Price determination Under different Market Forms | UGC NET Commerce Preparation Course PDF Download

What is Price Determination?

Price Determination is the process of figuring out the cost of goods and services in a free market.

• Demand in an economy refers to how many people want to buy a product or service.
• Supply represents the amount of goods produced and available for sale in the market.
• In a free market, prices are set by the interaction of demand and supply without external intervention, such as from the government.
• The price of a product is mainly influenced by how many people want it and how much of it is available in the market.
• Price determination in various market structures is impacted by the pricing and quantity of goods. The relationship between price and quantity is illustrated by the demand and supply curve.
• When prices are low, demand for a product increases as more people want to buy it. Conversely, when prices are high, demand decreases. This demonstrates an inverse relationship between price and demand.
• At lower prices, fewer sellers may be motivated to produce the product due to reduced profits. However, they are more inclined to produce more when prices are higher, indicating a direct relationship between price and supply.

Example

The concept of price determination can be illustrated through the dynamics observed during the Covid-19 pandemic. For instance, when there was a surge in the demand for masks due to the pandemic, the price of masks increased significantly. This occurred because more people sought to purchase masks in large quantities.

• The rise in price motivated more manufacturers to produce masks.
• However, as the market became flooded with supply and Covid-19 cases started declining, the demand for masks decreased the following year. Consequently, this decrease in demand caused the price of masks to drop, leading to a reduction in supply as well.

This scenario exemplifies the direct and inverse relationships between supply, demand, and price. Price determination is influenced by various factors and market conditions affecting goods and services.

Factors Affecting Determination of Prices

Manufacturing Cost:

• Manufacturing a product involves various fixed and variable expenses like raw materials, labor, and salaries. Companies must cover these costs to stay competitive and make a profit. Higher production costs usually lead to higher product prices. By managing variable and semi-variable expenses, companies can offer competitive prices and boost demand.

Market Competition:

• Competition plays a crucial role in setting prices. In a monopoly market, a few companies dominate the scene. New entrants often have to match or undercut existing prices to attract customers. In markets with little or no competition, a company can charge more without losing sales.

Product Utility:

• The value a product offers affects its pricing. If a product serves multiple purposes and has low substitutes, customers are less likely to switch. Price changes can significantly impact demand, especially in industries with many alternatives like FMCG, where small price adjustments can lead to large shifts in demand due to competitor availability.

 Pricing Objectives:

• Companies have different goals that influence how they set prices.
• For instance, one company may aim to be known for high quality, while another might focus on gaining a larger market share.
• When quality is the priority, prices may be higher due to the use of top-notch materials.
• On the other hand, a company aiming for market share might offer lower prices to attract more customers.

 Government Regulations:

• The government sometimes steps in to regulate certain industries, especially where there's a monopoly or dominant market player.
• For example, in essential sectors like healthcare, the government might set price caps on medications and treatments.
• Such regulations directly impact how companies decide on pricing strategies.

Marketing Costs: 

• Companies need to account for marketing expenses when setting prices for their products.
• If a company invests heavily in billboards and expensive advertising, the product's price is likely to be higher.

Factors Affecting Demand Curve Shifts

The demand curve illustrates the relationship between price (Y-axis) and the quantity of a product demanded (X-axis). When prices rise, demand typically decreases, and vice versa.
Shifts in the demand curve occur when there are changes in factors affecting demand. Let's explore the key factors that can shift the demand curve:
Shift of Demand Curve

Consumer Preferences:

• Introducing a new product with the latest features or market trends can influence customer preferences. This can either decrease or increase demand based on whether consumers favor the product.

Future Expectations:

• Customer expectations about a product's future price can impact their current purchasing decisions. If they anticipate a price increase, they are likely to buy it now, while the opposite expectation can reduce demand.

Consumer Income:

• Consumer income plays a significant role in determining demand and prices. Markets with higher income levels tend to prefer branded items and are willing to pay more for them.

Substitute Products:

• Substitute products are alternative brands or items that serve the same purpose. When the price of a product rises, its demand typically falls, leading to an increased demand for its substitutes. The reverse can also occur during the price determination process.

Complementary Products:

• Complementary products are those used together, like toothbrushes and toothpaste, or bread and butter. If the price of one product, such as bread, increases, fewer people may buy it, subsequently reducing the demand for its complementary product, like butter.

Factors Shifting the Supply Curve

The supply curve shows how the quantity of a product that suppliers are willing to produce changes with the product's price. When prices are higher, suppliers make more goods. If prices drop, the supply decreases.

Imagine the supply curve as a line on a graph. It shifts to the right when more goods are available for sale and to the left when fewer goods are available.

Shift of the Supply Curve

Below are the factors that can move the supply curve:

• Manufacturing Costs: If the cost of materials goes up, sellers make less profit. This can lead to reduced production and a focus on more profitable goods.
• Competition Level: When new competitors enter the market, supply increases. This excess supply can drive prices down.
• Government Regulations: Higher taxes increase production costs, reducing supply. Government subsidies can lower costs and increase supply.
• Technology: Improvements in technology can make production more efficient and profitable, leading to increased supply.

Process of Price Determination

The process of setting prices for products or services is crucial in marketing and business strategy. It involves several steps and considerations, influenced by factors like product type, market conditions, and company objectives. Here's a breakdown of the process:

Market Analysis:

• Identifying the Target Market: This involves understanding the characteristics and needs of the specific customer segments you aim to reach.
• Competitor Analysis: Evaluating the pricing strategies and price points employed by competitors within the same market space.

Cost Analysis:

• Calculating Production and Operating Costs: Determining the total costs linked to producing, marketing, and delivering your product or service.
• Including Overhead Costs: Factoring in indirect costs like rent, utilities, and administrative expenses.

Profit Margin Goals:

• Setting Profit Margin Targets: Defining the desired profit margin, which reflects the percentage of profit the company aims to earn on each sale.

Demand and Elasticity:

• Assessing Demand Elasticity: Understanding how changes in price impact the quantity demanded. Elastic demand signifies that price alterations significantly affect demand, while inelastic demand suggests minimal impact from price changes.

Value-Based Pricing:

• Considering Perceived Value: Pricing your product or service based on the value it delivers to customers. This strategy focuses on what customers are willing to pay for the benefits they receive.

Pricing Strategies:

• Choosing a Pricing Strategy: Selecting a pricing approach that aligns with your business objectives and market positioning. Common strategies include cost-plus pricing, competitive pricing, penetration pricing, premium pricing, and value-based pricing.

Psychological Pricing:

• Implementing Psychological Pricing: Utilizing pricing tactics that leverage consumer psychology, such as setting prices slightly below round numbers (e.g., $9.99 instead of $10) or offering discounts and promotions.

Price Testing:

• Conducting Price Testing: Experimenting with various price points to observe their impact on sales, revenue, and profit. A/B testing and price sensitivity analysis can be valuable tools in this process.

Price Adjustments:

• Considering Price Adjustments: Being prepared to modify prices in response to changes in market conditions, customer feedback, or shifts in demand.

Legal and Ethical Considerations:

• Ensuring Compliance with Legal and Ethical Standards: Making certain that your pricing practices adhere to relevant laws and regulations while avoiding deceptive pricing practices.

Communication and Positioning:

• Communicating the Price: Clearly conveying the price to customers through marketing and sales channels. Ensuring that your pricing strategy aligns with your brand's image and target market.

Monitoring and Review:

• Continuously Monitoring and Reviewing Pricing: Tracking sales, customer feedback, and market dynamics to assess the effectiveness of your pricing strategy. Being prepared to make adjustments as needed.

Competitive Dynamics:

• Keeping an Eye on Competitors: Staying aware of how competitors adjust their prices and evaluating the impact on your market position and customer loyalty.

Conclusion

The interplay of demand and supply is crucial for determining prices, ensuring a company's sustainability and profitability. Setting the right prices can also position a company as a leader in the market. Effective price determination processes are vital for making sound pricing decisions. Price determination in various market structures is a key aspect of any economy, leading to ongoing research and analysis in this domain.