By "price" economists mean the rate of exchange of one good, typically money, for another. Prices convey information to producers, consumers, and government essential to efficient decision making. By attaching values to goods and factors of production, prices affect the allocation of resources and thereby shape the distributions of consumption and income across individuals and nations.
Setting and Measuring Prices
Some prices are set by custom, by bargains struck between individual buyers and sellers, by businesses with "market power" (such as monopolies), or by government fiat. However, in a large, capitalist economy like that of the contemporary United States, most prices are determined by the interchange of numberless and typically anonymous buyers (demand) and sellers (supply) in competitive markets.
To measure the overall level of prices, economists construct price "indexes," essentially weighted averages of prices of specific goods. The index is set equal to unity (or 100) in a base year, and prices in any other year are expressed relative to prices in the base year. An index of "producer prices" refers to prices received by supplies commodities. The "consumer price index" measures prices paid for goods and services purchased by consumers. In the case of the consumer price index, the weights refer to the relative importance of the goods in consumer budgets. Ideally, the introduction of new products, improvements in the quality of existing goods, and changes in the weights should be reflected in the construction of the indices. In practice, this may be difficult or impossible to do, particularly with historical data.
Over the course of American history, both the price level and the structure of relative prices have changed markedly. Most economists believe that sustained changes in the level of prices are caused primarily by sustained changes in the supply of money per unit of output, although other factors may be relevant in specific historical periods.
From the point of view of consumers, the single most important change in relative prices has been a substantial long-term rise in the "real wage": the money wage relative to the price level. Most economists believe that, in the long run, increases in real wages reflect increases in labor productivity. Other examples of changing relative prices include new products and regional differences. Typically, new products are introduced at high relative prices that moderate over time as the products are improved. A spectacular example is the computer: on average, computer processor prices declined by 20 percent per year from the early 1950s to the mid-1980s. Historically, there were significant regional variations in relative prices in the United States, but these differences have diminished as internal (and international) transport costs have fallen, and national (and global) markets have evolved.
Price Trends in American History
Economic historians and economists have charted the course of prices in the United States from the earliest settlements of the seventeenth century to the present day. Fragmentary information suggests that prices were falling throughout the seventeenth century as the demand for money (shillings) grew faster than the irregular supply. Variations in relative prices across colonies were common, as were localized, and of ten sudden, inflation and deflation. As trade expanded and as the money supply became more regular, prices began to rise and price fluctuations to moderate. The development of wholesale commodity markets in the major port cities—Boston, New York, Philadelphia, and Charleston—led to the regular publication of price information in broadsheets or in tabular form in local newspapers known as "Prices Current," and these have facilitated the construction of historical price indexes beginning in the early eighteenth century.
The revolutionary war witnessed one of the first (if not the first, the French and Indian War being a precursor) occurrences of wartime inflation in American history. Prices fell after the mid-1780s but soon rose again sharply beginning in the mid-1790s through the War of 1812. Prices fell sharply from their wartime peak in 1814, and continued to fall until reversing course in the early 1830s. The fall in prices that occurred after the panic of 1837 cemented in place a cyclical pattern in prices that, while hardly new to the economy, would be repeated several times up to and including the Great Depression of the 1930s—prices generally rose smartly during booms, but then fell, sometimes quite abruptly, during a recession.
Following the recession of the early 1840s, the last two decades of the pre–Civil War period were generally a period of rising prices. Beginning in 1843, prices rose more or less continuously until once again declining in the wake of the panic of 1857, but stabilized shortly thereafter. Despite the increases of the preceding twenty years, on the eve of the Civil War the overall level of prices was still well below that experienced in the late eighteenth and early nineteenth centuries.
The war years (1861–1865) witnessed substantial—uncontrollable, in the South—increases in prices due to the issuance of paper money by both the Union and Confederate governments. Prices rose sharply, and more importantly, relative to wages, created an "inflation tax" that helped both sides pay for the war effort.
Prices fell after the Civil War, and except for a minor upswing in the early 1880s, continued on a downward trend until the late 1890s, when an expansion in the worldwide supply of gold produced an increase in the money supply and a rising price level that stabilized just before the outbreak of World War I. As during the Civil War, prices rose rapidly during World War I, as the sale of war bonds fostered an expansion of the money supply in excess of the growth of production.
Prices fell sharply after the end of World War I and remained stable for the remainder of the 1920s. Stock prices were an important exception. Fueled by the postwar boom, these prices rose to unprecedented heights, before crashing down in October 1929. The depression that followed was by the far the worst in American history. Just as it had in previous downturns, the price level fell sharply between 1929 and 1933. Money wages also fell, but not as much as prices. Real output per capita decreased, and unemployment soared to nearly a quarter of the labor force in 1933. Prices began to recover after bottoming out in 1932, but fell again when the economy again went into decline late in the decade. In 1940, on the eve of U.S. entry into World War II, the price level was lower than it had been in 1930, and lower still than in the 1920s.
With the entry into the war, the nascent economic recovery accelerated, and unemployment, which had stood at nearly 15 percent in 1940, declined sharply. The war effort put severe upward pressure on prices that, officially at least, was checked through the imposition of wage and price controls in 1942. Unofficially, price rises exceed those recorded by the government: black market activity was rampant, and black market prices do not figure into the official price indexes of the period. After controls were lifted in 1946, the price level rose rapidly, reaching a level in 1950 slightly more than double the level in 1940.
Since 1950, the American economy has experienced a steady and substantial rise in price level, although the rate of increase—the inflation rate—varied across decades. Consumer prices rose by 23 percent in the 1950s and by another 31 percent in the 1960s. These increases were sufficient to prompt the Republican administration of President Richard Nixon to impose wage and price controls from 1971 to 1974. In the end, however, the controls did little to stem rising prices, particularly after an international oil embargo in 1973–1974 caused a sharp spike in energy prices. By the end of the decade, the price level had risen a stunning 112 percent over the level prevailing in 1970. The price level continued to rise in the 1980s and 1990s but at a much reduced pace. By the end of the 1990s, the cumulative effects of post-1950 increases in the price level were such that one 1999 dollar purchased the equivalent of $0.19 in 1950 prices.
Information on prices is routinely collected by government agencies and by the private sector. At the federal level, much of the responsibility is entrusted to the Bureau of Labor Statistics and the Bureau of Economic Analysis. Indexes produced by these agencies are published regularly in government documents such as Statistical Abstract of the United States and on-line at agency Web sites. For historical price indexes, readers are directed to the various editions of Historical Statistics of the United States.
Bibliography
Cole, Arthur H. Wholesale Commodity Prices in the United States, 1700–1861. Cambridge, Mass.: Harvard University Press, 1938.
Gordon, Robert J. The Measurement of Durable Goods Prices. Chicago: University of Chicago Press, 1990.
Hanes, Chris. "Prices and Price Indices." In Historical Statistics of the United States: Millennial Edition. Edited by Susan B. Carter, Scott S. Gartner, Michael Haines, Alan L. Olmstead, Richard Sutch, and Gavin Wright. New York: Cambridge University Press, 2002.
McCusker, John J. How Much Is That in Real Money? A Historical Price Index for Use as a Deflator of Money Values in the Economy of the United States. 2d ed. Worcester, Mass.: American Antiquarian Society, 2001.
U.S. Bureau of the Census. Statistical Abstract of the United States: The National Data Book. 120th ed. Washington, D.C.: Government Printing Office, 2000.
———. Historical Statistics of the United States: Colonial Times to 1970. Washington, D.C.: Government Printing Office, 1976.
