Price mechanism


Price mechanism

Price mechanism is an economic term that refers to the buyers and sellers who negotiate prices of goods or services depending on demand and supply.[1] A price mechanism or market-based mechanism refers to a wide variety of ways to match up buyers and sellers through price rationing.

An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in a trade, the purchaser will announce a price he is willing to pay (the bid price) and seller will announce a price he is willing to accept (the ask price).

The main advantage of such a method is that conditions are laid out in advance and transactions can proceed with no further permission or authorization from any participant. When any bid and ask pair are compatible, a transaction occurs, in most cases automatically.

Contents

Effects of Price Mechanism

Price Mechanism causes many changes in the economic environment. If there is an increase in demand, then prices will go higher causing a movement along the supply curve.[2] An example of price mechanism in the long term is the oil crisis during the 1970’s.

The crisis caused more nations to start producing its own oil due to dramatic price increases of oil. Since more nations started to produce oil, the supply curve shifted more to the right meaning there was more supply of oil.

Price Mechanism affects every economic situation in the long term. Another good example of price mechanism in the long run is fuel for cars. If fuel becomes more expensive, then the demand of fuel would not decrease fast but eventually companies will start to produce alternatives such as biodiesel fuel and electrical cars.[3]

Stock market

When trading in a stock market, a person who has shares to sell may not wish to sell them at the current market price (quote). Likewise, a person who wishes to buy shares may not wish to pay the current market price either. Some negotiation is necessary in order for a transaction to occur.

The negotiation often comes in the form of adjusting the bid prices and the ask prices as the value of the share goes up and down. For example, if the share is worth $10, a buyer may "bid" $9.97 (3 cents less), and a seller may ask for $10.02 (2 cents more). If the value of the stock goes down, a seller may be forced to reduce his asking price. Conversely, if the value of the stock goes up, a buyer may be forced to increase his bidding price.

Most of the time, the bid and ask prices remain very close to the market value of the share, often separated by only a couple of cents. The difference between the bid and ask price is called the Bid/ask spread.

In actual trading, the parties involved might use a limit order to specify which bid or ask price he wishes to trade at. The trader specifies the number of shares and his bid/ask price (depending on whether he is buying or selling). Such orders can have execution limits, such as "by end of day" or "all or nothing".

Auctions

An auction is a price mechanism where bidders can make competing offers for a good. The minimum bid may or may not be set by the seller, who may choose to predetermine an ask price. The highest bidder, or the first one to reach a preset ask price, would be awarded the transaction.

Other Applications

If the terms "pay" and "sell" are understood very generally, then, a very broad range of applications and different market systems can be enabled this way. Internet dating for instance could be based on offers to talk for a period of time, accepted by those who are compensated not in money but in additional credits to keep using the system. Or, a political party could trade support for different measures in a platform, perhaps using allocation voting to "bid" a certain amount of support for a measure that a leader has "asked" them to support: if the measure has enough support in the party, the leader will proceed; a very explicit model of so-called "political capital".

Though there are many concerns about liquidating any given transaction, even in a conventional market, there are ideologies which hold that the risks are outweighed by the efficient rendezvous. In greenhouse gas emissions trading, companies doing the "bidding" argue that Earth's atmosphere can be seen as affected almost uniformly by emissions anywhere on Earth. They argue further that, as a result, there are almost no local effects, and only a measurable and widely agreed climate change effect, of a greenhouse gas emission, justifying a "cap and trade" approach. Somewhat more controversially, the approach was applied even earlier to sulfur dioxide emissions in the United States, and was quite successful in reducing overall smog output there.

In most applications of such methods, however, the comprehensive outcome of the transaction is not so easily measured or universally agreed. Some theorists assert that, with appropriate controls, a market mechanism can replace a hierarchy, even a command hierarchy, by ordering actions for which the highest bid is received:

An infamous example is the assassination market proposed by Timothy C. May, which were effectively bets on someone's death. This has since been generalized into the prediction market idea which the Pentagon proposed to operate as part of Total Information Awareness; however, this proved controversial as it would theoretically let assassins predict and then benefit from their predictions, which they would cause to come true. This is a problem even with the commodity markets and any other financial markets, where a single person's choices or fate might be influenced, predicted, or decided by someone already in the market.

Less controversial applications of bid and ask matching include:

  • industrial process control
  • various applications in social networks (including dating above)
  • calculating interest in court judgments or homestead credit
  • determining which of several assets in a divorce are most prized by each party, and accordingly, who should receive what for maximum amiability and minimum capital asset sale and lifestyle disruption

See also

References

  1. ^ Shaw, W.H. (2008). Business Ethics: Sixth Edition. Belmont, Ca: Thomson Wadsworth
  2. ^ Pettinger, T. (n.d.). Price Mechanism in the Long Term. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html
  3. ^ Pettinger, T. (n.d.). Price Mechanism in the Long Term. In Economics Help. Retrieved April 10, 2011, from http://www.economicshelp.org/microessays/equilibrium/price-mechanism-long-term.html

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