What is the Market Price?
Market price is the current price at which a product or a service can be bought or sold and therefore traded in the market place at a certain point of time. It exists in anything and everything we need in our daily lives – travel, food, work, and leisure.
There are two theories strongly supporting this concept. The first one is the economic theory which gives away the fact that the price at which forces of supply and demand meet is called a market price. The second one, the finance theory suggests the two prices, ask and bid, usually prevalent in stock exchangesFinance Theory Suggests The Two Prices, Ask And Bid, Usually Prevalent In Stock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ., the difference is termed as a spread or a margin. Only when a bid is equal to an ask, there is a defined market price.
Concept of Market Price
1 – Economic Theory
- Broadly, the market price is the point of intersection of the supply for any product or service and it’s demand. It forms a great base and is of significant importance in microeconomics studyMicroeconomics StudyMicroeconomics is a ‘bottom-up’ approach where patterns from everyday life are pieced together to correlate demand and supply.. It is in equilibrium only under the most efficient and rational expectationsRational ExpectationsRational expectations theory is a modeling technique that states that most common people base their decisions on three key factors: their previous experiences, the information available to them, and their human rationality..
- In the figure above, the X-axis represents the Output or Production of an asset or a service. The Y-axis represents the corresponding Price for that. The point where the demand curveDemand CurveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand i.e. as the price increases, demand decreases keeping all other things equal. (downward sloping) and supply curve (upward sloping) meet is termed as a market price. It can be found by looking into things like market trends, the number of existing buyers and suppliers, competitors and so on. However, putting it numerically can be a difficult task because it does not use our day to day formulas.
- A shift in either the supply or demand, due to any factor/s, will affect the market price. Keeping demand constant, an increase in supply results in a decrease in the price and vice versa. The concept is easy to understand – higher the production, cheaper the product or service. Similarly, if supply is constant, an increase in demand leads to an increase in the price and vice versa. If anything of the above scenarios happens, the business shifts the market price to bring in line with the changing supply and demand.
- Demand for any asset or service might change due to various factors – tastes and preferences, income, changes in prices of related products, future expectations, etc. Similarly, the supply might fluctuate due to – natural conditions, changes in factor prices, government policies, number of suppliers and the nature of the product.
2 – Finance Theory
- It is the last price at which a security, usually called a share, is traded. Various parties – investors, brokers, dealers, and traders interact with each other to make this trade happen in the market. In simple terms, for a share to be bought or sold, there should be a buyer and a seller who should agree on the same price at the same point in time.
- Buyers quote a bid, the price which they are ready to pay for a share; and sellers quote an ask/ offer, the price at which they want to sell the share. If it equals, the trade goes through and the share transfer happens subsequently. If not, there exists a difference between the two called a spread or a margin. Till that negates, or till the dealer/ broker agrees to pay the difference – trade does not go through.
Difference Between Market Price and Normal Price
Below are the key differences between the two –
|Market Price||Normal Price|
|It is temporary – it can be more or less than the average cost of production.||Normal price is permanent –usually equal to the average cost of production.|
|There exists an opportunity for supernormal profits if the price is more than the average cost of production. If it is less, there can be losses as well.||There is only a normal profitNormal ProfitThe term "normal profit" is used when the profit is zero after accounting for both the implicit and explicit expenses, as well as the overall opportunity costs. It happens when all of the resources have been used to their full potential and cannot be put to better use. over the long run since the normal price is always equal to the average cost of production.|
|Supply stays constant in a very short period, while demand can change.||In the long run, supply plays a key role in price determination.|
|It exists for all goods, even non-reproducible like arts, antiques.||Normal price only exists for reproducible goods.|
|It may/ may not change frequently.||Normal price remains stable over the long run.|
In today’s world, prices are termed in some forms of currency as compared to barters or exchange systems prevalent in the older times. Prices can be replaced by vouchers, stamps, or bitcoins, but generally – the price of an asset or service is it’s worth in currency – digital or print.
For a stock ABC, the bid and ask maybe $45.50 and $45.51. In that case, the trade would not happen. A trade-only takes place if a buyer interacts with a seller. To make that happen, there is a need for dealers and brokers. In the above scenario, if the buyer deems fit to increase the bid or the seller feels to decrease the ask to the respective prices, the share would trade or it will remain untraded.
- It is important in the aspect that it is the most effective price at which an asset or a service is traded. Knowing this price is key to knowing how to get a trade, increase revenue, reduce costs and expand the business. There may/ may not be multiple markets for the same product or service, that depends and varies on the offerings and the industry.
- Having said that, in the practical world, there are a lot of external factors not under the control of any individual, business or even industry – monetary and fiscal policiesFiscal PoliciesFiscal policy refers to government measures utilizing tax revenue and expenditure as a tool to attain economic objectives. , law and regulations, quotas and tariffs, trade barriers, cartelsCartelsA cartel is a group of producers of goods or suppliers of services formed through an agreement amongst themselves to regulate the supply of goods or services with the basic intent to illegally regulate the prices or restrict competition regarding the said goods or services. and other restrictions which shape the market price on a real-time basis. All these factors impact the market price of the good to a greater extent.
This has been a guide to What is Market Price. Here we discuss the concept of market price along with its importance and example. You can learn more about from the following articles –