Price

Definition

In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.

In all modern economies, the overwhelming majority of prices are quoted in (and the transactions involve) units of some form of currency. Although in theory, prices could be quoted as quantities of other goods or services this sort of barter exchange is rarely seen.

Price can sometimes alternatively refer to the quantity of payment requested by a seller of goods or services, rather than the eventual payment amount. This requested amount is often called the asking price or selling price, while the actual payment may be called the transaction price or traded price. Likewise, the bid price or buying price is the quantity of payment offered by a buyer of goods or services, although this meaning is more common in asset or financial markets than in consumer markets.

Economic Definition

Economists sometimes define price in a more general or abstract sense to the widely understood definition above. According to this view, price is defined as the ratio between the quantity of goods that are exchanged for each other in a transaction.

For example, consider the case of two people exchanging goods, say 5 apples for 2 loaves of bread. An economist might say that the price of apples was 2/5 = 0.4 loaves of bread. Likewise, the price of bread would be 5/2 = 2.5 apples. Hence if we consider that currency is simply another type of good like apples or bread, then this conception forms the general case of the widely held definition outlined above.

However it is far from clear that this generalisation serves any useful purpose at all. As noted above, in all real economies prices are virtually always quoted in (and transactions always involve) units of currency. Hence, an alternative view is that the most basic and general definition of price is that involving exchange of goods or services for money, and that the exchange ratio between two goods is simply derived from the two individual prices.

The exchange ratio is sometimes referred to as the real price, while the price quoted in money referred to as the nominal price.

This distinction is sometimes made to make sense of inflation. When all prices are quoted in terms of money units, and the prices in money units change more or less proportionately, the ratio of exchange may not change much. In the extreme case, if all prices quoted in money change in the same proportion, the relative price remains the same.

It is now becoming clear that the distinction is not useful and indeed hides a major confusion. The conventional wisdom is that proportional change in all nominal prices does not affect real price, and hence should not affect either demand or supply and therefore also should not affect output. The new criticism is that the crucial question is why is there more money to pay for the same old real output. If this question is answered, it will show that dynamically, even as the real price remains exactly the same, output in real terms can change, just because additional money allow additional output to be traded. The supply curve can shift such that at the old price, the new higher output is sold. This shift if not possible without additional money.

From this point of view, a price is similar to an opportunity cost, that is, what must be given up in exchange for the good or service that is being purchased. For example, if x=1 and y=2, the relative price of x in terms of y is 2, and the price of y in terms of x is 0.5.

Price Theory

Theory of price asserts that the market price reflects interaction between two opposing considerations. On the one side are demand considerations based on marginal utility, while on the other side are supply considerations based on marginal cost. An equilibrium price is supposed to be at once equal to marginal utility (counted in units of income) from the buyer's side and marginal cost from the seller's side. Though this view is accepted by almost every economist, and it constitutes the core of mainstream economics, it has recently been challenged seriously.

Price and Value

There was time when people debated use-value versus exchange value, often wondering about the paradox of value (diamond-water paradox). The use-value was supposed to give some measure of usefulness, later refined as marginal benefit (which is marginal utility counted in common units of value) while exchange value was the measure of how much one good was in terms of another, namely what is now called relative price.

Austrian theory

The last objection is also sometimes interpreted as the paradox of value, which was observed by classical economists. Adam Smith described what is now called the Diamond – Water Paradox: diamonds command a higher price than water, yet water is essential for life, while diamonds are merely ornamentation. One solution offered to this paradox is through the theory of marginal utility proposed by Carl Menger, the father of the Austrian School of economics.

As William Barber put it, human volition, the human subject, was "brought to the centre of the stage" by marginalist economics, as a bargaining tool. Neoclassical economists sought to clarify choices open to producers and consumers in market situations, and thus "fears that cleavages in the economic structure might be unbridgeable could be suppressed".

Without denying the applicability of the Austrian theory of value as subjective only, within certain contexts of price behavior, the Polish economist Oskar Lange felt it was necessary to attempt a serious integration of the insights of classical political economy with neo-classical economics. This would then result in a much more realistic theory of price and of real behavior in response to prices. Marginalist theory lacked anything like a theory of the social framework of real market functioning, and criticism sparked off by the capital controversy initiated by Piero Sraffa revealed that most of the foundational tenets of the marginalist theory of value either reduced to tautologies, or that the theory was true only if counter-factual conditions applied.

One insight often ignored in the debates about price theory is something that businessmen are keenly aware of: in different markets, prices may not function according to the same principles except in some very abstract (and therefore not very useful) sense. From the classical political economists to Michal Kalecki it was known that prices for industrial goods behaved differently from prices for agricultural goods, but this idea could be extended further to other broad classes of goods and services.

Price as productive human labour time

Marxists assert that value derives from the volume of socially necessary abstract labour time exerted in the creation of an object. This value does not relate to price in a simple manner, and the difficulty of the conversion of the mass of values into the actual prices is known as the transformation problem. However, many recent Marxists deny that any problem exists. Marx was not concerned with proving that prices derive from values. In fact, he admonished the other classical political economists (like Ricardo and Smith) for trying to make this proof. Rather, for Marx, price equal the cost of production (capital-cost and labor-costs) plus the average rate of profit. So if the average rate of profit (return on capital investment) is 22% then prices would reflect cost-of-production plus 22%. The perception that there is a transformation problem in Marx stems from the injection of Walrasian equilibrium theory into Marxism where there is no such thing as equilibrium.

Confusion between prices and costs of production

Price is commonly confused with the notion of cost of production as in “I paid a high cost for buying my new plasma television”. Technically, though, these are different concepts. Price is what a buyer pays to acquire products from a seller. Cost of production concerns the seller’s investment (e.g., manufacturing expense) in the product being exchanged with a buyer. For marketing organizations seeking to make a profit the hope is that price will exceed cost of production so the organization can see financial gain from the transaction. Finally, while pricing is a topic central to a company's profitability, pricing decisions are not limited to for-profit companies. Non-profit organizations, such as charities, educational institutions and industry trade groups, also set prices, though this is often not as apparent. For instance, charities seeking to raise money may set different “target” levels for donations that reward donors with increases in status (e.g., name in newsletter), gifts or other benefits. While a charitable organization may not call it a price in their promotional material, in reality these targets are prices since they specify a cost that must be paid by buyers (donors) in order to obtain something of value.

Price Point

The price of an item is also called the price point, especially where it refers to stores that set a limited number of price points. For example, Dollar General is a general store or "five and dime" store that sets price points only at even amounts, such as exactly one, two, three, five, or ten dollars (among others). Other stores (such as dollar stores, pound stores, euro stores, 100-yen stores, and so forth) only have a single price point ($1, £1, 1€, ¥100), though in some cases this price may purchase more than one of some very small items. Price is relatively less than the cost price.

See also

References

Milton Friedman, Price Theory.

George Stigler, Theory of Price.

Simon Clarke, Marx, marginalism, and modern sociology: from Adam Smith to Max Weber (London: The Macmillan Press, Ltd, 1982).

Makoto Itoh & Costas Lapavitsas, Political Economy of Money and Finance.

Pierre Vilar, A history of gold and money.

External links

Cost of Living - Contains prices of goods and services worldwide

Wages, Prices & Living Standards: The World-Historical Perspective

Historicalstatistics.org Links to historical statistics on prices

Price converter and calculator - Converting price between different currencies and calculating price in various measurements.

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