Theory Of Price

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.