Now that we have a precise definition of the word “price,” we can discuss price determination (or priced discovery) of what we refer to as “market price.” We can understand the determination of an individual price by understanding the previously discussed definition of “price.” The individual price results simply from the agreement between buyer and seller. But, what determines the “market price?”
To explain the discovery of a market price we will return to Joe’s restaurant. We will discuss how he determined the market price of the items on his menu. To understand that process, we will return to when Joe first opened his restaurant.
When Joe first started his restaurant, he offered three items on his menu: item A, item B, and item C (I’ve avoided naming specific food items so you don’t get caught up in judging which one you like the best.) Since he didn’t know how much customers would willingly pay for these items, he decided to offer them for $5.00 a plate. (For the sake of this argument, we assume that the cost of preparing each plate was the same.)
After about three months of operation, Joe discovered that he generally ran out of item A before closing time. On the other hand, Joe had to throw almost half of Item B away. Finally, the quantity he prepared of item C seems to be just enough. So, Joe decided to adjust the prices on each of the items.
Joe raised the price for item A to $8.00 a plate; for item B, he lowered the price to $3.00 a plate; and item C he left at the original price of $5.00 a plate. After making these price adjustments, Joe found that the quantities he prepared were just enough.
Joe managed to achieve these results without getting involved in individual negotiations with each customer for each item. Customers express their preferences by either buying or not buying the items offered. Joe now had a good idea of the market prices for each of these food items.
You will notice from this example that Joe’s customers, not Joe, ultimately determined the market price for the items on his menu. He could not forces customers to pay more for an item than they wanted. Nor could he force them to buy less of the product they enjoyed more.
Determining the market prices for the items in Joe’s restaurant is a lot more complex than this example. Still, it does provide a microcosm of the process that determines the market prices of all goods and services in a free market.
By using this crude example, I hoped to demonstrate what I referred to earlier as consumer sovereignty. The consumer determines the prices of all goods in a free market, from the lowest order to the highest order. The consumer signals at what price he will buy by a negotiating process of buying or not buying.
If consumers have more influence on determinating market prices than producers, how do we make consumers? From where do they acquire their money?