What Determines Price?

Supply and Demand right?  Easy enough.  The more that people want to buy a thing the more the sellers can hold out and find people willing to pay the higher prices.  Inversely the more of something there is to be had, the better chance the buyers have of shopping around for the more desperate sellers, forcing all sellers to lower their price to compete.  Simple high school level economics.

Before I get too far into this lecture I should put up a disclaimer.  I have never “studied” economics.  I have an intelligent and curious mind, and I follow freakonomics and planet money, and I try and make sense of the world in my own terms.

But wait a second.  Demand is flexible.  That means that If you lower the price, more people will be willing to buy it at the lower price point.  Every new product is hunting for the right price point.  If you lower the price and make less profit per unit, but sell more units do you make more money?  Sometimes you do, and sometimes you don’t, but my point here is that a second ago we said that price depends on demand, and now we see that demand also depends on price.

Supply can be distorted through monopoly control or through an agreement to limit production or coordinated purchasing policies.

  • diamond mines
  • OPEC
  • International manipulation of grain markets
  • Patent control / copywrite law

So we have supply, demand, price-demand feedback, supply manipulation.  But all this only applies to commodities.  Products and services differ from one another, where as commodities are interchangeable regardless of the source.  No one can tell whether a gallon of gas came from Texas, or Canada, or Iran.  And in a free market no one cares.  However you can tell whether your mp3 player is an ipod or sony.  You can tell the difference between Kraft cheese and macaroni and the store brand.  So there’s another set of things effecting demand:

  • The differences between similar products.
  • The reputations of the companies.
  • The effectiveness of their advertising.
  • The ease of change once you’ve started using a product.

Earlier we looked as Price-Demand feedback.  There’s a similar thing that happens on the seller side.  A sort of Profit-Supply feedback.  That is to say that if a product’s supply/demand situation has positioned itself so that a product has higher profit margins, this will draw more manufacturers into the market to compete.  This will increase supply and therefore lower price.  This is where price is really determined over the long term;  Average Profit Margins.

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15 thoughts on “What Determines Price?

  1. I would also say that a secondary long-term effector of prices, at least in terms of commodities, would be manipulation. While profit-margins are seen as the “bottom line” when determining the viability of a company, wouldn’t you agree that there have been, at least for a couple of centuries in the global market, macro-players such as governments, global trade agreements between such and those who have been ultra-wealthy for the past couple of centuries, who ultimately set the trend in prices through fiat? (I realize that you listed manipulation as a factor, I just feel that it ranks alongside the profit margin as a prime cause.) Good blog, by the way.

    • My gut tells me that manipulation of markets plays itself out in the “middle term” of up to 5 years or so. The manipulation will raise profit margins, which in turn will draw more competitor to the market, and then profit margins will come back to reasonable levels. Places where this doesn’t hold true are where a large percentage of the natural resources are controlled by a very few players (African diamond mines, to a lesser extent OPEC). Anywhere you picture a bunch of white men in suits buying and selling to manipulate price, I can’t see that lasting years. Most those guys can’t see past the next quarter.

      Glad you like the blog. If you read advice on starting a blog, they all tell you to pick a theme to focus on first. Narrowing my writing to a theme was the last thing I wanted out of this hobby.

      • Actually, OPEC and diamond markets WERE what I was thinking of, heh. I wonder, though, with some retail items becoming concentrated amongst fewer and fewer companies, does the ability to manipulate and fix prices in consumer non-perishable goods increase in importance? For example, there was the recent LCD flat-panel TV antitrust suit, where twelve manufacturers conspired to fix prices, and that was freaking TWELVE. What about areas of production that have become even more concentrated? Certain OSs come to mind, as do rare metal components.

  2. Pingback: Discount Hurdle | Shadman The Wonderguy

  3. Pingback: What determines pay? | Shadman The Wonderguy

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