We’ve all seen it before: the classic supply and demand graph. The theory of price is basically that graph: the economic theory that price for a good or service is based on the equilibrium where supply and demand meet.
The more demand there is for a limited good, the higher the price will be. The higher the supply, the less scarce it is, and the lower the price will be. Things like available substitute goods, seasonality, availability of raw materials, and market competition—all those outside forces you can’t really control—all factor in, affecting supply and demand.
And, of course, not all goods and services are created equal. Some goods have high price elasticity of demand, meaning that people change their behavior when prices change...while others have low price elasticity of demand, which means people will keep buying the goods, even when prices are changing.
The theory of price makes all of these outside forces endogenous. Supply and demand curves can rotate and shift, but at the end of the day, it’s the equilibrium that determines the price. In neoclassical theory, anyway.
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and finance Allah shmoop How does differential analysis affect pricing
decisions How well nicely we hope Yeah here's the basic
gist of differential pricing analysis that whatever price we're currently
charging for our pine scented hemorrhoid cream well it's not
optimal right We want to set the ideal price so
we can reap the ideal or maximum level of profit
Underlying this whole discussion is the slope of the demand
curve for the product So think about some examples here
Let's step into a time machine and visit nineteen ninety
eight The Land of Steve Urkal Blockbuster Video when it's
so existed and peak market power for the Windows operating
system Well simple is it seemed to us now there
simply was no other purveyor of operating systems in that
era And without an OS well your computer didn't work
and you needed a computer to run your word processor
to dial up the Internet and check your air Well
email you know to play solitaire Well Microsoft could basically
charge whatever it likes for that operating system At the
peak Bill Gates and his pals charged about two hundred
bucks a unit for their Windows operating system to be
installed in your computer so you could use it well
The demand curve for Windows in this era Well it
was almost vertical like they could raise prices with impunity
and the volumes they sold would barely diminished So people
didn't have any other choices if they wanted a functional
computer and so they'd pay quote anything unquote for the
Microsoft OS The opposite is true for pure commodities right
Think copper or bananas or chalk or missile grade plutonium
We'LL Copper is the same copper no matter where it
comes from there are different purity ranges but inside those
standards it doesn't make a difference whether the copper came
from Chicago or Nairobi or Southeast Moscow Well it comes
in boxes and bins and it's the same everywhere It's
hard to have a brand name in copper you could
sell Maybe LeBron James endorsed copper and still not have
much pricing power There are too many choices and each
unit is essentially the same Nobody has any advantage in
their product over anyone else And because of this fact
if buyers can buy the same copper for a penny
less per pound net of shipping in taxes and whatever
other transport grief there is Well then they'LL buy it
cheaper so that demand curve is almost flat like tiny
moves in price mean a massive move in demand on
the supply side of things The corollary positive element here
comes from the leveraging of technology meaning that if you
can find a way for robots using solar power to
mind copper for ten percent less than the human labour
mining system well then you can keep the same profit
margins and sell the copper for way less than what
everyone else is selling it for In real life most
products fall somewhere between the nineteen nineties era windows example
and the situation with a pure commodity like copper Well
to find the optimal price you use differential analysis to
test all the possible points along the demand curves You
crunch the numbers to discover what each increase in price
will do to the amount of items you sell Raised
the price of dollar How many fewer units do you
sell Lower it a dollar How many more do you
sell Well once you have your data set you confined
the point where your revenue and or profit are maximized
it's basically your casino and you want to make sure
that every table and every slot machine does just enough
to keep everyone playing while bringing in max profits to
the house And well if you have to bribe people
with free cocktails to stay in their seats so be 00:03:30.9 --> [endTime] it booze or a commodity to
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