Price

A price is the quantity of payment expected or given between two parties. This exchange happens in return for goods or services. While we usually use currency, prices can also be quoted in goods or vouchers. For example, some people use air miles or trading stamps. In certain historical moments, like during World War II, cigarettes even functioned as currency. In modern economies, most prices are expressed in units of money. For raw materials, this is often shown as currency per unit of weight, such as euros per kilogram.

Prices are influenced by several moving parts. Production costs, the supply of a product, and the demand for that product all play roles. Economic price theory suggests that in a free market, the market price reflects the interaction between supply and demand. This interaction sets the price to equate the quantity supplied with the quantity demanded. This process is driven by the marginal utility of an asset. Marginal utility is the perceived benefit a buyer or seller receives from an item. Other factors, such as government subsidies or industry collusion, can also influence these levels.

Economist Milton Friedman identified five specific functions of prices in a free-enterprise economy. First, prices transmit information about the importance of different products. Second, they provide an incentive for businesses to produce highly valued goods. Third, they encourage producers to use efficient methods that save scarce resources. Fourth, prices provide an incentive for resource owners to use their assets in highly remunerated ways. Finally, prices help distribute output among resource owners and ration fixed supplies among consumers.

History shows that thinkers have long debated the nature of price and value. Adam Smith observed the "diamond-water paradox." He noted that diamonds command a higher price than water. This is strange because water is essential for life, while diamonds are merely ornamentation. To solve this, Carl Menger proposed the theory of marginal utility. This theory suggests that value is subjective to the individual. Later, Karl Marx offered a different view. He asserted that value derives from the volume of socially necessary labor time used to create an object. This led to the "transformation problem," which discusses how mass values convert into actual prices.

It is important to distinguish between price and the cost of production. Price is the amount a buyer pays to acquire a product. Cost of production refers to the seller's expenses, such as manufacturing and labor. For-profit companies hope the price exceeds the cost to generate a profit. However, non-profit organizations also use pricing. Charities may set target donation levels to reward donors with status or gifts. Educational nonprofits might price seats for theatrical performances to maximize net revenue. Net revenue is the total money earned minus the total cost.

There are many ways to categorize or express prices in the real world. A seller might request an "offer price," while the final payment is the "transaction price." In finance, the price of a loan is expressed as a percentage rate of interest. This rate depends on the loan amount, the period, and the credit risk. Some stores also use "price points." A price point is a specific, set amount, such as the even numbers used by Dollar General. Other retailers use specific endings, like 99 cents, to set their prices.

Negative prices are a rare but possible phenomenon. This occurs when an owner pays a buyer to take an item. In April 2020, the price of West Texas Intermediate crude oil turned negative. It dropped to -$37.63 per barrel. This happened because of a global health and economic crisis. There was a glut of crude oil and no available storage. People with oil contracts had to pay others to take the oil to avoid delivery. This shows how extreme supply imbalances can reverse the direction of payment.