THE MECHANICS OF SUPPLY AND DEMAND

Most things we buy from day to day have a relatively fixed price, at least in the short term. Generally speaking, if you walk in to a newsagent and begin to haggle over the price of a chocolate bar, the shopkeeper will most likely be unimpressed.

But this isn’t always true.

As a raw chicken approaches its sell-by date a supermarket may reduce its price. Has the chicken’s value really changed? The reason the price has been lowered is because the supermarket perceives that there will be less demand for a chicken that is nearing its sell-by date. If you were to buy this chicken you would in a sense be speculating: you make a purchase because you feel that, although demand for the chicken has reduced amongst the other shoppers, you’re sure that its true value is just the same – it’s just as edible and tasty as when it first hit the shelves a few days before.

But would you buy the chicken a day after its sell-by date? Maybe you will think ‘this chicken has been in a chill cabinet, this shop has a reputation for quality, sell-by dates tend to be fairly conservative, the price has been reduced still further, and I once bought a chicken past its date before and I didn’t get ill’. In other words, you’d be weighing up price against perceived risks.

If you go to another supermarket selling identical chickens from the same farm, the price might be slightly less. Why? The second supermarket is keen to attract your custom and is willing to sell the chicken to you for a lesser price. The price is determined not just by how much customers want to buy a chicken, but by how much the supermarket wants to achieve a sale.

Suppose that you go to a market in Marrakech to buy a chicken. There will be no ‘fixed’ price, and you will be expected to haggle with the seller until a price is agreed upon – an amount at which the stall owner is willing to sell, and at which you are prepared to buy. Each of you will probably enter the negotiation with some fixed levels in mind. The seller will have a minimum amount that he is willing to accept (perhaps the price he has paid for the chicken plus a percentage mark-up on his costs), and you will have a maximum amount you are willing to pay (perhaps what you paid for a chicken last week, or how much a supermarket would sell the same chicken for).

So we can start to draw a few important ideas out of the above scenarios:

  • Both the demand for a product and the readiness of supply will affect the price of that product at any given time.
  • There may be a difference between the perceived value of an item, and its actual intrinsic value.
  • When we make judgements about price, we often make judgements about risk.
  • Exactly the same item may vary in price from one seller to another.
  • Price is not always fixed, and can be discovered by the point at which the expectations of buyers and sellers meet.
  • Where price is not fixed absolutely, there will be certain points above and below which it is unlikely to move.

Unlike a chocolate bar in a newsagent, the price for all the commodities, currencies, stocks, shares, contracts, and bonds with which traders concern themselves (each of which is known as an INSTRUMENT or SECURITY) are radically un-fixed in nature. Because of this, the price that you see quoted on your screen at any given time is said to be ephemeral (i.e. short-lived or transient). All of the factors just discussed affect and determine price on a split second basis.

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