The Efficient Market Hypothesis posits that asset prices reflect all available information, making it hard to consistently outperform the market. Yet, debates continue regarding the efficiency of markets, especially when stock prices are volatile. Prices in competitive markets are determined by supply and demand, with price elasticity playing a role in predicting changes.
The Efficient Market Hypothesis (EMH) is an investment theory that states that asset prices reflect all available information at any given time. According to EMH, it is impossible to consistently achieve returns in excess of average market returns on a risk-adjusted basis, given that market prices should only respond to new information.
Whether markets are generally efficient is a matter of debate. Proponents of EMH would say that markets are largely efficient, making it very difficult for investors to outperform the market through either technical analysis or fundamental analysis. On the other hand, critics of EMH would argue that markets can be irrational and subject to human emotion, and thus not always efficient.
Volatile stock prices can still be consistent with rational pricing if the volatility reflects changes in the available information. However, when prices fluctuate due to irrational behavior, speculation, or overreactions, it could suggest inefficiencies. It's also important to consider that there are three forms of EMH - weak, semi-strong, and strong - each with different implications for market efficiency and price volatility.
How are prices determined in a competitive market?
Prices in a competitive market are determined by the forces of supply and demand. When demand for a product increases or supply decreases, the price tends to go up. Conversely, when demand decreases or supply increases, the price usually goes down.
Importance of Price Elasticity
Price elasticity is important as it measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It helps predict consumer and producer behavior when prices change, which in turn affects market equilibrium.