A relative price is the

price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the c ...

of a commodity such as a

good In most contexts, the concept of good denotes the conduct that should be preferred when posed with a choice between possible actions. Good is generally considered to be the opposite of evil and is of interest in the study of ethics, morality, ph ...

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 the prices of any two goods or the ratio between the price of one good and the price of a

market basket A market basket or commodity bundle is a fixed list of items, in given proportions. Its most common use is to track the progress of inflation in an economy or specific market. That is, to measure the changes in the value of money over time. A ...

of goods (a weighted average of the prices of all other goods available in the market).

Microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...

can be seen as the study of how

economic agents In economics, an agent is an actor (more specifically, a decision maker) in a model of some aspect of the economy. Typically, every agent makes decisions by solving a well- or ill-defined optimization or choice problem. For example, ''buyers'' (c ...

react to changes in relative prices, and of how relative prices are affected by the behavior of those agents. The difference and change of relative prices can also reflect the development of productivity.

In a demand equation

In the

demand In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item ...

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 Nominal may refer to: Linguistics and grammar * Nominal (linguistics), one of the parts of speech * Nominal, the adjectival form of "noun", as in "nominal agreement" (= "noun agreement") * Nominal sentence, a sentence without a finite verb * Nou ...

price. It is the change in a relative price that prompts a change in the quantity demanded. 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 Real may refer to: Currencies * Brazilian real (R$) * Central American Republic real * Mexican real * Portuguese real * Spanish real * Spanish colonial real Music Albums * ''Real'' (L'Arc-en-Ciel album) (2000) * ''Real'' (Bright album) (2010) ...

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 while purchasing power has been unaffected, so the quantity of the good demanded will go down.

Budget constraint and indifference curves

In the graphical rendition of the theory of

consumer choice The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...

, as shown in the accompanying graph, the consumer's choice of the optimal quantities to demand of two goods is the point of

tangency In geometry, the tangent line (or simply tangent) to a plane curve at a given point is the straight line that "just touches" the curve at that point. Leibniz defined it as the line through a pair of infinitely close points on the curve. More ...

between an

indifference curve In economics, an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is ''indifferent''. That is, any combinations of two products indicated by the curve will provide the c ...

(curved) and the

budget constraint In economics, a budget constraint represents all the combinations of goods and services that a consumer may purchase given current prices within his or her given income. Consumer theory uses the concepts of a budget constraint and a preference ...

(a straight line). The graph shows an initial budget constraint BC1 with resulting choice at tangency point A, and a new budget constraint after a decrease in the absolute price of Y (the good whose quantity is shown horizontally), with resulting choice at tangency point C. In each case the absolute value of the slope of the budget constraint is the ratio of the price of good Y to the price of good X – that is, the relative price of good Y in terms of X.

Distinguishing relative and general price changes

Often

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...

makes it difficult for

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. In general, price change means that when the demand for a commodity increases, the price will go up, and when the demand for a commodity decreases, the price will also go down. However, during the period of inflation, the relationship between supply and demand and the change of demand are very special, which requires the judgment of special variation.

Relative price factors

1.There are many factors affecting relative price, such as the change of employee labor rate, the difference of production supply and the change of government price policy, which can affect the change of relative price among commodities. 2.Changes in market supply and demand will also cause changes in relative prices, such as changes in social consumption levels and consumer consumption habits. These are all factors that affect relative prices.

References

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External links