Price

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In economics and business, the price is the assigned numerical monetary Value (economics) of a product (business), service or asset.

The concept of price is central to microeconomics where it is one of the most important variables in resource allocation theory (also called price theory).

Price is also central to marketing where it is one of the four variables in the marketing mix that business people use to develop a marketing plan.

Conventional definition In ordinary usage, price is the quantity of payment or compensation for something. People may say about a criminal that he has 'paid the price to society' to imply that he has paid a penalty or compensation. They may say that somebody paid for his folly to imply that he suffered the consequence.

Economists view price as an exchange ratio between goods that pay for each other. In case of barter between two goods whose quantities are x and y, the price of x is the ratio y/x, while the price of y is the ratio x/y.

This however has not been used consistently, so that old confusion regarding value frequently reappears. The value of something is a quantity counted in common units of value called numeraire, which may even be an imaginary good. This is done to compare different goods. The unit of value is frequently confused with price, because market value is calculated as the quantity of some good multiplied by its nominal price.

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.

There was time when people debated use-value versus exchange value, often wondering about the Diamond-Water Paradox (paradox of value). 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.

Relative and nominal price The difference between nominal price and relative or real price (as exchange ratio) is often made. Nominal price is the price quoted in money while relative or real price is the exchange ratio between real goods regardless of money. The distinction is 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 there is 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.

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 sterling 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.

Marxian price theory In Marxian economics, it is argued that price theory must be firmly grounded in the real history of economic exchange in human societies. Money-prices are viewed as the monetary expression of exchange-value. Exchange-value can however also be expressed in trading ratios between quantities of different types of goods.

In Marxian economics, the increasing use of prices as a convenient way to measure the economic or trading value of labor-products is explained historically and anthropologically, in terms of the development of the use of money as universal equivalent in economic exchange. However, in an anthropological-historical sense, Marxian economists argue a "price" is not necessarily a sum of money; it could be whatever the owner of a good gets in return, when exchanging that good. Money prices are merely the most common form of prices.

Marxian economists distinguish very strictly between real prices and ideal prices. Real prices are actual market prices realized in trade. Ideal prices are hypothetical prices which would be realized if certain conditions would apply. Most equilibrium prices are hypothetical prices, which are never realized in reality, and therefore of limited use, although notional prices can influence real economic behavior.

According to Marxian economists, while all labor-products existing in an economy have economic value, only a minority of them have real prices; the majority of goods and assets at any time are not being traded, and they have at best a hypothetical price. Six criticisms Marxian economists make of neoclassical economics are that neoclassical price theory:

is not based on any substantive, realistic theory of economic exchange as a social process, and simply assumes that exchange will occur;
simply assumes prices can be attached or imputed to all goods and services;
assumes equilibrium prices will exist and that markets tend spontaneously to equilibrium prices;
fails to distinguish adequately between actual market prices; administered prices; and ideal, accounting, or hypothetical prices.
disconnects price theory from the real economic history of the use of prices.
is unable to provide a coherent explanation of the relationship between price and economic value.

Most marginalist economists dismiss Marxian theories of price on the grounds that they require a method of converting from labour values into monetary prices, and that the method given in Capital (Volume 3) is mathematically flawed.

Austrian theory The last objection is also sometimes interpreted as the paradox of value, which was observed by Classical economics. 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 besuppressed".

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.

See also

Cost
Real prices and ideal prices
Time based pricing
Suggested retail price (also called 'recommended retail price')
Resale price maintenance
Pricing in marketing
Price fixing
Variable pricing
Reservation price
Price point
Price trend
Unit of account
Value (economics)
Law of value
Currency
Marketing
Geo (marketing)
Yield management
Microeconomics
Marketing mix
Production, costs, and pricing
Price discovery function
Free price system

External links

Wages, Prices & Living Standards: The World-Historical Perspective
Historicalstatistics.org Links to historical statistics on prices

References

Milton Friedman, Price Theory.
George J. 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.

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