Price determination is the main problem and a must in economic theory. It is because every activity measured in terms of money (price) is called economic activity. Similarly, a commodity the value of which can be measured in terms of money (value in exchange) is called economic good.

Thus, determination of price of a commodity or service is an essential part of the study of economics. All the branches of economics like consumption, production, exchange and distribution are affected by the theory of price.

We know that a commodity can command value only when it has utility and scarcity. The utility aspect represents demand and the scarcity aspect represents supply.

In any transaction, there are two parties, the buyers and sellers. The price of a commodity is determined by mutual agreement between the buyers and sellers. Under perfect competition price of a commodity is determined by the interaction of demand (buyers) and supply (sellers).

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Pricing of commodities has been the most controversial issue in Economics. There are two approaches in this regard.

The first approach is propounded by the classical economists like Adam smith, Ricardo, J.S. Mill and some socialist thinkers like Robert Owen, Marx and Sismondi. According to these economists, the cost of production is the determinant of price. This view is one side and subject to criticisms.

The second approach is the Austrian approach, which is advocated by the Austrian economists like Manger, Wiser, Jevons and Bohme Bawerk. This approach is also known as the psychological or subjective approach. According to this approach, utility is the sole determinant of price. But this approach is also one-sided and subject to criticisms.

Prof Marshall synthesized the two approaches. He pronounced that price is determined by the interaction of the demand and supply forces. He compared price determination with the act of cutting with two blades of a pair of scissors. The cutting is done neither by the upper blade nor by the lower blade alone. Prof. Marshall remarks, “The price rests like the key stone of an arch, balanced in equilibrium between the contending pressures of its two opposing sides, demand on the one side and supply on the other.”

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The consumers will continue the consumption of the commodity until its price equals the marginal utility from the demand side. Similarly, sellers will continue with their sale until the price equals the marginal cost of production.

Equilibrium Price:

The Equilibrium price under perfect competition refers to that price at which the demand for and supply of the commodity are in equilibrium with each other.

In the words of Prof. J.L. Hansen, “The equilibrium price is one where quantity demanded of a commodity is exactly equal to the quantity supplied.” Prof. D.W. Pearce says, “Equilibrium price is the price at which market is equilibrium.”

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The wishes of both buyers and sellers are satisfied only at the equilibrium price. Dr. Marshall says, “When the demand price is equal to the supply price the amount produced has no tendency either to be increased or decreased, it is equilibrium”. If prices were greater than the equilibrium price quantity supplied would exceed quantity demanded. As a result, the price will go on declining till the quantity demanded equals quantity supplied. On the other hand, if prices were lower than the equilibrium price quantity demanded would exceed quantity supplied. Consequently, the price will go on rising till the quantity demanded and the quantity supplied are again equal. We thus see that the price, which will settle down, can be either greater or less than the equilibrium price.