_____ works best if the needs of customers vary, but the products being offered are fairly standard.

The theory of price is an economic theory that states that the price for a specific good or service is determined by the relationship between its supply and demand at any given point. Prices should rise if demand exceeds supply and fall if supply exceeds demand.

• The theory of price is an economic theory that states that the price for any good or service is based on the relationship between its supply and demand.
• The optimal market price is the point at which the total number of items available can be reasonably consumed by potential customers.
• When supply and demand are in sync, the market is said to have achieved equilibrium.
• Supply may also be affected by factors such as the availability of raw materials; demand may fluctuate depending on competitor products, an item's perceived value, or its affordability to the consumer market.

The theory of price—also referred to as "price theory"—is a microeconomic principle that says the market forces of supply and demand will determine the logical price point for a particular good or service at any given time.

In a free market economy, producers typically want to charge as much as they reasonably can for their goods and services, while consumers want to pay as little as they can to obtain them. Market forces will cause the two sides to meet somewhere in the middle, at a price consumers are willing to pay and that producers are willing to accept.

When the quantity of a good or service that's available matches the demand of potential consumers for it, the market is said to achieve equilibrium. The concept of price theory allows for price adjustments as market conditions change.

Supply denotes the number of products or services that the market can provide. This includes both tangible goods, such as automobiles, and intangible ones, such as the ability to make an appointment with a skilled service provider. In each instance, the available supply is finite in nature. There are only a certain number of automobiles available and only a certain number of appointments available at any given time.

Supply may be affected by forces that are beyond a producer's control, such as the availability of raw materials.

Demand applies to the market's desire for tangible or intangible goods. At any time, there is also only a finite number of potential consumers available. Demand may fluctuate depending on a variety of factors, such as whether an improved version of a product is available or if a service is no longer needed. Demand can also be affected by an item's perceived value by the consumer market.

As mentioned earlier, equilibrium occurs when the total number of items available—the supply—can be consumed by potential customers. If a price is too high, customers may avoid the goods or services or find other alternatives. This would result in excess supply and possibly cause producers to lower prices.

In contrast, if a price is too low, demand may significantly outpace the available supply, causing prices to rise again.

The optimal price, taking into account both supply and demand, is also referred to as the clearing price.

Companies often differentiate their product lines vertically, rather than horizontally, considering consumers' differential willingness to pay for quality. As noted by Michaela Draganska of Drexel University and Dipak C. Jain of INSEAD in the journal Marketing Science, many firms offer products that vary in characteristics like color or flavor, but that do not vary in quality.

Their study found that using uniform prices for all products in a particular product line tends to be the best pricing policy for producers.

For example, Apple Inc. offers several different MacBook Pro laptop computer models, with varying screen sizes, capabilities, and prices. The customer has a choice of two colors: silver and space gray. If Apple charged a higher price for a 13-inch silver MacBook Pro versus an otherwise identical space gray one, demand for the silver model might fall, and the available supply of the silver model would increase. At that point, Apple might be forced to reduce the price of that model.

Microeconomics focuses on interactions between individual consumers and the producers of goods and services, while macroeconomics looks at the economy as a whole.

Elasticity of demand, or price elasticity of demand, measures how sensitive the demand for a particular good or service is to changes in its price. If raising the price of a product will have little effect on the demand for it, it is said to be relatively inelastic.

The demand curve is a graphic illustration of how prices affect supply and demand. As prices rise, the quantity of a particular good or service that consumers demand will decline. Conversely, as prices fall, demand rises.

A supply curve illustrates the relationship between prices and supply. As the price rises for a particular good or service, the more of it producers will be motivated to provide.

When a demand curve and a supply curve for a particular item are overlaid on the same graph, the point at which they intersect is referred to as the equilibrium point. That's the price at which the quantity consumers are willing to buy and the quantity producers are willing to deliver are perfectly matched.

The theory of price in microeconomics states that the price of a particular good or service is determined by the relationship between producer supply and consumer demand at any given point. Prices should rise if demand exceeds supply and fall if supply exceeds demand. When supply and demand are equal, the market is said to have achieved equilibrium.

1. See: W. J. Abernathy, K. B. Clark, and A. M. Kantrow, Industrial Renaissance (New York: Basic Books, 1983); D. A. Garvin, “Quality on the Line,” Harvard Business Review, September–October 1983, pp. 64–75; D. A. Garvin, “Japanese Quality Management,” Columbia Journal of World Business, in press. J. M. Juran, “Japanese and Western Quality: A Contrast,” Quality Progress, December 1978, pp. 10–18; A. L. Robinson, “Perilous Times for U.S. Microcircuit Makers,” Science, 9 May 1980, pp. 582–586.

2. See: Barksdale et al., “A Cross-National Survey of Consumer Attitudes Towards Marketing Practices, Consumerism, and Government Relations,” Columbia Journal of World Business, Summer 1982, pp. 71–86; Center for Policy Alternatives, Consumer Durables: Warranties, Service Contracts, and Alternatives (Cambridge, MA: Massachusetts Institute of Technology, 1978), pp. 3-127–3-146; “Rising Concern on Consumer Issues Is Found in Harris Poll,” New York Times, 17 February 1983.

3. See J. G. Miller, The 1983 Manufacturing Futures Project: Summary of North American Survey Responses & Preliminary Report (Boston, MA: School of Management, Boston University, 1983), p. 14.

4. See: R. M. Pirsig, Zen and the Art of Motorcycle Maintenance (New York: Bantam Books, 1974); B. W. Tuchman, “The Decline of Quality,” New York Times Magazine, 2 November 1980.

5. See: S. Buchanen, ed., The Portable Plato (New York: The Viking Press, 1948); G. Dickie, Aesthetics: An Introduction (New York: The Bobbs-Merrill Company, Inc., 1971), p. 5.

6. See: L. Abbott, Quality and Competition (New York: Columbia University Press, 1955); Z. Griliches, ed., Price Indexes and Quality Change (Cambridge, MA: Harvard University Press, 1971); K. Lancaster, Consumer Demand: A New Approach (New York: Columbia University Press, 1971), p. 122; K. B. Leffler, “Ambiguous Changes in Product Quality,” American Economic Review (December 1982): 956–967.

7. See: Abbott (1955), p. 129; K. Lancaster, Variety, Equity, and Efficiency (New York: Columbia University Press, 1979), p. 28.

8. See: D. Levhari and T. N. Srinivasan, “Durability of Consumption Goods: Competition versus Monopoly,” American Economic Review (March 1969): 102–107; R. L. Schmalensee, “Regulation and the Durability of Goods,” Bell Journal of Economics and Management Science (Spring 1970): 54–64; P. L. Swan, “Durability of Consumption Goods,” American Economic Review (December 1970): 884–894; P. L. Swan, “The Durability of Goods and the Regulation of Monopoly,” Bell Journal of Economics and Management Science (Autumn 1971): 347–357; T. R. Saving, “Market Organization and Product Quality,” Southern Economic Journal (April 1982): 856.

9. See: C. D. Edwards, “The Meaning of Quality,” Quality Progress, October 1968, pp. 36–39; A. A. Kuehn and R. L. Day, “Strategy of Product Quality,” Harvard Business Review, November–December 1962, pp. 100–110.

10. See: Kuehn and Day (November–December 1962); R. M. Johnson, “Market Segmentation: A Strategic Management Tool,” Journal of Marketing Research, February 1971, pp. 13–18; P. Kotler, Marketing Decision Making: A Model Building Approach (New York: Holt, Rinehart and Winston, 1971), pp. 491–497; B. T. Ratchford, “The New Economic Theory of Consumer Behavior: An Interpretive Essay,” Journal of Consumer Research, September 1975, pp. 65–75.

11. See: E. H. Chamberlin, “The Product as an Economic Variable,” Quarterly Journal of Economics, February 1953, pp. 1–29; R. Dorfman and P. O. Steiner, “Optimal Advertising and Optimal Quality,” American Economic Review (December 1954): 822–836; L. J. White, “Quality Variation When Prices Are Regulated,” Bell Journal of Economics and Management Science (Autumn 1972): 425–436.

12. See: J. M. Juran, ed., Quality Control Handbook, 3rd ed. (New York: McGraw-Hill, 1974), p. 2; H. L. Gilmore, “Product Conformance Cost,” Quality Progress, June 1974, pp. 16–19.

13. See: Edwards (October 1968), pp. 36–39; Lancaster (1979), p. 28; H. Theil, Principles of Econometrics (New York: John Wiley & Sons, 1971), pp. 556–573.

14. See: E. Sheshinski, “Price, Quality, and Quantity Regulation in a Monopoly Situation,” Economica, May 1976, pp. 127–137; White (Autumn 1972).

15. See R. B. Yepsen, Jr., ed., The Durability Factor (Emmaus, PA: Rodale Press, 1982), pp. 12–15.

16. See: P. B. Crosby, Quality Is Free (New York: McGraw-Hill, 1979); Gilmore (June 1974).

17. See: G. Boehm, “ 'Reliability' Engineering,” Fortune, April 1963, pp. 124–127, 181–182, 184, 186; A. V. Feigenbaum, Total Quality Control (New York: McGraw-Hill, 1961), ch. 14; Juran (1974), pp. 8-9–8-32.

18. See: Feigenbaum (1961), chs. 10–13; J. M. Juran and F. M. Gryna, Jr., Quality Planning and Analysis (New York: McGraw-Hill, 1980).

19. See: J. Campanella and F. J. Corcoran, “Principles of Quality Costs,” Quality Progress, April 1983, p. 21; Crosby (1979).

20. See: R. A. Broh, Managing Quality for Higher Profits (New York: McGraw-Hill, 1982), ch. 1; Juran (1974), ch. 5.

21. See: Broh (1982); Feigenbaum (1961).

22. See The Consumer Network, Inc., Brand Quality Perceptions (Philadelphia, PA: The Consumer Network, Inc., August 1983).

23. See K. Ishikawa, “Quality and Standardization: Program for Economic Success,” Quality Progress, January 1984, p. 18.

24. See Juran (1974), pp. 2-4–2-9.

25. See E. S. Maynes, “The Concept and Measurement of Product Quality,” in Household Production and Consumption, ed. N. E. Terleckyj (New York: National Bureau of Economic Research, 1976), pp. 550–554.

26. See: K. Lancaster, “A New Approach to Consumer Theory,” Journal of Political Economy, April 1966, pp. 132–157; Lancaster (1971); Lancaster (1979).

27. See Lancaster (1971), p. 7.

28. See Juran (1974), pp. 8–12.

29. See C. J. Bliss, Capital Theory and the Distribution of Income (Amsterdam: North-Holland, 1975), ch. 6.

30. See “Retiring Autos at 14,” New York Times, 3 April 1983, sec. 3, p. 1.

31. See S. W. Burch, “The Aging U.S. Auto Stock: Implications for Demand,” Business Economics, May 1983, pp. 22–26.

32. See J. A. Quelch and S. B. Ash, “Consumer Satisfaction with Professional Services,” in Marketing of Services, ed. J. H. Donnelly and W. R. George (Chicago, IL: American Marketing Association, 1981).

33. See: Kuehn and Day (November–December 1962); Johnson (February 1971).

34. See: D. F. Cox, ed., Risk Taking and Information Handling in Consumer Behavior (Boston, MA: Division of Research, Harvard University, Graduate School of Business Administration, 1967), ch. 11; D. R. Lambert, “Price as a Quality Signal: The Tip of the Iceberg,” Economy Inquiry, January 1980, pp. 144–150.

35. See: W. O. Hagstrom, “inputs, Outputs, and the Prestige of American University Science Departments,” Sociology of Education, Fall 1971, pp. 384–385; D. D. Knudsen and T. R. Vaughan, “Quality in Graduate Education: A Reevaluation of the Rankings of Sociology Departments in the Cartter Report,” American Sociologist, February 1969, p. 18.

36. See Steinway & Sons (Boston, MA: Harvard Business School, HBS Case Services #9-682-625, 1981), p. 5.

37. See P. C. Riesz, “Price-Quality Correlations for Packaged Food Products,” Journal of Consumer Affairs, Winter 1979, p. 234.

38. See Lambert (January 1980).

39. See Riesz (1979), p. 244.

40. See: H. J. Leavitt, “A Note on Some Experimental Findings about the Meanings of Price,” Journal of Business, July 1954, pp. 205–210; A. Gabor and C. W. J. Granger, “Price as an Indicator of Quality: Report on an Enquiry,” Economica, February 1966, pp. 43–70; J. D. McConnell, “An Experimental Examination of the Price-Quality Relationship,” Journal of Business, October 1968, pp. 439–444.

41. See Riesz (1979), p. 236.

42. See R. A. Westbrook, J. W. Newman, and J. R. Taylor, “Satisfaction/Dissatisfaction in the Purchase Decision Process,” Journal of Marketing, October 1978, pp. 54–60.

43. See “The Buying Consumer: Room Air Conditioners,” a report by Appliance Manufacturer (Chicago, IL: Cahners Publishing, 1979).

44. See Lambert (January 1980).

45. See: P. Nelson, “Information and Consumer Behavior,” Journal of Political Economy (March–April 1970): 311–329; P. Nelson, “Advertising as Information,” Journal of Political Economy (July–August 1974): 729–754.

46. See R. L. Schmalensee, “A Model of Advertising and Product Quality,” Journal of Political Economy (June 1978): 485–504.

47. Ibid., pp. 485–486.

48. See H. J. Rotfeld and K. B. Rotzoll, “Advertising and Product Quality: Are Heavily Advertised Products Better?” Journal of Consumer Affairs, September 1976, p. 46.

49. See C. T. Gilligan and D. E. A. Holmes, “Advertising Expenditure and Product Quality,” Management Decision (Vol. 17, No. 5): 392.

50. See Barksdale et al. (Summer 1982), p. 78.

51. See: R. D. Buzzell and F. D. Wiersema, “Modeling Changes in Market Share: A Cross-Sectional Analysis,” Strategic Management Journal, 1981, pp. 27–42; R. D. Buzzell and F. D. Wiersema, “Successful Share-Building Strategies,” Harvard Business Review, January–February 1981, pp. 135–144; C. S. Craig and S. P. Douglas, “Strategic Factors Associated with Market and Financial Performance,” Quarterly Review of Economics and Business, Summer 1982, pp. 101–111; B. T. Gale and B. S. Branch, “Concentration versus Market Share: Which Determines Performance and Why Does It Matter?” The Antitrust Bulletin, Spring 1982, pp. 83–105; L. W. Phillips, D. Chang, and R. D. Buzzell, “Product Quality, Cost Position, and Business Performance: A Test of Some Key Hypotheses,” Journal of Marketing, Spring 1983, pp. 26–43; S. Schoeffler, R. D. Buzzell, and D. F. Heany, “Impact of Strategic Planning on Profit Performance,” Harvard Business Review, March–April 1974, pp. 137–145.

52. See Buzzell and Wiersema (January–February 1981), p. 140.

53. See: Schoeffler, Buzzell, and Heany (March–April 1974), p. 141; Gale and Branch (Spring 1982), pp. 93–95.

54. See: Buzzell and Wiersema (1981); Craig and Douglas (Summer 1982); Phillips, Chang, and Buzzell (Spring 1983).

55. See: R. E. Cole, “Improving Product Quality through Continuous Feedback,” Management Review, October 1983, pp. 8–12; Garvin (in press).

56. See Campanella and Corcoran (April 1983) p. 17.

57. See: Campanella and Corcoran (April 1983); Crosby (1979); Gilmore (June 1974); H. L. Gilmore, “Consumer Product Quality Cost Revisited,” Quality Progress, April 1983, pp. 28–33.

58. See: R. S. Kaplan, “Measuring Manufacturing Performance: A New Challenge for Managerial Accounting Research,” The Accounting Review (October 1983): 686–705; S. C. Wheelwright, “Japan — Where Operations Really Are Strategic,” Harvard Business Review, July–August 1981, pp. 70–71.

59. See Phillips, Chang, and Buzzell (Spring 1983), p. 27.

60. See Garvin (September–October 1983).

61. See Crosby (1979).

62. See “Quality Cost Survey,” Quality, June 1977, pp. 20–22.

63. See: Gilmore (June 1974); Gilmore (April 1983).

64. See Gale and Branch (Spring 1982), pp. 96–97.

65. See Phillips, Chang, and Buzzell (Spring 1983), pp. 38–39.

66. Ibid., p. 37.

67. See M. E. Bader, Practical Quality Management in the Chemical Process Industry (New York: Marcel Dekker, 1983), ch. 1.

68. See: Chamberlin (February 1953); Dorfman and Steiner (December 1954).

69. See: Craig and Douglas (Summer 1982); Phillips, Chang, and Buzzell (Spring 1983); Schoeffler, Buzzell, and Heany (March–April 1974).

70. See Schoeffler, Buzzell, and Heany (March–April 1974), p. 141.

71. See: Buzzell and Wiersema (January–February 1981); Phillips, Chang, and Buzzell (Spring 1983).

72. See A. R. Andreasen, “A Taxonomy of Consumer Satisfaction/Dissatisfaction Measures,” Journal of Consumer Affairs, Winter 1977, pp. 11–24.

73. See H. Takeuchi and J. A. Quelch, “Quality Is More Than Making a Good Product,” Harvard Business Review, July–August 1983, pp. 139–145.

74. See: W. Skinner, “Manufacturing — Missing Link in Corporate Strategy,” Harvard Business Review, May–June 1969, pp. 136–145; W. Skinner, “The Focused Factory,” Harvard Business Review, May–June 1974, pp. 113–121; S. C. Wheelwright, “Reflecting Corporate Strategy in Manufacturing Decisions,” Business Horizons, February 1978, pp. 57–66.

75. See Wheelwright (July–August 1981).