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Price theory explains why consumers buy goods or services from a particular company, based on the agreement of price and value. Supply and demand graphs help companies understand at what price they will sell the most goods or services. External factors such as competition, consumer demand, and market size also influence price theory.
Price theory is an economic concept that defines how or why a consumer will buy a good or service from a particular company. For this transaction to occur, both the company and the consumer must agree on the price of the item, which is inherently tied to the value of the product. Price and value are two important factors for the movement of goods or services in the economic market. Price theory can also include external factors, such as the number of competing products, aggregate consumer demand, and the size of the overall economic market.
In a free market economy, economists often explain price theory using a basic supply and demand graph. This chart helps companies understand at what price they will sell the most goods or services, thus maximizing their financial returns. On a right angle chart, the horizontal line represents price and the vertical line represents quantity. The supply curve starts from the lower left corner and slopes to the right. The demand curve starts in the upper left corner and slopes down and to the right. The intersection of these lines is known as the break-even point, where businesses and consumers will agree on the price of the product.
The supply and demand graph indicates that, according to price theory, firms are more willing to increase supply at higher prices because profits are higher. However, consumers are generally unwilling to pay high prices for goods they consider to be of little or no value. Conversely, demand is high when prices are low, although some companies are unwilling to sell many goods of this nature due to low profits.
The number of competing products in the economic market can affect the theory or the price. Competing companies will try to undersell other companies by offering similar goods at a lower price, which in turn will change the equilibrium price point for goods and services. Companies that offer inferior or substitute products can also drive the market away from a brand name product.
Consumer demand and the size of the general economic market also influence price theory. Consumers who are unwilling to buy a good or service will force companies to lower the price of the item until consumers find it valuable enough to buy at a specified price. For example, a company that makes pots may find that consumers are more interested in frying pans. Having too many pots for sale at a high price will generally result in fewer or no sales for the company. The company must reduce the price of its pots to the point where consumers are willing to buy them and try to rethink its production strategy.
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