The Economist's View of Price – Market Pricing

In classical economics,the view of price stems from the theory of supply and demand. Simply put, this states that demand will fall as price increases. Supply will rise as price increases.This is logical and in agreement with commonsense to a large degree. It is obvious that, all things being equal, the rise in price of a product will cause fewer people to want to buy it, and the demand will fall off ('demand' in economics means the quantity that will be bought at a particular price); and it is equally obvious that if manufacturers are supplying a limited quantity of goods at a given price, then the unsatisfied demand will tend to force up the price, and as the price rises, more manufacturers will be inclined to produce similar goods, so that the supply will increase.

In economic theory a measure called elasticity is used to indicate how much demand changes in response to an increase or decrease in price.Thus if elasticity is less than 1, a change in price gives a less than proportionate change in demand — the demand is relatively inelastic. If elasticity is more than 1, then a change in price gives a more than proportionate change in demand, and the demand is relatively elastic.

In a situation where demand is high and supplies low manufacturers may be able to price very high or 'charge what the market will bear' as it is often expressed.

Economists are accustomed to indicating these relations graphically, when two graphs are superimposed to get the position of a point of equilibrium at E where the amount supplied Q is equal to the amount demanded at price P.

Now, while it is true that in real life there will be a tendency for things to reach equilibrium in this way, in practice it is usually not quite so simple. The reason lies in the phrase 'all things being equal'. In real life all things are not equal.

For 'laws' of supply and demand to be true, economists have to assume a state of perfect competition, i.e., a market in which all suppliers and buyers are fully aware of the prices at which goods are available and where each type of goods is homogeneous. This is true in certain markets, such as primary commodities (metals, grain, cotton), currencies and stocks and shares. But in most markets in real life buyers and sellers do not have complete knowledge of the prices at which goods are on offer. Much more important, goods are certainly not homogeneous, but widely differing in performance, quality and in many other respects. Indeed, in a competitive economy, the seller's aim will normally be to bring about a situation where his product or service is clearly different from other people's a 'competitive differential advantage'.

Thus, although total demand for a particular category of goods is an important factor determining the price people will pay, it is by no means the only factor and is frequently not even the most important factor. For example, the total demand for confectionery may well have virtually no bearing on the price that can be obtained by a manufacturer of very expensive, high quality liqueur chocolates mainly bought as Christmas gifts.