Price Analysis and the

Exchange Function
The marketing system must
connect buyers and sellers.
How?
 Customs and traditions
 Central control
 Decentralized coordination through prices.
Price System
 The firm’s profit seeking behavior will lead
it to serve society’s interest by allocating
resources to their highest valued use.
 Adam Smith’s (1776) “invisible hand.”
The Job of Prices
Prices have the responsibility to guide and
regulate:
 producers’ output and selling decisions
 consumption decisions
 marketing decisions over time, place, and
form.
Everything is Relative
 Relative prices between products influences
production and consumption decisions
Supply and Demand
Law of Demand
 Formalizes the relationship between prices
and quantities purchased; the higher the
price, the less purchased, ceteris paribus.
Diminishing Marginal Utility
 As a buyer consumes increasing amounts of
a product in any time period, the usefulness
and desirability of each additional unit
decreases.
Substitution Effect
 When a food price declines, its price
relative to other good declines as well.
 Induces the consumer to substitute the first
good for other goods.
Income Effect
 As the price of a food declines, the
consumer’s real income (purchasing power)
increases.
 Induces the consumer to purchase more of
all goods.
Demand Curve for Corn
4.5
4
Peso per Ton

3.5
3

2.5
2
3 3.4 3.8 5 5.7 6.4 7.2
Millions of Tons Purchased
Watch Out!
 The demand schedule does not make the
price alone.
 There is a difference between demand (the
curve) and the quantity demanded (a point
on the curve).
 We are only concerned with effective
demand.
Changes in Demand
 Change in the number of buyers.
 Change in incomes.
 Change in tastes and preferences.
 Change in the price of related products.
 Change in expectations.
 Changes in marketing costs.
Derived Demand

Demand for Corn Demand for Hogs Demand for Pork Chops
Q
Derived Demand
 Demand for a raw product is “derived”
from consumer demand for finished
products.
Law of Supply
 The higher the price, the more that will be
offered in the market.
Supply Function for Corn

5
4
Peso per Ton

3
2
1
0
3 3.5 4 4.5 5 5.5 6
Millions of Tons Sold
Changes in Supply
 Short-run
– Storage costs
– Change in financial conditions
– Expectations about future prices
 Long-run
– Costs of production
– Relative prices
– Technology
Equilibrium
 The equilibrium is the point where supply
and demand are equal.
 Equilibrium represents the “agreement”
between producers and consumers about the
quantity and price to be bought and sold in
the market.
 Equilibrium is the price at which all of a
product that is produced will be purchased.
Equilibrium

4.5
4
Peso per Ton

3.5
3
2.5
2
3 4 5 6 7 8
Millions of Tons
Equilibrium
 Prices are not constant; always changing.
 Prices vary because of changing conditions
and lack of knowledge of the “true”
equilibrium.
 Prices tend toward the “true” equilibrium.
Elasticity
 Price elasticity is a measure of the
responsiveness of quantity supplied or
demanded to changes in price.
Elasticity

% Q
Ep 
% P
Elasticity
Ep > |1|  Elastic
Ep = |1|  Unitary
Ep < |1|  Inelastic
Elastic
 A 10% change in the price leads to a greater
than 10% change in the quantity supplied or
demanded.

Ex. E(demand)=-1.23
A 10% increase in the price would lead to a
12.3% decrease in the quantity demanded.
Unitary
 A 10% change in the price leads to a 10%
change in the quantity supplied or
demanded.

Ex. E(supply)=1.00
A 10% increase in the price would lead to a
10% increase in the quantity supplied.
Inelastic
 A 10% change in the price would lead to a
less than 10% change in the quantity
supplied or demanded.

Ex. E(demand)=-0.27
A 10% increase in price would lead to a 2.7%
decrease in quantity demanded.
Factors Affecting the Price
Elasticity of Demand
 Number of substitutes.
 Time
Cross-Price Elasticity of Demand
 Shows how changes in the price of one
product affect the quantity demanded of
another product.
(cont.)
 E(cp)=(+)substitutesprice increase in
one product leads to increase in quantity
demanded of another product.

Ex. Beef and Pork

(cont.)
 E(cp)=(-)complementsa price increase
in one product leads to a decrease in the
quantity demanded of another product.

Ex. Coffee and Sugar

Elasticity and Total Revenue
TR,P
E>1

E=1

E<1

Q
Factors Affecting Elasticity of
Supply
 Time
 Technology
Law of One Price
 Under competitive conditions, all prices
within a market are uniform after taking
into account the costs of adding place, time,
and form utility to products within the
market.
Arbitrage
 Buying low in one market to sell at a profit
in a higher priced market.