Prices, in economics, the value of things measured in terms of what the buyers in a market will give in exchange for them. Prices are usually measured in money—indeed, money’s effectiveness as a medium for expressing prices is the main reason for its existence—but in barter systems prices could be expressed in other commodities with their own value, so that prices of all commodities were mutually determining without the intervening medium of money. Prices are the fundamental mechanism of adjustment of supply and demand, for any commodity in a free market economy should eventually find the level at which production and consumption are balanced: this equilibrium price will be the compromise reached between what the producers can afford to charge and what the consumers are prepared to pay. Prices will, therefore, decide what and how much is produced, how it is produced, and who can buy it. Questions of price are therefore crucial to economics, particularly microeconomics, and the subject of intensive study.
II DETERMINATION OF PRICES BY SUPPLY AND DEMAND
Both supply and demand factors decide the prices of commodities: prices will fall if there is too much supply and rise if there is too much demand until equilibrium is reached. On the supply side, prices are fixed by costs of production and distribution, as determined by the scarcity of materials, technology, organizational limits like the law of diminishing returns, labour costs, and so on. The producer will decide his pricing strategy to maximize his profits, though other wishes of the sort covered by the theory of the firm may also operate. However, the nature of the market also comes into play: in a monopoly or oligopoly, the price can be raised still further because the competition is not operating freely. A cartel can fix prices between them; long-term company strategy may dictate the choice of a price below market value or even below cost; game theory may be influencing the decisions of firms. In practice, few markets are perfectly competitive, and the bias usually favours the supplier.
Demand is the sum of the separate purchasing decisions by the buyers in a market as they each attempt to maximize available utility. Of course, this assumes that buyers are making rational choices: just the ones which advertising and marketing exist to circumvent. A company’s efforts to dictate demand may even feed back into the price, through extra costs of a promotional budget. People will decide whether to buy a commodity according to its price, but in practice demand, once in play, will decide how many units of a commodity are sold rather than its price, for most companies will produce a new commodity rather than let the fixed price of the old one drift towards an equilibrium level. Nor are low prices automatically best: quality goods may not sell at rock-bottom prices because consumers suspect faults or because the commodity loses the exclusivity which is actually its utility. The kind of purchase via haggling implied by many free market economic models can, in fact, operate only rarely in modern integrated economies, so that the relationship of prices to demand is often considerably less direct than economic theory implies.
III PRICE CONTROLS AND INFLATION
Governments have consistently tried to influence prices, for various reasons. In planned economies, prices are fixed by the state, so market forces do not operate at all. The failure of most modern planned economies testifies to the efficiency of prices as an economic adjustment mechanism, but lesser state intervention in pricing is common. In some cases, this may be to artificially raise prices, as in the case of the Common Agricultural Policy of the European Union (EU), where prices of agricultural products are kept high by state buying of surpluses to protect EU farmers (and win their votes for ruling politicians). In others, prices may be held down, as in the case of many public utilities after privatization, where the utility companies’ profits are curbed to limit the effective monopoly which they often enjoy. Governments may subsidize certain industries, freeing them to lower prices or place tariffs on imports, raising the price of foreign goods. Prices may be frozen in wartime to control the disruptive economic effects of scarcities.
State price controls often form part of a package prices and incomes policy which attempts to control inflation, which itself is expressed by persistently rising prices: not so much a change in the value of commodities as of money. This reflects the fact that money is itself a commodity with its own price, in terms of other commodities, which may fall if it becomes too common (the argument of monetarism). Excess of demand over supply should normally make prices rise, but if the government holds prices down artificially, the resulting inflation will be masked but the excess demand will remain, leading to shortages, rationing, black markets, and the other common features of planned economies. Insufficient demand for a nation’s currency in foreign exchange markets can create inflation, as its price in terms of other currencies falls, and raise prices of imports, though the prices of exports will fall and boost export activity.
Many common ideas about economics, and systems such as doctrinaire Marxist economics, preserve some notion of the ideal “just price”, determined by natural law and usually arrived at via any means other than supply and demand. In reality, the price mechanism has achieved the happiest results when left to itself but has responded poorly to altruistic or selfish attempts to interfere with it.