shadow price

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shadow price

the imputed PRICE or value of a good or service where such a price or value cannot be determined accurately owing to the absence of a market for the good or service, or to gross distortions in any markets which exist. To impute a price or value is to make the best estimate possible of what that price or value would be if a normal market existed.

One use of shadow pricing is when intra-firm trading occurs. The inputs of company division B may be the outputs of company division A. The products in which the two company divisions trade may not have an equivalent market price because no open market for them exists (for example intermediate components or managerial services). The transactions are given shadow prices, usually based on estimated costs plus a return on the capital involved.

A particular application of shadow pricing can be found in LINEAR PROGRAMMING where the solution to a problem yields hypothetical prices for scarce factor inputs, showing how much additional profit would result from an extra unit of each fully used resource. See TRANSFER PRICE.

shadow price

the imputed PRICE or VALUE of a good or service where such a price or value cannot be accurately determined because of the absence of an ordinary price-determined MARKET or because of gross distortions in any markets that do exist. To impute a price or value is to make the best estimate possible of what that price or value would be if a normal market existed.

WELFARE ECONOMICS attempts to equate the price of a product to its marginal social cost. The marginal social cost of a product is the summation of all costs associated with it. For instance, the true cost of electricity is not just the capital, labour and inputs of raw material; it includes the additional cost of disposing adequately of the waste products, such as smoke and dirt, and even the decrease in aesthetic appeal of the area in which the power station is situated. No values are given for these costs because no markets exist to price them. Shadow prices for such items are frequency estimated in COST-BENEFIT ANALYSIS.

A different use of shadow pricing is when intra-firm trading occurs. The inputs of company division B may be the outputs of company division A. The products in which the two company divisions trade may not have an equivalent market price because no open market for them exists (for example, intermediate components or managerial services). The transactions are given shadow prices, usually based on estimated costs plus a return on the capital involved. Such an estimate of market prices is used frequently in CENTRALLY PLANNED ECONOMIES (see TRANSFER PRICE).

A particular application of shadow pricing can be found in LINEAR PROGRAMMING where the solution to a problem yields hypothetical prices for scarce factor inputs, showing how much additional profit would result from an extra unit of each fully used resource.