.

Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount e. Research has shown that this practice can significantly influence consumers' ability to understand and process price information. Micromarketing is the practice of tailoring products, brands microbrands , and promotions to meet the needs and wants of microsegments within a market. High prices are often taken as a sign of quality, especially when the product or service lacks search qualities that can be inspected prior to purchase.

Consumers can have different perceptions on premium pricing, and this factor makes it important for the marketer to understand consumer behaviour. The Veblen Effect explains how this group of consumers makes purchase decisions based on conspicuous value, as they tend to purchase publicly consumed luxury products.

This shows they are likely to make the purchase to show power, status and wealth. They will also avoid purchasing products consumed by a general mass of people, as it is perceived that items in limited supply hold a higher value than items that do not.

## Main Topics

The price of an item is the point where the supply at a given price intersects the demand at a specific price. If it costs \$1 to create a widget, then a widget manufacturer may be willing to supply , widgets if customers pay \$10 for each, 50, for \$5, 10, for \$1, and 1, for \$1.

### Privacy FAQs

What is PRICE DETERMINATION?. The interaction between the demand and supply in the free market that is used to determine the costs for a goods or service.. TLD Example: The unexpected cold weather is expected to influence the price determination of oranges by decreasing the size of .

Definition of price determination: Interaction of the free market forces of demand and supply to establish the general level of price for a good or service. An Engineering & Managerial Economics presentation on Price Determination, topics covered were price determination under Perfect Competition, Monopoly, Duopoly and Oligopoly.