2.2 Price Theory and Economic Theory

PRICE THEORY AND
ECONOMIC THEORY
BSBA 4-1 FM BLK A
PRICE THEORY
The theory of price—also referred to as "price theory"—is

a microeconomic principle that uses the concept of supply and
demand to determine the appropriate price point for a given good or
service.
The theory of price is an economic theory that states that the price
for any specific good or service is based on the relationship between
its supply and demand.
Economic Theory
 Macroeconomic theory
 Scientific theories that seek to explain phenomena
associated with the macroeconomy. The primary
phenomena investigated are unemployment, inflation, and
the level of aggregate production. Macroeconomic theories
also inevitably provide policy recommendations intended to
improve the performance of the economy and to correct
macroeconomic problems.
CHARACTERISTICS OF
MICROECONOMICS
CHARACTERISTICS OF MICROECONOMICS
 Looks at the decision of individual units. It focuses on the choices made by

individual decision units such as households, producers, and firms. Resource
allocation decisions are made by these individual entities in a market economy.
 Concerned with social welfare. It examines the efficiency, relative desirability,
and choice of alternative methods by which resources are utilized to alleviate
scarcity. This branch in microeconomic is termed, “welfare economics”
 It does not examine the processes or efficiency of allocation in alternative types
of economic systems, such as socialistic planned economy. Neither does
microeconomics focus on other economic issues such as aggregate level of
employment of resources or the rate of inflation.
 The concepts of microeconomics are applicable to personal resource allocation
decisions, such as career choices or financial investments.
ECONOMIC MODELS
ECONOMIC MODELS
 Composed of series of statements of assumptions are given and

statements of implications or deductions. The statement describes
the essential features of an item or process and the
interrelationships between factors or variables model.
 Competitive market or “supply and demand.”
Supply and demand illustrate the working of a market and the
interaction between suppliers and consumers. Supply and demand
curves determine the price and quantity of goods and services. Any
changes in supply and demand will have an effect on the equilibrium
price and quantity of the good sold. It will also affect the incentives for
producers and consumers
SUPPLY AND DEMAND
• Supply is the amount of the good that is being sold onto the
market by producers. At higher prices, it is more profitable
for firms to increase supply, so supply curve slopes upward.
• Demand is the quantity of the good that consumers wish to
buy at different prices. At higher prices, less will be
demanded. As prices fall, more will be demanded.
SUPPLY AND DEMAND
• The supply and demand relationships can be expressed in three

different forms:
❖Verbal (or logical)
❖Mathematical notations
❖Graphical
SUPPLY AND DEMAND
❖ Verbally, the law of supply can be expressed in the

following words: Supply is a schedule of prices and
quantities that a supplier or suppliers are willing to
offer for sale at each price per period of time. These
suppliers will be encouraged to sell more at higher
prices and would sell less at lower prices. This is
because higher prices, other things being constant,
mean higher profits and lower prices mean lower
profits. Thus prices and quantity offered for sale are
directly related, that is, the higher the price, the more the
supply; the lower the price, the less supply.
SUPPLY AND DEMAND
❖ Mathematical notations shortcut representation

of verbal explanations. The law of supply can be
expressed succinctly in an equation:
Qs = 500P
Qs = 500P
❖ The equation Qs = 500P means that if the price is, say PHP 1.00,
quantity supplied (Qs) would be PHP 500 (500x1).
Table 1 Supply Schedule

PRICE QUANTITY SUPPLIED
1 500
2 1,000
3 1,500
4 2,000
5 2,500
6 3,000
❖ Graphical
Supply Schedule in Graph Form

3000
2500
2000
Quantity
1500
1000
500
0
1 2 3 4 5 6
Price (in Peso)
MODELS ARE ABSTRACTIONS
Microeconomics is concerned in three types:

1. Models to explain the resource allocation or “choice”
decisions of individual household, producers, and firms.
2. Models to explain how prices and quantities exchanged
be determined in various types of structures.
3. Models to examine the market economy as an interrelated
system (general equilibrium model).
Oligopoly
An oligopoly is a market structure in which a few firms

dominate. When a market is shared between a few firms, it is
said to be highly concentrated. Although only a few firms
dominate, it is possible that many small firms may also operate
in the market.
Example of a Model
Intervention in the energy industry has been practiced by government at least for
forms: price and tax administration, licensing, rationing, corporate participation in
the industry. One can attempt a theoretical construct to defend government
presence in an oligopoly industry like oil refining and marketing. It has been
demonstrated in earlier works in oligopoly theory that a government purchase
entry to an oligopoly industry can improve short-run market performance by
inducing an increase in total industry output.
Borrowing from those pioneering works and using simplifying assumptions, it can
be illustrated that government presence in the petroleum refining/marketing
sector should be able to maximize industry elative to a purely private oligopoly
situation that operates in the fashion of a joint monopoly. In the Philippines, it can
perhaps be argued that the oil multinationals had never operated as a joint
monopoly and that therefore the need for government entry may be ill-advised.
This contention does not detract from the validity of the arguments suggested by
theory. At least government presence will still provide a useful deterrent or threat
to and such occurrence.
Assume a petroleum product demand function that can be expressed as:
Qt = a - bp
Where: Qt is total industry sales;
P represents the selling price of the private firms acting jointly;
a and b are positive coefficients
Start with three firms of equal sizes acting initially as a joint monopoly with identical unit variable of bk.
Profit will be maximized when:
P=a+b
2
And the resultant sales would be:
Qt = (a + bk)
2
Then allow government entry through a buy out of existing
capacity(perhaps one of the three firms). Presume that the government has
been mandated to engineer the highest possible industry output without
inflicting losses on the private firms and that prices are set so that there is
never unsatisfied demand at those price levels.
One can conceive of two sales policy options that government can take.
We can call a sales neutral strategy in the sense that regardless of the price
it sets, it leaves the elasticity of demand facing the private firms the same as
before the entry of government.
The other is a discriminatory sales policy is the sense that it elect to sell the
product to buyers who are prepared to pay higher prices for the
commodity. This can happen only if it is the low price seller in the market
and is so tolerated by the private firms.
In turn, private firms can follow any of the tree price strategies in reaction to
price set by the government firm.
Strategy A. Select a price level that will maximize joint monopoly profits after
allowing the government firm to sell all it can at the price that it selects.
Private firms will end up pricing above the government’s price level.
Strategy B. Price within the government firm’s price level and sell all that the
market will clear up to the extent of its (private) capacity.
Strategy C. Match the government price in cooperative fashion and share

the market proportionately.
The “residual” demand curves that private oil firms will be left after
government entry can be derived from any combination of strategies
pursued by government and private industry, respectively. Corresponding
industry output at profit-maximizing price strategies by the government firms
can then be estimated for any price level the government sets. Likewise,
private profit resulting from a point of monopoly decision mode can then
be expressed as a function of the government strategy.
If we analyze this example, we can see that this model satisfies the tree
types of models microeconomics in concerned with : resource allocation
decisions, pricing decisions, and market economy as an interrelated system
found in a market model called “oligopoly”.
Comparative Statics vs
Dynamic Analysis
Dynamic Analysis
 Focuses on the shift in equilibrium  Let us say in a competitive market,

position (statics) for an individual supply and demand for a commodity
decision unit, a market, or an reach equilibrium at the price of
economic system. Microeconomics PHP 20 per unit. If demand exceeds
supply because of an increase in
extensively uses comparative statics population and an effective
analysis. advertising program, it is possible that
 Equilibrium refers to a state in which price would go up to PHP 22 per unit.
there is a balance of internal forces Comparative statics is applicable
here because there is a shift in
and no tendency for the situation to
equilibrium brought about by an
change unless outside forces increase or shift in demand. Thus,
intervene. A system in such price would go up from PHP 20 to
equilibrium may also be termed PHP 22 per unit.
“static”.
Dynamic Analysis
 Focuses on the pattern and rate of change from some variables

between points in time. In the static model the initial price of
PHP 20 was predicted to go up to PHP 22 without informing the
consumers when or how much time it would take the price to
increase. If the model tells us that price of the commodity would go
up in a week’s time, then the dynamic analysis is used.
Partial Equilibrium Analysis vs
General Equilibrium Analysis
Partial Equilibrium Analysis
 Compares equilibrium changes for one decision unit or one market
independent of related changes in the economic system.
It assumes for the purpose of analysis that other factors will remain
the same.
 For example, we know that the demand for a commodity depends
on its price (other things being constant). Demand for the
commodity can this be expressed as:
Qd = f (P)
General Equilibrium Analysis
 Recognizes the  For example, we know that the

interdependence all decision demand commodity depends not
units and all markets in the only on its price (P), but also in income
economic system. It examines (Y), population (Po), price expectation
changes within the context of (Pe), advertising and promotion (Ad),
the entire system. All variables among other things. This attempt
are allowed to adjust in include all possible variables that
response to the initial change. affect demand all under the general
equilibrium analysis. A more realistic
The changes are then
demand equation can now be
incorporated into the
expressed as:
calculations.
Qd = f (P, Y, Po, Pe, Ad)
AN OVERVIEW OF THE ECONOMY
Model of
Economic
Circular
Flow
Types of Economic System
1. Traditional Economic System - production decision is

based on customs and traditions.
2. Command Economy – answers to economic problems
are indicated by the government.
3. Market System - deals with economic, problems by
considering consumers’ choices.
REFERENCES
 Pagoso, Cristobal M., Dinio, Rosemary P., Villasis, George A., Meneses, Pamela Pagoso., Veloso,
Priscilla Pagoso, 2014. Introductory Microeconomics Fourth Edition. Sampaloc Manila: Rex Book
Store, Inc. (RBSI).
 CAROLINE BANTON. Feb 19, 2020. Theory of Price.
https://www.investopedia.com/terms/t/theory-of-price.asp
 MACROECONOMIC THEORIES, AmosWEB Encyclonomic WEB*pedia,
http://www.AmosWEB.com, AmosWEB LLC, 2000-2020. [Accessed: September 21,
2020].https://www.amosweb.com/cgi-
bin/awb_nav.pl?s=wpd&c=dsp&k=macroeconomic+theories
 Tejvan Pettinger. 25 February 2020. Explaining supply and demand.
https://www.economicshelp.org/blog/160660/economics/explaining-supply-and-demand-
2/#:~:text=Supply%20is%20the%20amount%20of,prices%2C%20less%20will%20be%20demanded.
 https://www.economicsonline.co.uk/Business_economics/Oligopoly.html#:~:text=An%20oligopo
ly%20is%20a%20market,also%20operate%20in%20the%20market.

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PRICE THEORY AND

The theory of price—also referred to as "price theory"—is

 Looks at the decision of individual units. It focuses on the choices made by

 Composed of series of statements of assumptions are given and

• The supply and demand relationships can be expressed in three

❖ Verbally, the law of supply can be expressed in the

❖ Mathematical notations shortcut representation

Table 1 Supply Schedule

Supply Schedule in Graph Form

Microeconomics is concerned in three types:

An oligopoly is a market structure in which a few firms

Strategy C. Match the government price in cooperative fashion and share

 Focuses on the shift in equilibrium  Let us say in a competitive market,

 Focuses on the pattern and rate of change from some variables

 Recognizes the  For example, we know that the

1. Traditional Economic System - production decision is

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