What is Price?

In a market economy Opens in new window, everything comes at a price which is almost invariably denominated as so many units of the local currency.

The price of such product is decided by the sellers, although in saying that it must be understood that there are an immense number of constraints on sellers that narrow their pricing options.

A seller cannot choose just any price and cannot raise (lower) prices without significant consequences. There may be a best price from the seller’s point of view but it is very hard for the seller to know what that price is.

A price, in a market economy, does more than indicate the number of units that have to be paid to a seller.

The price is also a reflection of scarcity on the one hand, and the intensity of demand amongst those who wish to purchase the good or service on the other.

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Price Determination

Goods and services are sold in a market economy at a price that is somehow, in some way, determined by the forces of supply and demand.

Those with a product to sell make decisions about what price they should charge, the most important constraints typically being their own production costs and the prices being charged by others for similar products.

But into these pricing calculations go many other considerations, both long term and short, that are matters of judgement.

Supply and demand is the theoretical answer, but since no one setting a price has any idea where these curves are, nor could they even pretend to do the kind of analysis that somehow equates the quantity produced with the quantity bought across the entire market, given the multitude of products a typical business sells, there is more of a trial-and-error approach to pricing than any kind of science.

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Relative Prices

A price is just a number with almost no meaning in itself until it is related to the difficulty required to get the number of units of currency required to pay the price attached to some good or service.

But more importantly, so far as the economy Opens in new window is concerned, it is relative prices that are of first-rank importance. Buyers can make judgments on the qualities of the products they wish to buy and compare how much they have to pay for one product rather than another.

In the same way, producers are able to use the relative prices of possible inputs to work out the lowest-cost means to produce. This not only ensures that prices are kept as low as possible but also means that production across the economy is driven to its highest level of efficiency.