What is price? How is it determined?


Let’s make a reintroduction into economics today:

From ancient Greek philosophers to companies that produce today’s digital technologies. “price”, which expresses the monetary value of goods and services, has been one of the first priority analyses throughout history. On the other hand, finding the causes of the increase in the general level of prices, also known as “inflation”, which has been the main problem of ancient civilisations such as Romans, Chinese and Ottomans as well as today’s developing countries, especially the Latin American countries and Turkey, has become one of the most important challenges among the makers of economic policy.

The changes in prices of goods and services, including the commodities necessary for production, closely affect not only a country’s economy but also the global economy. However, when I say, “closely affect”, I can say that this proposition does not guarantee a prescription that can provide a “solution”.

According to a well-known author, people will definitely reach the stars one day, but even then they will continue to think about the causes of price increases and how they can bring these increases under control.

Although this argument may seem demoralizing, it does not seem completely wrong considering the endless efforts of the humanity who has been in pursuit of the “right price” since ancient Greece. Based on these facts, I think it may be a reasonable next step to deepen our analysis of price and price determination.

As I mentioned earlier, price is the expression of “value” in monetary terms. Even though the value that determines the price of a good or service has been defined in various ways throughout history, studies made in late 19th century and early 20th century happen to offer more tangible theories.

Usually, people seem to view the concept of “value” of goods or services from the following perspectives:

– Scarcity or abundance

– Use

– Production cost

These theories, which seem to be logical at first glance, are in fact inadequate considering today’s circumstances. For example, thinkers constantly tried to find explanations to the fact that the value (price) of water, whose total utility is much higher than the total utility of diamonds, is very low compared to that of a diamond or the relative nature of the concept of scarcity, or goods sold at prices excessively above production costs, etc.

“Economy is Based on Observation, Not Experiment.”

It was finally made possible to add new concepts to economic analysis as a result of the widespread use of psychology in the 19th century. For example, the phenomenon of “saturation” that occurs when consuming a good or service has become a generally accepted approach. As the units of goods people consume or keep ready for consumption increase and approach their physiological or mental saturation point, they tend to give less importance to the goods they have consumed or added to their inventory compared to the newly acquired ones, because approaching saturation point gradually reduces the additional utility (marginal utility) that each new unit of good brings. When saturation is reached, it is noticed that the contribution of the marginal unit of goods that brought the person to this point to total utility has been zero. In that case, from that person’s perspective, the value of the good consumed by the person depends on the amount of consumption and stock at a point far or close to the saturation point. So, we could assume that the value of a good is not about its objective qualities such as colour, shape, or density, it is rather about its subjective qualities that may vary depending on the amount consumed and the tendencies of the consumer.

To illustrate, today’s retail sales methods include keeping the demand alive by offering different prices depending on the good’s consumption volume in order to make consumers buy more goods or services. From fast food chains to various fashion accessory brands, we could say that the sales tactics designed to push consumers to demand more supply are prepared according to the above-mentioned physiological and psychological reaction.

So, the factors that determine the value of the goods or services, and the utility that is created based on the amount consumed are of utmost importance, and the price adjustments, which are the monetary expression of the value of a good or service, are made accordingly. However, early economic theories did not focus on the simultaneity of utility and quantity, and it was not until the end of the 19th century when economists started to include both factors in their studies. Finally, it is accepted that price is formed where the quantity demanded, and the quantity supplied are equal.

Where the price is accepted as “data”, invariant in the short term, costs would naturally be a major problem for the supplier. When costs are falling, producers will produce and sell more goods, and when costs are rising, they will try to avoid doing so. Analyses are deepened with the ceteris paribus in economics, which generally means ‘with other conditions remaining the same; other things being equal.’

Economics is not a positive science. It is rather shaped by human behaviour and natural events. Therefore, in order to better understand economics, it is necessary to examine it under a microscope, so to speak.

So, first off, it is necessary to know from which elements the production of a company arises. When the company wants to increase its production volume, what does it do if it cannot manage to expand all of the factors of production it uses? If it employs a suitable and cheap factor and adopts a slower pace in the use of others, will the efficiency of the factor it focuses on and that it gradually increases its use remain the same? Or is it likely that efficiency decrease? How will this situation affect the company’s costs hence the supply of goods?

These questions are not theoretical, and businesses seek answers to these questions every day. It is possible to find out the answers to all these questions using software that generates various simulation-based scenarios. However, it should not be forgotten that the design behind such software is the experience accumulated and discussed throughout centuries.

Dear friends, as I remember my late father Professor Alkin with much love and gratitude today, I must say that I have tremendously enjoyed sharing with you my own experience and his lecture notes.