Microeconomic Pricing Model

A microeconomic pricing model is a model of the way prices are set within a market for a given good. According to this model, prices are set based on the balance of supply and demand in the market. In general, profit incentives are said to resemble an "invisible hand" that guides competing participants to an equilibrium price.

The demand curve in this model is determined by consumers attempting to maximize their utility, given their budget. The supply curve is set by firms attempting to maximize profits, given their costs of production and the level of demand for their product. To maximize profits, the pricing model is based around producing a quantity of goods at which total revenue minus total costs is at its greatest.

In general, the balance of power within the market determines who is more successful in setting prices. Where there is little competition — a duopoly, for example, in aircraft manufacturing — Boeing Company and Airbus SE have pricing power. Internet advertising is another example of a segment dominated by two companies, Alphabet Inc. (Google) and Facebook, Inc. They can act as price makers instead of price takers. On the other hand, in a perfectly competitive market with little or no product differentiation, firms must accept the prevailing market price if they wish to sell their goods or services.

In a simple supply and demand model where the intersection pinpoints a price at a given quantity, movements of the demand or supply curve will reset the equilibrium price. If the downward-sloping demand curve shifts to the right and the upward-sloping supply curve remains static, for example, the equilibrium price will increase. It will also increase if the supply curve shifts to the left and the demand curve remains static.