Price Analysis and the Exchange Function

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Price Analysis and the Exchange Function
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The marketing system must connect buyers and
sellers.
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How?

• Customs and traditions
• Central control
• Decentralized coordination through prices.

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Price System

• The firms profit seeking behavior will lead it
  to serve societys interest by allocating
  resources to their highest valued use.
• Adam Smiths (1776) invisible hand.

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The Job of Prices

• Prices have the responsibility to guide and
  regulate
• producers output and selling decisions
• consumption decisions
• marketing decisions over time, place, and form.

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Everything is Relative

• Relative prices between products influences
  production and consumption decisions

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Supply and Demand
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Law of Demand

• Formalizes the relationship between prices and
  quantities purchased the higher the price, the
  less purchased, ceteris paribus.

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Diminishing Marginal Utility

• As a buyer consumes increasing amounts of a
  product in any time period, the usefulness and
  desirability of each additional unit decreases.

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Substitution Effect

• When a food price declines, its price relative to
  other good declines as well.
• Induces the consumer to substitute the first good
  for other goods.

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Income Effect

• As the price of a food declines, the consumers
  real income (purchasing power) increases.
• Induces the consumer to purchase more of all
  goods.

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Demand Curve for Corn
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Watch Out!

• The demand schedule does not make the price
  alone.
• There is a difference between demand (the curve)
  and the quantity demanded (a point on the curve).
• We are only concerned with effective demand.

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Changes in Demand

• Change in the number of buyers.
• Change in incomes.
• Change in tastes and preferences.
• Change in the price of related products.
• Change in expectations.
• Changes in marketing costs.

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Derived Demand
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Derived Demand

• Demand for a raw product is derived from
  consumer demand for finished products.

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Law of Supply

• The higher the price, the more that will be
  offered in the market.

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Supply Function for Corn
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Changes in Supply

• Short-run
• Storage costs
• Change in financial conditions
• Expectations about future prices
• Long-run
• Costs of production
• Relative prices
• Technology

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Equilibrium

• The equilibrium is the point where supply and
  demand are equal.
• Equilibrium represents the agreement between
  producers and consumers about the quantity and
  price to be bought and sold in the market.
• Equilibrium is the price at which all of a
  product that is produced will be purchased.

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Equilibrium
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Equilibrium

• Prices are not constant always changing.
• Prices vary because of changing conditions and
  lack of knowledge of the true equilibrium.
• Prices tend toward the true equilibrium.

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Elasticity

• Price elasticity is a measure of the
  responsiveness of quantity supplied or demanded
  to changes in price.

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Elasticity
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Elasticity

• Ep gt 1 ? Elastic
• Ep 1 ? Unitary
• Ep lt 1 ? Inelastic

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Elastic

• A 10 change in the price leads to a greater than
  10 change in the quantity supplied or demanded.
• Ex. E(demand)-1.23
• A 10 increase in the price would lead to a 12.3
  decrease in the quantity demanded.

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Unitary

• A 10 change in the price leads to a 10 change
  in the quantity supplied or demanded.
• Ex. E(supply)1.00
• A 10 increase in the price would lead to a 10
  increase in the quantity supplied.

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Inelastic

• A 10 change in the price would lead to a less
  than 10 change in the quantity supplied or
  demanded.
• Ex. E(demand)-0.27
• A 10 increase in price would lead to a 2.7
  decrease in quantity demanded.

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Factors Affecting the Price Elasticity of Demand

• Number of substitutes.
• Time

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Effect of Substitutes
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Cross-Price Elasticity of Demand

• Shows how changes in the price of one product
  affect the quantity demanded of another product.

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(cont.)

• E(cp)()?substitutes?price increase in one
  product leads to increase in quantity demanded of
  another product.
• Ex. Beef and Pork

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(cont.)

• E(cp)(-)?complements?a price increase in one
  product leads to a decrease in the quantity
  demanded of another product.
• Ex. Strawberries and Shortcake

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Elasticity and Total Revenue
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Factors Affecting Elasticity of Supply

• Time
• Technology

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Law of One Price

• Under competitive conditions, all prices within a
  market are uniform after taking into account the
  costs of adding place, time, and form utility to
  products within the market.

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Arbitrage

• Buying low in one market to sell at a profit in a
  higher priced market.