Price analysis is an overly complex task for apprentice scholars especially given its coverage in economics publications. This essay aims to help undergraduate students and other readers develop skills applicable to price analysis. Supply and demand form a foundation for that analysis. On the supply side of the analysis, this foundation and those skills are valuable for understanding the status of a firm in terms of whether it is operating near the shut-down point, the break-even point, or somewhere in between. Value also accrues by helping students and readers determine whether a firm is earning a normal profit or an economic profit. The degree of competition is a key feature in these analyses, which falls under the notion of a market structure. There is a variety of ways in which to conduct price analysis whether one examines supply or demand.
The information presented in this essay provides a frame of reference with which to simplify price analysis and to distinguish macroeconomic price levels from microeconomic market prices. Though this essay provides a foundation to examine resource markets, its main purpose to help undergraduate students and other readers develop skills in analyzing prices found in the goods and services market. Specifically, this essay will improve the reader's ability to answer the following questions: Why do prices change or differ? What are the key determinants driving price variations? Which prices are of greatest interest and to whom? How do producer costs interact with the market prices consumers pay and producers receive? Perhaps the most important question is: What do market prices tell us in precise terms about a firm's operating status, its profit level, and its competition?
In order to answer this last question, a need exists to define the term price. Pearce (1992) informs us in a concise manner what the terms price and price level mean. An input's or an output's price is the amount of money that is required to obtain an item whether it is an input or an output. With its focus on consumer and firm behavior, microeconomics is an area of inquiry that focuses, in part, on production decisions and price theory. At a much broader perspective, macroeconomic inquiry concerns itself, in part, with the general level of prices or a price index, which indicates the extent to which the prices for items within a larger bundle of goods change over time. The index is an average of item prices weighted according to the proportion of total expenditures on each item of the bundle. Price analysis in this essay will touch upon that broad perspective, but it conveys many more crucial details about the narrower perspective, especially with regard to production decisions and price theory.
Prices generally reflect an agreement between sellers and buyers who exchange goods and services as they interact in the marketplace. In addition, most sellers take the price dictated by market forces and very few sellers are able to set the market price. As many undergraduate students experience graph phobia, readers of this essay are encouraged to postpone cross references between the text printed herein and the graphs found in textbooks by Guell (2007), McConnell & Brue (2008), or other economists. In the pages at hand, without the aid from and/or the distraction that graphs provide, the reader will gain a preliminary understanding about the foundations of demand and supply before moving onward to examine how inputs and their costs, production rules and outputs, producer's and consumer's willingness and ability, and market forces and structures converge to determine an item's price.
Foundations of Price Analysis: Demand
When viewing a two-dimensional graph showing the demand and supply curves in the market for any given item, viewers would notice that its price appears on the vertical axis and its quantity is appears on the horizontal axis. Equilibrium price and quantity occur where quantity demanded equals quantity supplied or where the downward-sloping demand curve intersects the upward sloping supply curve. At this juncture, take note that two forms of movement may occur on the graph: Movement along a curve and a shift in the curve. To keep these movements straight, price analysts should simply note that a change in price initiates movement along the curve whereas a change in a determinant initiates a shift in the curve. An equilibrium point is static at one instance, but it is also dynamic in nature by virtue of a curve shift that results in a different intersection of the demand and supply curve. New intersections and new equilibrium prices and quantities often result from any inward or outward curve shift.
Determinants of Supply
The demand curve will shift in accordance with a change in a determinant and so will the supply curve. Keep in mind that five determinants exist each for the demand curve and for the supply curve and each can prompt a shift in one curve or both curves. Because it is quite easy to feel overwhelmed and lose track of a critical sequence when more than one curve shift occurs, the author of this essay encourages students to contemplate only one change in one determinant of supply or demand at a time. In other words, each change will likely produce a shift in the curve under consideration.
Before listing the sets of determinants, price analysis is easier by committing to memory various aspects of curve shifts. A rightward, outward, or upward shift in the demand curve is an increase in demand whereas an opposite shift is a decrease in demand. By extension, an increase (decrease) in demand means consumers will purchase a larger (smaller) quantity of an item at any given price. A rightward, downward, or outward shift in the supply curve is as an increase in supply whereas an opposite shift is a decrease in supply. Likewise, an increase (decrease) in supply means producers will supply a larger (smaller) quantity of an item at any given price. In contrast to curve shifts, any movement along a demand curve or a supply curve is respectively a change in quantity demanded or quantity supplied to which there is a corresponding change in price.
The list of five determinants for demand and those for supply is as follows:
Demand Supply Consumer income Prices of alternative outputs Population or number of buyers Number of sellers Consumer tastes and preferences Technology Prices of related goods Resource prices Expected prices Expected prices
Correspondence between prices and quantities is revealed through demand and supply schedules. Construction of these schedules occurs at two levels of aggregation. Compilations of a market-level demand schedule and supply schedule originate with individual-level schedules. All individuals that buy or sell an item constitute the market for that item. Individual demand schedules represent the quantities each consumer are willing and able to purchase at each price. The summation of quantities from those individual demand schedules across each price becomes the market demand schedule. In comparison, market supply schedules represent the sum of quantities that individual producers are willing and able to sell at each price as long as the market price makes it feasible for them to do so, which is...
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