Price Determination—Part One

The determination of prices represents another piece in the free market puzzle. As frequently as you hear people refer to prices, I find it surprising how many misconceptions people have about prices. How do you define “price.” What factors determine price? What role do prices have in resource allocation?

In this article, I will address the definition of “price.” I will discuss other important aspects of prices in future posts.

To discuss price in a meaningful way, we must first give it a definition.

The ratio of what a market actor gives up for what he gets determines the price of the item received.

In dollar-denominated transactions, we would state that in terms of dollars per unit, e.g., dollars per pound, dollars per bushel, or dollars per item. We can only express that price after the completion of a transaction. The dollar amount on a price tag represents only an “offering price.” If a person accepts that offer, the resulting ratio from that transaction becomes the price.

When a number of transactions occur at the same ratio of dollars to units, we generally refer to that as the “market price.” A “market price,” however, does not commit the parties to any future transaction to that price. “Market prices” simply indicate a ratio at which future exchanges will likely occur.

Along with this definition, we need to define two terms closely related to the term “price:” “buyer” and “seller.” Market transactions consist of exchanges. The distinction between “buyer” and “seller” (or “buying” and “selling”) depends on perspective. With every exchange, we can refer to both parties as either“buyer” or “seller.” One party buys goods and sells dollars. The other party buys dollars and sells goods. So, who’s which?

In referring to exchanges involving dollars, normal usage for “buyer” refers to the person offering dollars, and “seller” refers to the person offering goods.

Does what I have just written simply describe a distinction without a difference?

Understanding the common nature of “buying” and “selling” as exchanges can change our perspective. For example, when a store own raises his (offering) price, he signals that he wants more dollars for his goods; when you wait for a sale, you just want more goods for your dollars. What’s the difference?

In the next article, I will discuss the process of price determination or discovery.

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