Price is a specific value expressed in money, being the equivalent of a given good.The buyer making the purchase of a good or service is obliged to pay the seller the equivalent of the price. For the buyer, the price is the cost that must be incurred at the time of purchase; a certain value from which he must give up in exchange for the purchase of a good or service. For the seller, the price is the source of income. The price means the value at which both the seller and the buyer are ready to make a transaction. The prices should cover all socially necessary production costs, should be set at a level that ensures full disposition of the consumer goods produced, preventing any shortages or surpluses.
Prices coordinate decision making producers and consumers on the market.Higher prices result in reduced purchases and encourage production. Lower prices stimulate consumption and tend to reduce production.Prices are the driving force of the market mechanism.
Price is a feature of every transaction, regardless of its type. Even for some public services, for which you do not pay directly, there is a price. It is also included in taxes imposed on citizens. Such products or services are referred to as nongoods. The price due to the form of the transaction can take many forms.
Traditionally, the term “price” is defined as a financial expression of the product value. However, nowadays price is described as a market value of goods or services but regardless of utility value, the price level depends on current market situation which is result of interaction between seller and customer.
Prices influences on producer and consumer decisions on the market. On the one hand, higher prices cause decrease of purchases and production raise, and on the other hand, lower prices cause consumption and decrease of production. Prices are the driving wheel of market mechanism.
The price functions:
- redistributive function – allows to income reallocation between social groups,
- stimulating function – imposes obeying the market regulations and helps to regulate supply and demand,
- informative function – informs about relations of products value.
The price formation can be influenced by many different factors:
- production cost and expenses connected with distribution or promotion,
- competitors’ price of similar products,
- buying habits and customer perception of product quality and attractiveness,
- economic condition: inflation, unemployment rate and related work expenses, etc.,
- laws and regulations which might impact on some product groups and periodically restrict their price formation,
- supply and demand, lack of efficient supply leads to raise of price and gross margin; demand limitation to supply causes price and gross margin decline.
- Informative - prices are a parameter reaching all business entities that are market participants, understandable for them, allowing to determine the size of their monetary income, and stimulating to a specific action. The prices inform the buyer, if his money is reduced, if he purchases the good, while the seller informs about how much the revenue will increase when he makes a sale.
- Redistributive (breakdown) - prices are a tool for distributing goods and services, and shifting income from one social group to another and to the state budget also depending on the structure of purchased goods and services and the structure and level of prices.The state also redistributes income by means of prices, by diversifying the price burden of taxes and duties, or subsidizes certain branches of the economy.
- Simulative (stimulus) - price is a tool of influence on suppliers and recipients - the higher the price level at constant costs, the higher the profitability of production. The lower price level, on the other hand, discourages producers and limits production. A higher price level also causes producers to increase the utility value of their products. When it comes to consumers, the higher price leads them to lower their consumption, while the lower one stimulates its growth. With the help of prices, the state can stimulate the growth of consumption of some products, and regulate the level of real income in society.
Price level in the free market economy
In a perfectly functioning market economy, the process of price formation should take place on its own. According to the laws of economics, the greater the demand for a given good, the higher its price will be. This is because the availability of goods is limited - therefore only those buyers who agree to a higher price will be able to get the good. Consumers will therefore be willing to buy at higher prices, and producers will lower prices of their products until the market balance point is reached. At this point, in a perfectly functioning economy, producers produce exactly as much goods as there is demand. Transactions, on the other hand, take place at an optimal price, which is a compromise between the expectations of buyers and producers.
Price elasticity of demand
The price elasticity of demand is understood as the ratio of the relative change in the size of demand to the relative price change. The amount of the index so calculated in this way shows the price elasticity, i.e. price sensitivity to a change in demand. Stiff demand (completely inelastic) means that the price change does not translate into a change in demand. Stiff demand is characteristic for goods necessary for survival, for which the consumer is willing to pay any price, for example, life-support drugs. Inelastic demand is characterized by goods for which a proportional price change results in a smaller proportional change in demand, for example, a 10% increase in consumer prices will reduce the demand for these goods by 5%. Proportional demand means that the percentage change in price triggers a proportional change in demand, for example, an increase in the price of goods by 10% will reduce the demand for these goods by exactly 10%. Flexible demand is characteristic of a situation in which a relative change in price results in a greater relative change in demand, for example, a 10% increase in commodity prices will reduce the demand for these goods by 20%. The perfectly flexible demand occurs when the minimum price change has a significant impact on the change in demand.
The process of shaping prices by enterprises and pricing strategies
Price is one of the key factors shaping the marketing advantage in an enterprise. Setting prices at an appropriate level can significantly increase the company's profit in a short period of time. Typically, increasing the price is a simpler and less costly process for the company than increasing production - this is a way to dynamically increase revenues. Proper price fixing eliminates the gap between the internal costs of the company and external demand, and enables the achievement of positional advantage. However, it should be remembered that the higher the price, the fewer buyers will be willing to pay it for purchasing a good or service. The optimal price of the product is what unites marketing and product strategies and determines the long-term probability of the company's existence within constraints created by the cost structure and the market. Enterprises set prices based on:
- The structure of company costs,
- The competitive position of the company,
- Competition prices,
- Marketing strategies, especially those that form the basis of competition,
- Organizational options,
- The economic situation of a given market.
- The pricing strategy defines the company's policy towards pricing, so as to maximize profits in the long run.
Types of prices
- Manufacturer - this is the price at which you can purchase the product directly from the manufacturer,
- Wholesale - that is, the intermediate price (without margin),
- Retail - includes all production, marketing and distribution costs (wholesale price + retail margin ),
- Official - otherwise regulated, determined by state authorities,
- Maximum - they deprive the party of the option of contracting a price above a certain value,
- Minimum - deprive the parties of the option of contracting a price below a certain value,
- Berndt, E. R., & Wood, D. O. (1975). Technology, prices, and the derived demand for energy. The review of Economics and Statistics, 259-268.
- Glosten, L. R., & Milgrom, P. R. (1985). Bid, ask and transaction prices in a specialist market with heterogeneously informed traders. Journal of financial economics, 14(1), 71-100.
- Lambert, Z. V. (1970). Product perception: An important variable in price strategy. The Journal of Marketing, 68-71.
Author: Justyna Michalik