The Mechanism of Price

Today I thought I'd give you my thoughts on one of the most overlooked facets of an economy: a good, or services, price.

A "price" is the amount of one good you trade for another good, as agreed upon by the buyer and the seller. In all but the most primitive of economies, this price is usually listed as the commonly agreed upon "monetary unit" (ounces of gold or silver, paper dollars, etc).


SUPPLY AND DEMAND

A good, or services, price is determined by many many factors, collectively referred to as the Law of Supply and Demand (a Law like gravity or relativity, not a law like a speed limit.) According to this law, if the supply of a good increases, then it's price decreases. It usually means that production techniques are cheaper and more efficient, or more of the good has been found to dig out of the ground (in the case of natural resources). The reverse is true. If the supply of a good goes down, for whatever reason, the price will tend to increase.

If the Demand for a good goes down (that is, if consumers do not wish to purchase a good) then the price also goes down, as the people who are trying to sell the good need to give the consumer a reason to buy. It's better to sell at a lower price, and get some money, than not to sell at all. If, however, the demand for a good goes up, then prices will rise, as people will be willing to spend more money on that good.

The ratio between supply and demand is what ultimately determines the price. Many factors contribute to the supply and demand of a good or service: the availability and cost of raw materials, he overall cost to produce the good, the current economic climate, the general need for the good being produced, and the amount of competition (or threat of competition) in that sector of the economy.

In short, an objects price is a very complex amalgamation of many different pieces of information about the availability, demand, manufacturing costs, durability, efficacy, or usefulness of a given good or service, and as such it is the mechanism which drives an economy. It is the flag that displays to the world the economic viability of buying, or producing, a good or service.


THE MECHANISM OF PRICE

Think about it: how does an entrepreneur know that a business is worth starting? Simple. He looks around at businesses of that type, if their are any, and sees what price they are charging for that good or service. If he feels he can sell that good, or service, for less than his would-be competitors, and still make a reasonable profit, then he will immediately begin producing this good or service. And seeing as he is providing it for a reduced price, the other companies must also lower their prices, or be put out of business. The effect is a lowering of price.

What about the other way around? How does a business owner know when producing a good or service is no longer economically viable? Simple: when he has reduced his prices as low as they can go, and people are still not buying his good or service. Our business owner must cut costs, or lay off employees, or move to a different sector of the economy. His efforts are turned to a good or service that people do desire, and that will produce him a profit. The net effect of which is a removal of the over-supply of the first good, and a shifting of the businessman's, and his ex-employees, skills and resources to more productive sectors of the economy.


THE WAGE

An employees salary or wage is a price as well. An employee is trading their skill and/or labor in exchange for a fee. Salaries and wages are subject to the same supply and demand laws as every other commodity on the market. That's why many dangerous or genuinely unpleasant jobs, as well as jobs that require rare skills, have such high salaries (the supply of workers, or the skill in question, is low, relative to their demand), whereas common jobs that don't require much skill have lower salaries.

SO MUCH INFORMATION

It is essentially impossible for any one person to predict, control, or understand, the movements of prices in the every day market. That's because prices are the net result of trillions of decisions made by billions of people every day. What do buy, what not to buy, what to sell and how to sell it, where to invest. In short, the only people that can know the decisions, wants, and needs of everyone on the planet... is everyone on the planet. And the decisions of everyone on the planet result in this wonderful number, the price, and the price influences the next round of decision making.



Hopefully you've learned something from this impromptu essay. Remember this, as I'm sure I'll be talking about price again, in the near future.