Theory Of Price 2009 3


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Theory Of Price 2009 3

  1. 1. Theory of Price Foundation Economics BIMTECH June 2009
  2. 2. <ul><li>General Theory of price identifies the forces that help in determination of equilibrium price. Price determination is the key concept in micro economic theory. </li></ul><ul><ul><li>Approaches to Pricing Problem </li></ul></ul><ul><ul><li>Classical Approach </li></ul></ul><ul><ul><li>Austrian Approach </li></ul></ul><ul><ul><li>Marshallian Approach </li></ul></ul><ul><ul><li>Classical Approach was propounded by Adam Smith who put forward two theories for price determination. </li></ul></ul><ul><ul><ul><li>Labor theory of value states that the price of a commodity is determined by the amount of labor embodied. </li></ul></ul></ul><ul><ul><ul><li>Cost of Production theory states that the price of a commodity is determined by the cost incurred in it’s production. </li></ul></ul></ul><ul><ul><li>Austrian Approach : Economists like Jevons remarked that “Value depends entirely upon utility”.. Prof. Menger states that “goods command price because they have utility, they have utility because they satisfy wants.” This approach is based on utility completely but fails to notice how much price the seller will charge for it. </li></ul></ul><ul><ul><li>Marshallian Approach propounded that price is determined by the interaction of the demand and supply forces. </li></ul></ul>
  3. 3. Equilibrium Price <ul><li>The point where the demand equates supply is called the Equilibrium Point and price prevalent at that point is the Equilibrium Price. </li></ul><ul><li>Marshall said : “ When the demand price is equal to the supply price, the amount produced has no tendency either to be increased or decreased, it is in Equilibrium. </li></ul><ul><li>Equilibrium is where the Demand Curve intersects the Supply Curve. </li></ul><ul><ul><li>Assumptions of Equilibrium : </li></ul></ul><ul><ul><li>Demand curve should always have a negative slope. </li></ul></ul><ul><ul><li>Supply curve should always have a positive slope. </li></ul></ul><ul><ul><li>If demand increases more than supply, price will increase and if supply increases more than demand price will decrease. </li></ul></ul>
  4. 4. <ul><li>Increase in Demand results in an increase on the equilibrium price, quantity sold and purchased also increases. Fall in demand brings down the equilibrium price and quantity sold and purchased also declines. </li></ul><ul><li>Increase in supply brings down the equilibrium price, amount purchased and sold increases while decrease in supply increases the equilibrium price and quantity sold and purchased diminishes. </li></ul><ul><li>Joint Demand : </li></ul><ul><li>When the two commodities are complimentary to one another, they maybe jointly demanded. A change in demand for one commodity will bring about a similar change in demand for the other commodity. Simmilarly, change in supply of one brings about a similar change in the supply of the other commodity. </li></ul>
  5. 5. Effect of Time in Determination of Price <ul><li>Very short period: Supply remains perfectly inelastic. The price is governed by change in demand. Larger the demand higher will be the price and smaller the demand lower will be the price. </li></ul><ul><li>Short period : In a short period time is limited. New firms cannot be set-up and the technique of production cannot be altered. Alteration can be only made by increasing the use of existing resources. Demand plays a greater role than supply in price determination. Supply is initially perfectly inelastic especially for individual firms but for the industry supply is elastic. Changes are possible in variable factors of production not fixed factors. </li></ul><ul><li>Long period : Long period is a situation in which supply can adjust to the change in demand. Number and size of firms can vary in response to the change in demand. Long period is also known as the Normal Price . In long period all factors become variable, new factories can be opened, new machines can be acquired. </li></ul><ul><li>Very long period : Price under this period is called Secular Price . </li></ul>