The following points highlight the three main types of price changes of goods and services. The types are: 1. General Price Changes 2. Specific Price Changes 3. Relative Price Changes.
Type # 1. General Price Changes:
A general price change is the result of a change in the value of the monetary unit during periods of inflation and deflation. Generally all prices would move together by the same percentage.
However, if prices are moving at different rates, which is the usual case, a measure of general price changes can be obtained only by computing an average or index of prices to express the general level of current prices compared with some base period.
The ratio of the current index of prices to the base-period index expresses the relative change in all prices included in the index. For example, if the price index should increase from 100 to 200, prices would have doubled, but the purchasing power of the Rupee would have decreased to one half of its previous level.
The term purchasing power means the ability to buy goods and services with a given quantity of money compared with what the same quantity of money could have purchased at an earlier date. To obtain a good comparison of the purchasing power of money at two different dates, the goods and services available at the two dates must be the same or similar.
Since the types and qualities of goods and services available change considerably over time, good comparisons of purchasing power is not possible. General purchasing power means the ability to buy all types of goods and services available in the economy, and it is measured by changes in the general price level. Specific purchasing power refers to the ability to buy specific goods and services at different dates. Thus, specific purchasing power can be measured by changes in specific prices.
Type # 2. Specific Price Changes:
A change in the price of a specific commodity represents a change in its exchange value. Changes in prices in an input market result in increase or decrease in costs or expenses of the firm, and changes of prices in the output market result in a shift in revenues (assuming that the price change does not affect the quantity sold).
A more useful matching of expenses with revenue is obtained by reporting as expenses the current prices of the goods used in the process of obtaining revenue. This matching of the current input prices with the current output (revenue) prices is more relevant as a measure of operating efficiency and as a better basis for the prediction of the results of future transactions.
Type # 3. Relative Price Changes:
Most often, prices of goods and services move at different rates, and some even in different directions. The extent to which specific prices move at different rate or in a different direction from general price is known as relative price changes. This is explained with the help of the following example.
If the market price of product A was Rs. 20 in 2007 and Rs. 30 in 2008; and further, if the market price of all the products comprising general price index was Rs. 200 in 2007 and Rs. 240 in 2008, calculate:
(i) Specific price index for product A
(ii) General price index for all the products
(iii) Relative price index of product A
(i) Specific Price Index of product A, Rs. 30 – Rs. 20 = Rs. 10 i.e., 10/20 x 100 = 50%
(ii) General Price Index for all products, Rs. 240 – Rs. 200 = Rs. 40 i.e., 40/200 x 100 = 20%
(iii) Relative Price Index of Product A
Assuming price index of 100 in 2007 as a base, specific price index in 2008 will be 150, and General
Price Index will be 120 in 2008.
Therefore, relative price index of product A is
Rs. 150 – Rs. 120 = Rs. 30
i.e., 30/120 x 100 = 25%