Dollar Prices And Relative Prices Are Both Real Variables.
When we talk about the prices of goods and services, we often use the term "real prices" to refer to the prices adjusted for inflation. But what does it mean for a price to be "real"? In economics, a real price is a price that has been adjusted for inflation, so it reflects the actual purchasing power of the currency.
However, it is important to note that there are two types of real prices: dollar prices and relative prices. Both of these are real variables, but they measure different things.
Dollar Prices
Dollar prices are the prices of goods and services measured in terms of dollars. For example, if a gallon of milk costs $3, then $3 is the dollar price of milk. Dollar prices are important because they allow us to compare the prices of different goods and services in a common unit of measurement.
However, dollar prices can be misleading when it comes to measuring changes in the cost of living. This is because changes in the value of the dollar can affect dollar prices, even if the actual cost of producing the goods and services has not changed. For example, if the value of the dollar decreases, then the dollar price of goods and services will increase, even if the actual cost of producing those goods and services has not changed.
Relative Prices
Relative prices, on the other hand, are the prices of goods and services measured in terms of other goods and services. For example, if the price of a gallon of milk is $3 and the price of a loaf of bread is $2, then the relative price of milk is 1.5 loaves of bread. Relative prices are important because they reflect the relative scarcity of different goods and services.
Relative prices are also important when it comes to measuring changes in the cost of living. This is because changes in the relative prices of goods and services can affect the real cost of living, even if the dollar prices of those goods and services remain unchanged. For example, if the relative price of milk increases compared to the relative price of bread, then the real cost of living for someone who buys more milk than bread will increase, even if the dollar prices of milk and bread remain the same.
The Relationship Between Dollar Prices and Relative Prices
While dollar prices and relative prices measure different things, they are closely related. In fact, changes in relative prices can affect dollar prices, and changes in dollar prices can affect relative prices.
For example, if the relative price of milk increases compared to the relative price of bread, then consumers will demand less milk and more bread. As a result, the price of milk will decrease (because there is less demand for it) and the price of bread will increase (because there is more demand for it). This means that the dollar price of milk will decrease and the dollar price of bread will increase, even though the relative prices have changed.
On the other hand, if the value of the dollar decreases, then the dollar prices of all goods and services will increase. However, the relative prices of different goods and services may not change. For example, if the dollar price of milk increases from $3 to $4 and the dollar price of bread increases from $2 to $3, then the relative price of milk will remain 1.5 loaves of bread.
Conclusion
In conclusion, dollar prices and relative prices are both real variables that measure different things. Dollar prices measure the prices of goods and services in terms of dollars, while relative prices measure the prices of goods and services in terms of other goods and services. While these two measures are closely related, changes in one can affect the other. Understanding the difference between dollar prices and relative prices is important for understanding changes in the cost of living, inflation, and other economic concepts.