Price is the worth that buys a finite amount, weight, or another match of goods or services. In other words, it also expresses the value of the goods produced and the services rendered by factors of production such as land, labor, and capital. Thus, the determination of prices is of great significance in an economy.
Introduction to Determination of Prices
Determination of Prices means to determine the cost of goods sold and services rendered in the free market. In a free market, the forces of demand and supply determine the prices.
The Government does not interfere in the determination of the prices. However, in some cases, the Government may intervene in determining the prices. For example, the Government has fixed the minimum selling price for the wheat.
Browse more Topics under Determination Of Prices
- Changes in Demand
- Changes in Supply
- Simultaneous changes in Demand and Supply
- Features of Perfect Competition
- Price Determination under Perfect Competition
- Long Run Equilibrium of Competitive Firm and Industry
- Monopoly Market
- Monopolist’s Revenue Curve
- Price Discrimination
- Monopolistic Competition
- Kinked Demand Curve
Factors affecting Determination of Prices
The factors which affect the price determination of the product are:
1] Product Cost
Product cost is one of the most important factors which affect the price. It includes the total of fixed costs, variable costs and semi-variable costs incurred through the production, distribution, and selling of the product. Fixed costs refer to those costs which remain fixed at all the levels of production or sales. For instance, rent, salary, etc.
Variable costs attribute to the costs which are directly related to the levels of production or sales. For example, the costs of basic material, apprentice costs, etc. Semi-variable costs take into account those costs which change with the level of activity but not in direct proportion.
2] The Utility and Demand
Habitually, end user demands more units of a product when its price is low and vice versa. On the other hand, when the demand for a product is elastic, little variation in the price may result in large changes in quantity demanded.
While, when it is inelastic a change in the prices does not affect the demand significantly. In addition, the buyer is ready to pay up to that point where he perceives utility from the product to be at least equal to the price paid.
3] The extent of Competition in the Market
The next consistent factor affecting the price of manufactured goods is the nature and degree of competition in the market. A firm can fix any price for its product if the degree of competition is low. However, when there is competition in the market, the price is fixed after keeping in mind the price of the substitute goods.
4] Government and Legal Regulations
The firms which have a monopoly in the market, habitually charge a high price for their products. In order to protect the interest of the public, the government intervenes and regulates the prices of the commodities. For this purpose, it declares some products as indispensable products. For example, Life-saving drugs, etc.
5] Pricing Objectives
Another consistent factor, affecting the price of an item for consumption or service is the pricing objectives. Profit Maximization, Obtaining Market Share Leadership, Surviving in a Competitive Market and Attaining Product Quality Leadership are the pricing objectives of an enterprise. By and large, firm charges higher prices to cover high quality and high cost if it’s backed by the above objective.
6] Marketing Methods Used
A range of marketing methods such as circulation system, quality of salesmen, marketing, type of wrapping, patron services, etc. also affects the price of manufactured goods. For instance, an organization will charge sky-scraping revenue if it is using the classy material for wrapping its product.
Determination of Equilibrium Price
The price that makes demand equivalent to supply is called the equilibrium price. Graphically, it can be said that the equilibrium price is the point where the demand curve and supply curve intersect. It is the price at which there is no unsold stock left neither is any demand unfulfilled. Thus, it is also known as the market clearing price.
Once the Equilibrium price and quantity are reached, we attain Stable Equilibrium. Stable equilibrium adjusts any disturbance in the demand and supply and restores the original equilibrium.
Other things remaining the same, when the price falls below the equilibrium price, the demand increases and supply decreases. There arises a shortage of goods which in turn increases the price to equilibrium price.
Similarly, when the price rises above the equilibrium price, the demand decreases and supply increases. There arises a surplus of goods which in turn decreases the price to equilibrium price. Thus, the market restores the equilibrium price on its own.
However, the prices are not determined only by the forces of demand and supply. Other factors such as the price of substitute goods, price of related goods, government policies, competition in the market, etc. also play an important role in the determination of the prices.
Solved Example on Determination of Prices
Q: Which of the following is correct about product cost?
- Product cost refers to a distribution system.
- Product cost refers to the total of fixed costs, variable costs and semi-variable costs
- It refers to the total cost of the product.
- Product cost refers to the sales of the product.
Ans: While calculating the cost of a product, the sum of all costs associated with the production of a specific quantity of a good or service is included. So the correct option is B.