A price consists of the ratio of economic goods given up to the economic goods received. Any exchange of economic goods yields one of two types of prices: a direct exchange price or an indirect price. A direct exchange price relates to a direct exchange, and an indirect price relates to an indirect exchange.
When, on the one hand, one economic good gets exchanged for another economic good, for the purpose of holding or consuming, that comprises a direct exchange. When, on the other hand, one economic good gets exchanged for another economic good, for the purpose of exchanging for a third economic good, that comprises an indirect exchange.
An economic good that people generally use for indirect exchange acts as money. Thus, money prices become the most common and most important source of market information in a free exchange, or market, economy. I will address the importance of pricing information elsewhere on this website, but, for now, I will address how prices react to the changes in the various quantities of the economic good involved.
At the heart of this explanation lies two economic principles: 1) subjective value, and 2) marginal utility.
- Subjective Value
- The subjective preference scales of individuals determine all economic value.
- Marginal Utility
- Each additional (marginal) unit of an economic good has less utility for an individual (falls lower on their preference scale) than the preceding additional unit of that good—at the same time.
Thus, as the quantity of an economic good increases relative to another economic good, it will require more units of the first good
to acquire each unit of the second good. This principle applies to the exchange of all goods, including those acquired for indirect exchange—including money.
Since most of us find visualizing the effects of this principle in market exchange processes a bit difficult, I have developed a simple model that shows direct exchange and money (indirect exchange) prices based on changing quantities of the economic goods involved.
Move to the Development
of the Pricing Model