Introduction to Price Determination

The price of a product is the exchange value of the item under consideration, that is, the measure of how much you give to get the item. Prices do not always reflect the actual value of the product, that is, the value required to manufacture it. The price of a commodity covers not only the capital, labour, and land costs but also includes some profit for the sellers. Therefore, the prices of goods need regulation and a fair system of determination. In this article, we will go through several topics such as the importance of price determination that determines the level of prices in a market, and how to determine the price of a product.

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Introduction of Price Determination 

Determination of prices in an ideal or free market is an outcome of the competition. In a free market, the cost of commodities and the services provided are a result of the balance between demand and supply. In such a scenario, no third-party needs to intervene in the determination of prices. However, no real-world market is ideal, and there is always some degree of monopoly, and here, the Government has to step in. The Government provides the upper and lower limits for the price of a commodity in most cases.

Now that we have a fair idea of what is price determination and the importance of price determination, we will move onto topics like what determines the level of prices in a market, and how to determine the price of a product. 

Factors Determining the Price of a Product

What determines the level of prices in the market? To answer this question, we will look at the external factors that influence the Maximum Retail Price (MRP) of goods in the market. These factors are as follows.

• Total Product Cost: The total cost of a product incorporates all the charges required for the product to complete its journey from manufacturing, through distribution, and up to selling and marketing. These include fixed, variable, and semi-variable costs.

• Utility/Demand: The demand for a commodity can depend on the utility of the product or in many cases, on its price as well. Here comes the concept of elastic and inelastic demand. If the demand for a product is inelastic, that is, unchanging with time, the price of the commodity does not affect the demand significantly. On the other hand, for elastic commodities, a slight change in price causes a huge shift in the demand curve. People tend to lean towards cheaper substitutes.

• Market Competition: If the level of competition for a certain product is high in the market, the manufacturers have to be careful while price setting. However, in a monopolistic market, the manufacturer can set any price for their product.

• Government Regulations: In a monopolistic market, the company often misuses its advantage and sets a very high price for their products. To protect the interests of the customer, the Government intervenes and introduces price regulations. For example, a government can set a price ceiling for certain products or can declare a product as indispensable.

• Enterprising Objectives: Often, companies have certain objectives that they want to achieve, for example, becoming a leader in quality control, obtaining share market supremacy, maximizing profits, or surviving in an overly competitive market. The company sets its product prices, keeping its objectives in mind.

• Marketing Costs: Storage, Packaging, Distribution, and Marketing all together amount to a total of marketing costs which depends on the quality of these individual services. For example, the increasing sturdiness of the packaging will lead to heightened costs.

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Now that we know the factors that affect the market price of a commodity, we can try to answer the question: how to determine the price of a product?

How to Determine The Price of a Product? 

"How to determine the sale price of a product" - understanding this is the main focus of this lesson. Let us start with the concept of the equilibrium price. The equilibrium price of a product is the cost at which demand and supply become equal. Statistically speaking, if we plot the demand and supply curve on a graph, the point at which they intersect is the equilibrium price.

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When we achieve the equilibrium price and quantity, we create a stable equilibrium. At this stage, there are no disturbances in the demand and supply rates. When the price reduces below equilibrium, the demand shoots up, and stocks fall, which results in the price increasing to the equilibrium point again. Similarly, when the prices rise above equilibrium, demand decreases, and to clear the stocks, price is reduced. Therefore, the forces of demand and supply primarily control the price of goods. 

Solved Example

Q1. How to determine the price of a product in a real-world market?

Ans: In a real-world market with monopolistic trading, and other problems, a lot of factors determine the price of commodities, such as demand/supply, government regulations, company objectives, etc.

Did You Know?

• Fixed prices of goods include the rent, salary of workers, etc. The variable prices cover the charges which change with demand and supply levels. The semi-variable prices change with time but are unaffected by demand levels.

• The equilibrium price is such an ideological quantity that, at this level, all the demands of the customers are met completely, and at the same time, no stock is left unsold in the market. The equilibrium price is, therefore, also known as the market-clearing price.