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In order to measure the ebb and flow of supply and demand, a measurable value is needed. The oldest and most commonly used is Price, or the going rate of exchange between buyers and sellers in a market. Price theory, therefore, charts the movement of measurable quantities over time, and the relationship between price and other measurable variables. In Adam Smith's Wealth of Nations this was the trade-off between price and convenience. A great deal of economic theory is based around prices and the theory of supply and demand. In economic theory, the most efficient form of communication is when changes to an economy occur through price, where too much supply leads to lower prices, and too much demand leads to higher prices.
225px Exchange rates are determined by the relative supply and demand of different currencies — an important issue in international trade.
In many practical economic models, some form of "price stickiness" is incorporated to model the observed fact that in many markets prices do not move fluidly. Economic policy often revolves around arguments as to what is causing "economic friction", or price stickiness, and which is, therefore, preventing the supply and demand from reaching equilibrium.
Another area of economic controversy is on whether price measures value correctly. In mainstream market economics, where there are significant scarcities not factored into price, there is said to be an externalization of cost. Market economics predicts that scarce goods which are under-priced are over-consumed (See social cost). This leads into public goods theory.
Because scarcity and decision are central to economic theory, the question of what is the basic trade-off in economics is of central importance. In every economic theory, there is a basic exchange of two or more ultimately scarce commodities. For Adam Smith, it was defined as the trading of time, or convenience, for money. For example, a person could live near town, and pay more for rent or his domicile, or live farther away and pay less, "paying the difference out of his convenience".
240px Trades on the floor of the New York Stock Exchange always involve a face-to-face interaction. There is one podium/desk on the trading floor for each of the exchange's three thousand or so stocks.
This view, that the primary trade-off involved in economics is between time and money, has several challengers. Each of these bases its view of scarcity on a different fundamental trade-off. A small number of economists prefer to define economics as the study of how and why people trade; this definition implies relative scarcity.
In economic theory, the price level is determined by the marginal cost and marginal utility. The price of all goods will be the cost of making the last one that people will purchase, the price of all the employees in a firm will be the cost of hiring the last one the firm needs. Marginalism looks at decisions based on "the margins", what the cost to produce the next unit is, versus how much it is expected to return in profit. When the marginal return of an action reaches zero, the action stops. Marginal utility is how much more happiness or use an individual gets out of a purchase versus purchasing less. Marginal rewards are often subject to diminishing returns, getting less reward out of more production or consumption - the 10th candy bar doesn't taste as good as the first, and so brings less marginal utility.
Marginalism became increasingly important in economic theory in the late 19th century, and is a tool which is used to analyze how economic systems will react. Marginal cost of production divides costs into "fixed" costs which must be paid regardless of how many of a commodity are produced, and "variable costs". The marginal cost is the variable cost of the last unit, plus the percentage of fixed costs. Marginalism states that when the profit from the next unit will be zero, that unit will not be produced.
It could be argued that beneath an economic theory is a theory of value. Value can be defined as the underlying activity which economics describes and measures. It is what is "really" happening.
right Representative money like this 1922 US $100 gold note could be exchanged by the bearer for its face value in gold.
Adam Smith defined "labor" as the underlying source of value, and "the labor theory of value" underlies the work of Karl Marx, David Ricardo and many other "classical" economists. The "labor theory of value" argues that a good or service is worth the labor that it takes to produce. For most, this value determines a commodity's price. This labor theory of price and the closely related cost-of-production theory of value dominates the work of most classical economists, but they are far from the only accepted basis for "value". For example neoclassical economists and Austrian School economists prefer the marginal theory of value.
"Market theory" argues that there is no "value" separate from price, that the market incorporates all available information into price, and that so long as markets are open, that price and value are one and the same. This theory rests on the idea of the "rational economic actor". This was originally asserted by Mill.
Another set of theories rest on the idea that there is a basic external scarcity, and that "value" represents the relationship to that basic scarcity. Theories based on economics being limited by energy or based on a "gold standard" are of this type.
All of these value theories are used in current economic work.
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