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A basic hypothesis of price theory is that individuals respond to relative prices rather than absolute prices. It is relative prices which are the conveyors of information in the marketplace. For the buyers, the relative price of a good indicates what the individual consumer must give up in terms of other goods in order to purchase that good. In certain cases, it also indicates the amount of resources given up to produce that good. Hence, when the relative price of a commodity goes up, that bit of information tells the buyer and the seller that the good is now relatively scarcer. Note that neither the producer nor the consumer has to know why that particular commodity has become relatively scarcer. It may not matter to you as a consumer whether the price of gasoline has gone up because of a restriction on imports or because of a new law which requires gasoline refineries to install more expensive pollution-abatement equipment. The only thing that does matter is the higher relative price, for that is the basis on which you normally will make a decision about the quantity to purchase. The message is transmitted by the higher relative price. Of course, how you respond to the message is impossible to predict on an individual basis, for the number of ways in which you can "conserve" on a relatively scarcer item is probably infinite.

Changes in relative prices convey this type of information to both buyers and sellers. Of course, buyers respond differently from sellers. Sellers may see a rise in the relative price of a particular commodity as an opportunity to increase profits, and eventually such information may be translated into a larger amount of resources going to the production of that now relatively higher-priced and at least temporarily more profitable product. It is in this manner that resources are allocated in a system that allows prices to convey the information about relative scarcities. We call this a market system: Prices convey the information to the participants—buyers and selJers—in the marketplace. There is no need for a central agency to produce information or allocate resources. This does not mean that problems will not arise and that certain economic activities could not be better handled by other than unrestricted market processes.