What Is Market Price?
The market price is the current price at which an asset or service can be bought or sold. The market price of an asset or service is determined by the forces of supply and demand. Thepriceat which quantity supplied equals quantity demanded is the market price.
The market price is used to calculate consumer and economic surplus. Consumer surplusrefers to the difference between the highestpriceaconsumeris willing to pay for a good and the actualpricethey do pay for the good, or themarket price. Economic surplus refers to two related quantities: consumer surplus and producer surplus. Producer surplus may also be referred to as profit: it is the amount that producers benefit by selling at the market price(provided that the market price is higher than the least that they would be willing to sell for). Economic surplus is the sum total of consumer surplus and producer surplus.
Key Takeaways
- The market price is the current price at which a good or service can be purchased or sold.
- The market price of an asset or service is determined by the forces of supply and demand; thepriceat which quantity supplied equals quantity demanded is the market price.
- In financial markets, the market price can change quickly as people change their bid or offer prices, or as sellers hit the bid or buyers hit the offer.
Understanding Market Price
Shocks to either the supply or the demand for a good or service can cause the market price for a good or service to change. A supply shock is an unexpected event that suddenly changes thesupplyof a good or service. A demand shock is a sudden event that increases or decreases the demand for a good or service. Some examples of supply shock are interest rate cuts, tax cuts, government stimulus, terrorist attacks, natural disasters, and stock market crashes. Some examples of demand shock include a steep rise in oil and gas prices or other commodities, political turmoil, natural disasters, and breakthroughs in production technology.
In regards to securities trading, the market price is the most recent price at which a security was traded. The market price is the result of the interaction of traders, investors, and dealers in the stock market. In order for a trade to occur, there must be a buyer and a seller that meet at the same price. Bids are represented by buyers, and offers are represented by sellers. The bid is the higher price someone is advertising they will buy at, while the offer is the lowest price someone is advertising they will sell at. For a stock, this may be $50.51 and $50.52.
If the buyers no longer think that is a good price, they may drop their bid to $50.25. The sellers may agree or they may not. Someone may drop their offer to a lower price, or it may stay where it is. A trade only occurs if a seller interacts with the bid price, or a buyer interacts with the offer price. Bids and offers are constantly changing as the buyers and sellers change their minds about which price to buy or sell at. Also, as sellers sell to the bids, the price will drop, or as buyers buy from the offer, the price will rise.
The market price in the bond market is the last reported price excluding accrued interest; this is called the clean price.
Example of Market Price
For example, assume that Bank of America Corp (BAC) has a $30 bid and a $30.01 offer. There are nine traders wanting to buy BAC stock; at this given time, this represents the demand for BAC stock. Five traders bid for 100 shares each at $30, three traders bid at $29.99, and one trader bids at $29.98. These orders are listed on the bid.
There are also nine traders wanting to sell BAC stock; at this given time, this represents the supply of BAC stock. Five traders sell 100 shares each at $30.01, three traders sell at $30.02, and one trader sells at $30.03. These orders are listed on offer.
Say a new trader comes in and wants to buy 800 shares at the market price. The market price, in this case, is all the prices and shares it will take to fill the order. This trader has to buy at the offer: 500 shares at $30.01, and 300 at $30.02. Now the spread widens, and the price is $30 by $30.03 because all the share offered at $30.01 and $30.02 have been bought. Since $30.02 was the last traded price, this is the market price.
Other traders may take action to close the spread. Since there are more buyers, the spread is closed by the bid adjusting upward. The result is a new price of $30.02 by $30.03, for example. This interaction is continually taking place in both directions, and is constantly adjusting the price.
