Clearing price is the equilibrium monetary value of a traded security, asset, or good.

This price is determined by the bid-ask process of buyers and sellers, or more broadly, by the interaction of supply and demand forces.

Clearing prices are most stable in a liquid market. In illiquid markets, with few buyers and sellers, it may take longer for prices to reach equilibrium.

How a Clearing Price Works
 

Sellers, in any exchange, want the highest price possible for a security or asset, while investors interested in buying it desire the lowest purchase price possible.

At some point, a mutually agreeable price is reached between buyers and sellers. It is at this point that economists say the market has "cleared" and a transaction has taken place.

Supply and demand are key elements of the bid-ask process in a securities market. The clearing price of a security or asset will be the price at which it was most recently traded.

In an actively traded market with many participants on both sides, price discovery can be quick, particularly when bid-ask quotes are updated continuously in real-time on an electronic exchange.

For illiquid or thinly traded securities, such as distressed debt, it will take longer to find a stable clearing price because there are fewer buyers and sellers.

Special Considerations

For products or services, the market-clearing price is also determined primarily by the interplay of supply and demand.

The intersection of the downward-sloping demand curve and upward-sloping supply curve represents the equilibrium price, or clearing price, for the product or service.

Take a high-end smartphone, for example. If the manufacturer sets the price too high, then a surplus of its smartphones will develop; if it sets the price too low, then demand may leave the manufacturer short of inventory.

In either case, assuming no friction in the market, an adjustment process between supply and demand will take place to find the clearing price for the smartphone.

Price Stickiness

However, clearing prices may not respond immediately to changing market conditions. Price stickiness refers the tendency of some goods to adjust more slowly than the market changes, even when new dynamics suggest a different optimal price.

A classic example of this is wage stickiness: employers are usually unlikely to cut the salaries of their employees, except in cases of severe downturns.

Example of a Market Clearing Price



For a simple example of how clearing prices are set, imagine a stock called XYZ, that is trading on a certain stock market.

On a typical day, the order book reports a daily transaction volume of $1 million, with share prices trading in a narrow band between $95 and $100.

In other words, about 10,000 shares change hands every day, and the market is in equilibrium between buyers and sellers.

However, these are not the only prospective trades. Some buyers might have open orders for lower prices, in anticipation of sharp price drops. Some sellers would likewise have open orders for extremely high prices, in anticipation of a price spike.

Market clearing prices form one of the key ideas in market economics. When buyers enter the market seeking the lowest possible price, and sellers seek the highest price, the market eventually reaches an equilibrium point where demand is exactly equal to supply. This idea is also key to securities markets, where prices are established through the bid-ask process on exchange order books.

The market clearing price is the price at which the demand for a good by consumers is equal to the number of goods that can be produced at that price.

At this price, the supply and demand are exactly equal: there are no unused goods waiting to be sold, and no buyers who are unable to buy.

Source: Investopedia