Price

Lore & Background

A price is the quantity of payment or compensation expected, required, or given by one party to another in return for goods or services. In some situations, especially when the product is a service rather than a physical good, the price for the service may be called something else such as 'rent' or 'tuition'. Prices are influenced by production costs, supply of the desired product, and demand for the product. A price may be determined by a monopolist or may be imposed on the firm by market conditions. Prices are usually non-negative. Price can be quoted in currency, quantities of goods or vouchers. In modern economies, prices are generally expressed in units of some form of currency. For raw materials they are expressed as currency per unit weight. Although prices could be quoted as quantities of other goods or services, barter exchange is rarely seen. Prices are sometimes quoted in terms of vouchers such as trading stamps and air miles. In some circumstances, cigarettes have been used as currency, for example in prisons, in times of hyperinflation, and in some places during World War II. According to Milton Friedman, price has five functions in a free-enterprise exchange economy: transmitting information about changes in the relative importance of different end-products and factors of production; providing an incentive for enterprise to produce those products valued most highly by the market and to use methods that economize scarce factors; providing an incentive to owners of resources to direct them into the most highly remunerated uses; distributing output among the owners of resources; and rationing fixed supplies of goods among consumers.

Reader's Guide

The concept of price is central to economic theory and practice. It serves as the mechanism through which goods and services are exchanged, and its determination involves the interplay of supply and demand, production costs, and market structure. Economic price theory asserts that in a free market economy the market price reflects the interaction between supply and demand: the price is set so as to equate the quantity being supplied and that being demanded. These quantities are determined by the marginal utility of the asset to different buyers and sellers. Supply and demand, and hence price, may be influenced by other factors, such as government subsidy or manipulation through industry collusion. Price is not a synonym for cost. Price is what a buyer pays to acquire products from a seller, while cost of production concerns the seller's expenses. Negative prices are very unusual but possible under certain circumstances, as seen in April 2020 when West Texas Intermediate crude oil futures turned negative, meaning the owner paid the buyer to take the oil. The paradox of value, observed by Adam Smith, highlights that diamonds command a higher price than water despite water being essential for life. This paradox is addressed by the theory of marginal utility. Different schools of thought, including Marxist and Austrian, offer varying explanations of price and value, with Marxists asserting that value derives from socially necessary labour time and that price equals cost of production plus average rate of profit.

Did You Know?

• Prices are usually non-negative, but negative prices are possible, as when West Texas Intermediate crude oil futures turned negative in April 2020.
• In some circumstances, cigarettes have been used as currency, for example in prisons, in times of hyperinflation, and in some places during World War II.
• According to Milton Friedman, price has five functions in a free-enterprise exchange economy, including transmitting information and rationing fixed supplies.
• The paradox of value, observed by Adam Smith, notes that diamonds command a higher price than water, though water is essential for life.