What is Price Discovery? - Definition & Examples

Instructor: Morgan Gannarelli
In this lesson we will discuss price discovery, a term used when the price of an asset is determined by the market supply and demand factors. We will also go over some examples of price discovery.

Price Discovery

Have you ever heard the phrase, 'the higher the demand, the higher the price?' This refers to when companies increase the price on a product because of the high demand, which enables them to maximize profits on a hot product. It can also go the opposite way: when supply is high, price is low. When companies need to get rid of inventory they will usually lower the price of that product to do so. For example, when blu-ray players first came to the market, some were selling for over $1,000! Can you believe that? Now you can get one for around $25-$50 depending on the features. It seems crazy that someone would pay so much for a blu-ray player, but when the demand is so high for a product, and the supply is low, people are sometimes willing to pay more for a product that they desire. This is the best time for manufacturers to maximize sales. These are the factors that determine price discovery.

Factors

Many factors affect price discovery. These may include the number of buyers, number of sellers, quantity of items for sale, and recent purchase prices. These factors are also known as demand, supply, output, and price. The point where supply and demand intersect is the discovered market price.


supply-demand-chart
chart

Why Price Discovery Matters

When the economy changes, it affects the market (buyers and sellers). If unemployment is high and median income is low, then the demand for some products will go down due to people not having as much disposable income. Companies may choose to adjust their pricing due to the economic changes. Economic changes can also affect the price that companies have to pay manufacturers for the product that they sell. For example, let's say oil prices go up and what used to cost $200 to ship now costs $350. The company needs to adjust the price they charge to consumers to make up for this increased business expense. However, consumers need to know that the price quoted is fair and true, which means that the price offered must be the most recently discovered price, and fair to the market.

Predicting Future Prices

Price discovery can help to predict future pricing in the market. This future pricing serves as the expectation of the spot price. The spot price is the current market price that an asset is bought and sold for at present, whereas the future price is the price an asset can be bought or sold for in the future. Although the spot price is a continually changing and fluctuating figure, investors have created derivatives to mitigate the risk of these constant changes. The derivatives allow buyers and sellers to 'lock in' the price of an asset that they wish to buy or sell in the future, allowing them to minimize risks.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create an account
Support