MARKET PRICE: HOW IT IS ESTABLISHED AND EXAMPLES - ECONOMY - 2024

The market price is the real price at which a service or asset can be bought or sold in an open market, at a given time. Economic theory holds that the market price converges at a point where the forces of demand and supply meet.

The shocks, whether on the demand side or the supply side, can lead to a revaluation of the market price of a product or service. For example, a shortage of oil in one country during a season can cause prices to rise, falling again when high reserves are found by another country.

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The market price of a security is the most current price at which that security traded. It is what results from negotiators, investors and brokers, who interact with each other in the market. Meanwhile, the market price in the bond market is the last reported price, excluding accrued interest. Also called clean price.

It is of interest mainly in the study of microeconomics. Market value and market price are only equal under conditions of efficiency, equilibrium, and rational market expectations.

How is the price set in the market?

The market price is arrived at by the interaction between demand and supply. The price depends on the characteristics of these two fundamental components of a market.

Demand and supply represent the willingness of consumers and producers to participate in buying and selling. The exchange of a product takes place when buyers and sellers can agree on a price.

When there is imperfect competition, as in the case of a monopoly or a one-off company, the price results may not follow the same general rules.

Market price

When an exchange of products occurs, the agreed price is called the "equilibrium" price or the market price. Graphically, this price occurs at the intersection of demand and supply as presented in the following figure.

Both buyers and sellers are willing to exchange quantity C at price P. At this point, supply and demand are balanced.

The determination of the price depends equally on the demand and supply. It is really an equilibrium of the two components of the market.

Price variations

To see why equilibrium must occur, one must examine what happens when there is no equilibrium, for example, when the market price is below P, as shown in the figure.

At any price below P, the quantity demanded is greater than the quantity supplied. In such a situation, consumers would demand a product that producers would not be willing to supply. Therefore, there would be a shortage.

In this case, consumers would choose to pay a higher price to obtain the product they want, while producers would be encouraged by a higher price to bring more product to market.

The end result is an increase in price, at P, where supply and demand are balanced.

Similarly, if a price above P were arbitrarily chosen, the market would be in surplus, too much supply relative to demand.

If that happened, producers would be willing to take a lower price to sell and the lower prices would induce consumers to increase their purchases. Only when the price falls will equilibrium be restored.

Other considerations

A market price is not necessarily a fair price, it is simply a result. It does not guarantee total satisfaction on the part of the buyer and the seller.

Usually, some assumptions are made about the behavior of buyers and sellers, which adds a sense of reason to the market price.

For example, buyers are expected to take an interest in themselves and, although they may not have perfect knowledge, they will at least try to look out for their own interests.

Meanwhile, sellers are seen as profit maximizers. This assumption limits their willingness to sell within a price range, high to low, where they can stay in business.

Examples

Any change in supply or demand affects the market price of an item. If demand remains constant, a decrease in supply results in a rise in the market price and vice versa.

Similarly, if supply remains constant, an increase in demand for an item results in an increase in the market price and vice versa.

In the real world, there is great interest in policies that impact market prices.

Rent control laws in New York City, production quotas adopted by OPEC countries, and trade barriers enacted by national governments are examples of policies that affect market prices in the real world.

On restaurant menus, "market price" is written instead of a specific price, which means that the price of the dish depends on the market price of the ingredients, and the price is available upon request. It is used especially for shellfish, especially lobsters and oysters.

The market price on the Stock Exchange

For example, suppose that the market price for shares of company ABC is in the range of $ 50/51. There are eight negotiators who want to buy shares of ABC.

This represents the demand. Five of them are looking to buy 100 shares at $ 50, two at $ 49 and one at $ 48. These orders are considered on demand.

There are also eight negotiators who want to sell shares of ABC. This represents the offer. Five are looking to sell 100 shares at $ 51, two at $ 52 and one at $ 53. These orders are listed in the offer.

Supply and demand at this point are balanced, and brokers do not want to cross the existing spread to execute their trade.

However, a new trader enters who wants to buy 800 shares at market price, causing a shock. This negotiator has to buy according to the offer, which would be 500 shares at $ 51 and 300 shares at $ 52.

At this time the spread widens, becoming the market price of $ 50/53. Brokers immediately take action to close that range. Since there are more buyers, the margin is closed by adjusting the offer upwards.

As a consequence, there is a new market price in the range of $ 52/53. This interaction occurs continuously in both directions.

References

1. Will Kenton (2018). Market Price. Investopedia. Taken from: investopedia.com.
2. Wikipedia, the free encyclopedia (2019). Market price. Taken from: en.wikipedia.org.
3. Investing Answers (2019). Market Price. Taken from: investinganswers.com.
4. Business Dictionary (2019). Market price. Taken from: businessdictionary.com.
5. Alberta Agriculture and Forestry (2019). How Demand and Supply Determine Market Price. Taken from: agric.gov.ab.ca.