When people agree to trade or exchange, they must agree on the rate of exchange or the price. The price of an exchange is a relative price - the price of one good expressed in terms of the price another good. In a barter exchange, a relative price is established between the goods traded. Relative prices are a measure of what one must give up in order to get one unit of a good or service and are therefore a measure of opportunity costs. Since opportunity costs are what decisions are based on, when economists refer to the price of something, it is the relative price they have in mind. The relative price is the price that affects economic decision making. A relative price is an opportunity cost.
Since the relative price is the price of one good or service in terms of another; it is, in other words, the ratio of two prices.
The relative price of good X in terms of good Y is pX / pY
Relative price is a very important concept in economics because several important concepts are based on it. The difference between nominal price and relative or real price (as exchange ratio) is often made. Nominal price is the price quoted in money while relative or real price is the exchange ratio between real goods, regardless of money. One of the goals of microeconomics is to evaluate market mechanisms that establish relative prices amongst goods and services and allocation of limited resources among several alternative uses. The theory of demand and supply determines relative prices, and the word 'price'means relative price. When we predict that a price will fall, we mean that its relative price will fall. This means that its price will fall relative to the average price of other goods and services.
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