Price, in economics, is the amount of money (or, in a barter exchange, other goods) that a buyer gives up to obtain one unit of a good, service or asset. Every market transaction has one, from a loaf of bread to an hour of labor, a share of stock or a unit of foreign currency. Economists study prices because they carry information about scarcity and steer what is produced, by whom and for whom.
The term covers several related ideas. A nominal price is quoted in money; a relative price compares one good with another; the general price level is an average across the whole economy, measured by indexes and watched for inflation. In most market economies prices are set by the interaction of supply and demand, but some are fixed or capped by governments and regulators.
Price in plain terms
Think of a price as a short message attached to a product. When strawberries are cheap in summer, the message is "there are plenty, help yourself". When they are expensive in winter, the message is "these are hard to get, use them only if you really want them". Shoppers do not need to know why the harvest was poor; the number on the label tells them enough to adjust.
The same message reaches growers. A high price says "people want more of this than you are bringing", so farmers plant more or fly fruit in from elsewhere. A low price says the opposite. Millions of people respond to these signals at once without anyone giving orders, which is why economists describe prices as a coordination system rather than just a cost.
How prices are formed
In a competitive market, the price settles where the quantity buyers want equals the quantity sellers offer, a point known as economic equilibrium. If the price is above that point, unsold stock piles up and sellers cut prices; if it is below, queues and shortages push it up. The process of finding that level through trading is called price discovery, and it is visible in real time on exchanges, where the latest market price changes with each trade.
Buyers' willingness to pay is shaped by the marginal utility of one more unit, while sellers' minimum acceptable price is shaped by marginal cost. How strongly quantities react when the price moves is measured by elasticity. Where firms have market power, as in a monopoly, the seller chooses the price rather than taking it from the market, usually above the competitive level.
The Austrian economist Friedrich Hayek argued in his 1945 essay "The Use of Knowledge in Society" that prices compress knowledge scattered across millions of people into a single number that anyone can act on. He shared the 1974 Nobel Memorial Prize in Economic Sciences with Gunnar Myrdal. The same idea underlies Adam Smith's older image of the invisible hand.
Kinds of price
- List and transaction prices. The advertised price is often not what is paid once discounts, rebates and fees are counted.
- Spot and forward prices. A spot price is for immediate delivery; a forward or futures price is agreed now for delivery later.
- Administered prices. Utilities, public transport and some payment fees are set or capped by regulators; the European Union, for example, caps consumer card interchange fees under its 2015 Interchange Fee Regulation.
- Prices of money itself. Interest rates are the price of borrowing money over time, and an exchange rate is the price of one currency in terms of another.
Price levels and price indexes
Individual prices move for their own reasons, but the average across the economy matters for wages, pensions and central bank policy. Statistical offices track it with baskets of goods such as the Consumer Price Index (CPI) and producer or wholesale price indexes. When products improve over time, statisticians use hedonic adjustment to separate a genuine price change from a change in quality. Many prices adjust only slowly to new conditions, a feature known as sticky prices, which helps explain why monetary policy affects output in the short run.
Price controls and price discrimination
Governments sometimes override market prices. A price ceiling, such as rent control, holds the price below equilibrium and tends to create shortages, queues and informal markets. A price floor, such as a minimum wage or an agricultural support price, holds it above equilibrium and can create surpluses. In the United States, President Nixon imposed a 90-day freeze on wages and prices in August 1971; controls in various forms lasted until 1974. Economists broadly agree that controls can redistribute income but disagree about when the side effects are worth it. A subsidy or tax changes the price paid without fixing it directly, and tax incidence analysis shows who ends up bearing the cost.
Price discrimination means charging different buyers different prices for the same product when the difference is not explained by cost. The British economist Arthur Pigou classified it in 1920 into three degrees:
- First degree. Each buyer pays the most they are willing to pay, as approximated by individual negotiation or personalized pricing.
- Second degree. Prices vary with quantity or version, such as bulk discounts or basic and premium tiers, and buyers sort themselves.
- Third degree. Identifiable groups pay different prices, such as student, senior or regional pricing.
Some goods break the usual rules: demand for Veblen goods can rise with price because the price itself signals status.