Relative price
Encyclopedia
A relative price is the price
of a commodity such as a good or service in terms of another; i.e., the ratio of two prices. A relative price may be expressed in terms of a ratio between any two prices or the ratio between the price of one particular good and a weighted average of all other goods available in the market. A relative price is an opportunity cost
. Microeconomics
can be seen as the study of how economic agents
react to changes in relative prices.
In the demand equation Q = f(P) (in which Q is the number of units of a good or service demanded), P is the relative price of the good or service rather than the nominal price. It is the change in a relative price that prompts a change in demand. For example, if all prices rise by 10% there is no change in any relative prices, so if consumers' nominal income and wealth also go up by 10% leaving real income and real wealth unchanged, then demand for each good or service will be unaffected. But if the price of a particular good goes up by, say, 2% while the prices of the other goods and services go down enough that the overall price level is unchanged, then the relative price of the particular good has increased, and unless the good is a Giffen good
the demand for it will go down.
Often inflation
makes it difficult for economic agents
to immediately distinguish increases in the price of a good which are due to relative price changes from changes in the price which are due to inflation of prices in general. This situation can lead to allocative inefficiency, and is one of the negative effects of inflation.
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
of a commodity such as a good or service in terms of another; i.e., the ratio of two prices. A relative price may be expressed in terms of a ratio between any two prices or the ratio between the price of one particular good and a weighted average of all other goods available in the market. A relative price is an opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
. Microeconomics
Microeconomics
Microeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...
can be seen as the study of how economic agents
Agent (economics)
In economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
react to changes in relative prices.
In the demand equation Q = f(P) (in which Q is the number of units of a good or service demanded), P is the relative price of the good or service rather than the nominal price. It is the change in a relative price that prompts a change in demand. For example, if all prices rise by 10% there is no change in any relative prices, so if consumers' nominal income and wealth also go up by 10% leaving real income and real wealth unchanged, then demand for each good or service will be unaffected. But if the price of a particular good goes up by, say, 2% while the prices of the other goods and services go down enough that the overall price level is unchanged, then the relative price of the particular good has increased, and unless the good is a Giffen good
Giffen good
In economics and consumer theory, a Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods...
the demand for it will go down.
Often inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
makes it difficult for economic agents
Agent (economics)
In economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
to immediately distinguish increases in the price of a good which are due to relative price changes from changes in the price which are due to inflation of prices in general. This situation can lead to allocative inefficiency, and is one of the negative effects of inflation.