How are prices determined in a market

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  • Created on: 09-04-13 13:01
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Prices are entirely dependant on supply and demand, the factors of each, price elasticity of demand
and the processes of production. Supply has a proportionate effect on price: as quantity rises, so
does the price of the good. Demand is exactly the opposite: as demand rises for a good, the price
falls. These are the 2 basic laws of demand and supply, and begin to determine prices within a
market. There are some goods however that are exempt from these laws, called luxury goods. They
can vary in price completely independently of supply or demand. But supply and demand laws are
only accurate after a company has considered price elasticity of demand and cost of production.
The cost of production is always passed on to the consumer with a slight increase to earn the
manufacturer a profit. This is the profit margin. Technology giant Apple has a huge mark-up on all
their products, which is passed on to the consumer. It costs them $180 to make an iPhone, yet they
sell it for $500+, generating colossal profits. Oil companies do the same as oil becomes scarcer and
more difficult to withdraw from the ground: the cost of drilling that extra metre under the sea bed
can be seen in the price of modern day petrol compared to petrol prices of the 1990s. Apple
however can charge those sorts of prices due to the inelasticity of all their products and consumer
brand loyalty; whereas oil companies must charge those sorts of prices to create a profit whilst
covering their costs. So prices in a market are determined through the process of production
including the materials and methods used, and the desirable profit margins of the companies.
Price elasticity of demand basically determines optimal profit margins. It forecasts the impact
changing the price would have on the demand for a good. Elastic is highly sensitive, inelastic isn't.
Unitary is completely proportionate, perfectly inelastic is unresponsive to a price change and
perfectly elastic changes demand when the price is altered. Other things are key features to these
forecasts: brand loyalty
usually attracts inelasticity
of some degree, as do
necessary goods.
Occasional and slightly
luxurious goods tend to be
more elastic than anything.
Cross price elasticity of
demand furthers from this
by measuring the change in
demand for one good
following a price change in another good. These good tend to be compliments, cars and petrol, or
substitutes, PlayStation and XBOX. If the price of one good rockets, demand for the other good will
either go down or up, depending if it's a substitute or a compliment respectively. Therefore,
valuable information about the pricing and demand of other goods can help companies price theirs
accurately, especially when paired with an elasticity of demand graph.
The biggest thing affecting prices at market are simply demand and supply. But many things affect
demand and supply too. Firstly, all these contributors have to be considered under Ceteris Paribas.
Things affecting demand are as follow: price of other products, which ties into substitutes and
compliments; number and therefore a `title of exclusivity'; advertising; current fashion and trends;
income, normal goods demand rises as income rises whilst inferior goods demand falls. This can be

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Supply is affected by the following: environmental
conditions; development costs, lower costs mean there can be more supplied for the same price,
shifting the supply curve to the right; technology, allowing for more efficient and productive supply;
total amount of suppliers, this links in with compliments and substitutes.
Evan Davis wrote for the BBC about how market prices are determined. He said "...In this world,
companies will also be reluctant to raise prices because their competitors might not follow.…read more


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The Price Mechanism moves market equilibrium resulting in new prices

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