In any market exchange, participants trade goods for other goods or for money. The exchange price consists of the quantity of the good given in relation to the quantity of the good received. This means that each party to the transaction has a unique perspective on the price. When the exchange involves money, the parties usually state the price from the perspective of the party providing the money.

It is essential to understand that prices do not provide a measure of value. Based on the objective price, an outside observer can only say that each party to the transaction valued what they received more than what they gave. Price only acts as a proxy for value; it never measures value.

In spite of the fact that price does not measure value, it still provides valuable information to the market. After a number of transactions have occurred in the market for a particular product, a price pattern will develop. Sellers of that product can assume that if they offer their product at a price much higher than the “market price,” they will not sell many units of that product. Some markets have a much narrower range of prices than others, which allows sellers in those markets to calculate their offering price more effectively.

By ensuring that both parties to exchanges leave with something they value more, the pricing mechanism provides crucial information to the market. This information, in turn, leads to a more efficient allocation of resources. Although prices only serve as an indicator of the actors' values, they provide producers with an objective figure from which they can effectively calculate the allocation of their resources.

Market prices provide an objective measure from which producers can estimate the balance of supply and demand in the market. When prices trend higher, it generally indicates a relative shortage in the market and the possible need for more production. On the other hand, when prices trend lower, it generally indicates a sufficient or excess supply in the market.

Because money acts as an indirect medium of exchange, the pricing mechanism I have described only works with a relatively fixed overall quantity of money. When the quantity of money expands, the market receives distorted prices. Money prices may rise in the face of a stable or increasing supply of goods. Based on increasing prices, producers may make the logical assumption that the market has a supply deficiency. To meet the apparent shortfall in supply, they might expand production only to find they made a malinvestment, which they might have to liquidate in the future. A decrease in the quantity of money will have the opposite effect.

Exchange prices play a critical role in the market, and keeping them in mind acts as a guiding principle for this publication.