Price

Price as a reflection of worth

Price and worth can seem like synonyms but where price is defined, it is the amount you pay for a product, worth is more subjective and different people will have different opinions on how much a product is worth. Worth can also vary while the price remains the same. A cold drink available at your tennis club for £1 might seem more worth it after you have played and are hot and sweaty. Sentimentality and personal opinion will also impact worth. Sometimes consumers will pay a higher price for a product but still feel it is worth it. Many brands count on it.

Equilibrium price and quantity

So given that worth is subjective, how can price be determined. In a market economy the price will always trend towards equilibrium.

Equilibrium price and quantity is the point at which the quantity supplied exactly matches the quantity demanded as seen in the diagram on the left. This would mean all goods would be sold. It can be said that this is the price at which the market clears.

If there is a price set at O in the diagram on the right, there are more products being supplied than bought. This is known as oversupply. This means stock will be left over. Typically, then stores would discount this stock to try and clear it. Thereby the market moves back towards equilibrium.

If there is a price set at U in the diagram on the right, there are less products being supplied than demanded. This is known as undersupply. If it is possible to increase supply this is likely to happen but the additional costs to do so will likely mean higher prices. If supply can't be increased then sellers are likely to raise the prices. In some cases where they don't third party sellers might see an opportunity and buy up stock to resell for higher prices like has happened with some games consoles and concert tickets.

It is important to remember that this is the way the average price for products in a market is determined and prices will trend towards it, but not all firms sell for the same amount for various reasons so it is not the price everyone will pay.

The interaction of demand and supply

If you look at the image to the left of a right shift of supply you will see that this right shift of supply has caused a simultaneous expansion of demand to the new equilibrium point. This idea that when one changes it affects the other can confuse students. For instance if a scenario said "Demand increased for bus tours after two new tour operators joined the four already operating in town." many students would only see demand increased and would rush off to draw a right shift of demand. In fact this would be because there are more firms so a right shift of supply has occurred leading to an expansion of demand. In this instance the equilibrium price has decreased but the equilibrium quantity has increased.

You have to be able to draw these interactions and one of the common questions students ask is where do I draw lines on my graph. The lines mark the equilibrium point before and after the change. P1 and Q1 represent the first and P2 and Q2 the second equilibrium point. If a point you are making can be shown as a graph it is generally a good idea to add one.

In another scenario a firm might for instance run a successful marketing campaign. This would lead to a right shift of demand for their goods which means a simultaneous expansion of supply to the new equilibrium point as seen in the graph on the right. In this case both the equilibrium price and equilibrium quantity have increased.

Don't forget if a question mentions the elasticity of demand and or supply then draw them that way. Drawing them will actually help you to identify key points to discuss such as whether the percentage change in quantity is greater or less than the percentage change in price.

The determination of price and the allocation of resources

Prices help to allocate resources in a market economy. Consumers send signals through their preferences to producers of what things they want them to produce. This is also known as consumer sovereignty. Producers will move their resources to wherever they can get the best return. This means unsuccessful industries decline and popular ones grow.

Prices can also have a rationing effect on goods with limited supply. As they become more limited in supply the price will increase and as this happens less people will be able to afford them and demand will go down.

The factors that collectively affect supply and demand are known as market forces. These largely determine price in a market economy but government intervention may also impact the price in some markets.

Knowledge check

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Questions

Explain the difference between price and worth. (2 marks)

Price is the amount you have to pay for something(1) where as worth is more subjective as what something is worth will vary from one person to the next.(1)

Explain what is meant by equilibrium price and quantity. (2 marks)

Individual demand is the amount of a good or service that an individual would buy at each price in a given time period(1)

Market demand is the total demand from all potential customers at each price in a given time period.(1)

Draw an market equilibrium curve. (2 marks)

You don't have to draw the dotted lines but you need to make sure you labelled the x and y axis and the demand and supply curves.

1 mark for the line at the supply and demand sloping in the right directions, 1 mark for all the labels.

Explain what consumer soverignty is. (2 marks)

The way that consumers through their decisions(1) influence what is produced.(1)

Case study/Scenario

Steve runs a driving school called Oldhill Driving School. Both his major competitors raise the price they charge for their lessons but Steve does not.

Analyse the effect on Oldhill Driving School. (6 marks)

Sample answer:

Diagram can substitute for the first two points - A rise in price for a substitute good like his competitors lessons{A01} means an increase in demand for his lessons{AO2} because some of the people who would have taken lessons with his competitors may now come to him instead{AO3a} meaning an increase in profits.{AO3a}

He can then use those profits to invest back into the business perhaps with additional marketing{AO2} which could further improve demand in the future.{AO3a}

Case study/Scenario

The Jones Food Company is building the worlds largest vertical farm in Gloucestershire. This is an indoor climate controlled method of farming that uses hydroponics to reduce water usage by 95% and can be feulled by 100% renewable energy. In addition, because the plants are grown inside there is no risk of fertilizer run off polluting rivers in the area. Because of its efficient methods it can greatly reduce costs in the production of edible plants that could not otherwise be produced in the UK meaning lower transport costs and less food miles.

Analyse the effect on the Jones Food Company of successfully implementing vertical farming. (6 marks) NOTE: This story is about a real farm. Pretty interesting stuff. Look it up after you finish the question.

Sample answer:

Graph can substitute for first two points - An ability to produce more with fewer resources{AO2} means they can supply more at each price.{AO1} This means they can lower their prices and attract more customers{AO3a} leading to more revenue and more profit.{AO3a}

This profit can then be reinvested back into the business to further develop their technoology or increase the scale of their production{AO2} which will lead to further profit in the future.{AO3a}