Price mechanism

Last updated December 21, 2023

In economics, a price mechanism is the manner in which the profits of goods or services affects the supply and demand of goods and services, principally by the price elasticity of demand. A price mechanism affects both buyer and seller who negotiate prices. A price mechanism, part of a market system, comprises various ways to match up buyers and sellers.

The price mechanism is an economic model where price plays a key role in directing the activities of producers, consumers, and resource suppliers. An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in trade, the purchaser will announce a price he is willing to pay (the bid price) and the seller will announce a price he is willing to accept (the ask price).

The primary advantage of such a method is that conditions are laid out in advance, and transactions can proceed with no further permission or authorization from any participant. When any bid and ask pair are compatible, a transaction occurs, in most cases automatically.^[1]

Samuelson wrote that "the price mechanism, working through supply and demand in competitive markets, operates to (simultaneously) answer the three fundamental problems of economic organization in our mixed private enterprise system..."^[2] and establish an equilibrium system of prices and production.^[2] At competitive equilibrium, the value society places on a good is equivalent to the value of the resources given up to produce it (marginal benefit equals marginal cost). This ensures allocative efficiency: the additional value society places on another unit of the good is equal to what society must give up in resources to produce it.^[3]

Working of the price mechanism

Under a price mechanism, if demand increases, prices will rise, causing a movement along the supply curve.^[4]

For example: the oil crisis of the 1970s drove oil prices dramatically upwards, which in turn caused several countries to begin producing oil domestically.

A price mechanism affects every economic situation in the long term. Price Mechanism plays a vital role in determining prices in a capitalist economy. An example of the effects of a price mechanism, in the long run, involves fuel for cars. If fuel becomes more expensive, then the demand for fuel would not decrease fast but eventually, companies will start to produce alternatives such as biodiesel fuel and electrical cars.^[5] A price mechanism is a system by which the allocation of resources and distribution of goods and services are made on the basis of relative market price. There are two important elements of price mechanism – 1. PRICES - prices are essence of price mechanism. Price mechanism works through prices in a free enterprise economy, where all goods and services carry price tags with them. A whole set of prices prevail in such an economy. Goods and services are available at a price because it involves cost in producing these goods and services. Consumers have to pay some prices if they want to buy some goods like food, clothes, etc. Producers are willing to sell goods and services only if they get the appropriate price. 2. MARKET - forces of demand and supply operate within the framework of market. Market constitute an integral part of the price mechanism A market means a system or a set-up in which the buyers and sellers of the commodity are able to interact and communicate with each other and strike a deal, i.e., price and the quantity to be bought and sold.

Auctions

An auction is a price mechanism where bidders can make competing offers for a good. The minimum bid may or may not be set by the seller, who may choose to predetermine a minimum asking price. The highest bidder would be awarded the transaction.

Other applications

If the terms "pay" and "sell" are understood very generally, then, a very broad range of applications and different market systems can be enabled this way. Internet dating for instance could be based on offers to talk for a period of time, accepted by those who are compensated not in money but in additional credits to keep using the system. Or, a political party could trade support for different measures in a platform, perhaps using allocation voting to "bid" a certain amount of support for a measure that a leader has "asked" them to support: if the measure has enough support in the party, the leader will proceed; a very explicit model of so-called "political capital".

Though there are many concerns about liquidating any given transaction, even in a conventional market, there are ideologies which hold that the risks are outweighed by the efficient rendezvous. In greenhouse gas emissions trading, companies doing the "bidding" argue that Earth's atmosphere can be seen as affected almost uniformly by emissions anywhere on Earth. They argue further that, as a result, there are almost no local effects, and only a measurable and widely agreed climate change effect, of a greenhouse gas emission, justifying a "cap and trade" approach. Somewhat more controversially, the approach was applied even earlier to sulfur dioxide emissions in the United States, and was quite successful in reducing overall smog output there.

In most applications of such methods, however, the comprehensive outcome of the transaction is not so easily measured or universally agreed. Some theorists assert that, with appropriate controls, a market mechanism can replace a hierarchy, even a command hierarchy, by ordering actions for which the highest bid is received:

So price mechanism is a technique by which inflation is controlled. The price can only be increased if the supply is less and has more demand for the same.

Less controversial applications of bid and ask matching include:

industrial process control^{[ citation needed ]}
various applications in social networks (including dating above)
calculating interest in court judgments or homestead credit
determining which of several assets in a divorce are most prized by each party, and accordingly, who should receive what for maximum amiability and minimum capital asset sale and lifestyle disruption

Related Research Articles

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In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum.

<span class="mw-page-title-main">Supply and demand</span> Economic model of price determination in a market

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good, or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

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In economics, deadweight loss is the difference in production and consumption of any given product or service including government tax. The presence of deadweight loss is most commonly identified when the quantity produced relative to the amount consumed differs in regards to the optimal concentration of surplus. This difference in the amount reflects the quantity that is not being utilized or consumed and thus resulting in a loss. This "deadweight loss" is therefore attributed to both producers and consumers because neither one of them benefits from the surplus of the overall production.

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"The Market for 'Lemons': Quality Uncertainty and the Market Mechanism" is a widely cited seminal paper in the field of economics which explores the concept of asymmetric information in markets. The paper was written in 1970 by George Akerlof and published in the Quarterly Journal of Economics. The paper's findings have since been applied to many other types of markets. However, Akerlof's research focused solely on the market for used cars.

In economics, economic equilibrium is a situation in which economic forces such as supply and demand are balanced and in the absence of external influences the values of economic variables will not change. For example, in the standard text perfect competition, equilibrium occurs at the point at which quantity demanded and quantity supplied are equal.

In economics, insurance, and risk management, adverse selection is a market situation where buyers and sellers have different information. The result is the unequal distribution of benefits to both parties, with the party having the key information benefiting more.

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In economics, market clearing is the process by which, in an economic market, the supply of whatever is traded is equated to the demand so that there is no excess supply or demand, ensuring that there is neither a surplus nor a shortage. The new classical economics assumes that in any given market, assuming that all buyers and sellers have access to information and that there is no "friction" impeding price changes, prices constantly adjust up or down to ensure market clearing.

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In economics, an excess supply, economic surplus market surplus or briefly supply is a situation in which the quantity of a good or service supplied is more than the quantity demanded, and the price is above the equilibrium level determined by supply and demand. That is, the quantity of the product that producers wish to sell exceeds the quantity that potential buyers are willing to buy at the prevailing price. It is the opposite of an economic shortage.

This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.

References

↑ A seminal article on the firm in relation to transaction costs is R. H. Coase (1937), "The Nature of the Firm," Economica 4(16), pp. 386–405, which has with some 41 uses of "price mechanism" in it (via cntrl-F: price mechanism), illustrating contexts for its usage.
1 2 Samuelson, P. Anthony., Samuelson, W. (1980). Economics. 11th ed. / New York: McGraw-Hill. p. 49
↑ Callan, S.J & Thomas, J.M. (2007). 'Modelling the Market Process: A Review of the Basics', Chapter 2 in Environmental Economics and Management: Theory, Politics and Applications, 4th ed., Thompson Southwestern, Mason, OH, USA
↑ Pettinger, T. (n.d.). Price Mechanism in the Long Term. or price mechanism is the mechanism in which price plays a key role in directing the activities of producers, consumers and resource suppliers. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html
↑ Pettinger, T. (n.d.). Price Mechanism in the Long Term. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html

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[1] A seminal article on the firm in relation to transaction costs is R. H. Coase (1937), "The Nature of the Firm," Economica 4(16), pp. 386–405, which has with some 41 uses of "price mechanism" in it (via cntrl-F: price mechanism), illustrating contexts for its usage.

[Samuelson-2] 1 2 Samuelson, P. Anthony., Samuelson, W. (1980). Economics. 11th ed. / New York: McGraw-Hill. p. 49

[3] Callan, S.J & Thomas, J.M. (2007). 'Modelling the Market Process: A Review of the Basics', Chapter 2 in Environmental Economics and Management: Theory, Politics and Applications, 4th ed., Thompson Southwestern, Mason, OH, USA

[4] Pettinger, T. (n.d.). Price Mechanism in the Long Term. or price mechanism is the mechanism in which price plays a key role in directing the activities of producers, consumers and resource suppliers. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html

[5] Pettinger, T. (n.d.). Price Mechanism in the Long Term. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html

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