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Lunch in an javerage restaurant in Italy these days costs over 10,000 lira. Does that sound expensive? Not to Americans when they realize that is about $5. Price numbersabsolute prices or nominal pricesmean little by themselves. Occasionally you see projections that if the rate of inflation averages a said rate, then in the year 2020 a loaf of bread that now costs $1 will cost $5. What does that tell us? Not much since we don't know what will happen to income and other prices by that time. If average incomes are ten times higher in 2020 than today, then bread that costs $5 at that time may seem cheaper than it does now.
While absolute prices are important in the study of macroeconomics because of inflation, microeconomics is concerned with relative or real prices. Relative prices tell us what something costs compared to other goods. The greatest confusion about prices occurs during periods of inflation (or deflation), when the general price level is changing at the same time that relative prices are changing. From 1967 to 1985 the general price level, as measured by the Consumer Price Index (CPI), rose 217 percent. Using an index stating that 1967 prices of all goods equalled 100, the government collects price information monthly to calculate the rate of inflation and to show what is happening to individual prices, so that we can measure change in the absolute price level and in relative prices. We see this in Table 1-1. The absolute price index rose from 100 in 1967 to 317 in 1985 for all items included in the price survey. Over the years, however, we see that relative prices changed at different rates (all were indexed at 100 in 1967). For example, fuel oil almost doubled in relative price. Taxi fares stayed about the same as the general price level, while the price of televisions fell by 71 percent. Not only did televisions fall in relative terms, they fell in absolute terms (from 100 to 92 on the index). Of course, these prices do not tell us everything, since changes in quality and other factors cannot be accurately measured.
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