Price - Price Theory

Price Theory

Economic theory asserts that in a free market economy the market price reflects interaction between supply and demand: the price is set so as to equate the quantity being supplied and that being demanded. In turn these quantities are determined by the marginal utility of the asset to different buyers and to different sellers. In reality, the price may be distorted by other factors, such as tax and other government regulations.

When a commodity is for sale at multiple locations, the Law of one price is generally believed to hold. This essentially states that the cost difference between the locations cannot be greater than that representing shipping, taxes, other distribution costs etc. In the case of the majority of consumer goods and services, the distribution costs are quite a high proportion of the overall price, so the law may not be very useful. In practice it may well make economic sense to offer a product or service for sale at a higher price in a wealthy area than in a deprived area as the marginal utility of the asset for purchasers will be higher in the former.

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