money price. A relative price is the ratio of two absolute prices; it
expresses the price of one good in terms of (relative to) another.
We have been reminded several times that what matters for demand and
supply is the price of the product in question relative to the prices of other
products; that is, what matters is the relative price. For example, if the
price of carrots rises while the prices of other vegetables are constant, we
expect consumers to reduce their quantity demanded of carrots as they
substitute toward the consumption of other vegetables. In this case, the
relative price of carrots has increased. But if the prices of carrots and all
other vegetables are rising at the same rate, the relative price of carrots is
constant. In this case we expect no substitution to take place between
carrots and other vegetables.
The same thing is true on the supply side of the market. If the price of
carrots increases while all other prices are constant, we expect producers
to grow and supply more carrots because it is more profitable to do so. In
contrast, if all prices increased together, relative prices would be
unchanged and we would expect no particular change in the quantity of
carrots supplied.
In microeconomics, whenever we refer to a change in the price of one product, we mean a
change in that product’s relative price, that is, a change in the price of that product relative to
the prices of all other goods. The demand and supply of specific products depends on their
relative, not absolute, prices.