Principles of Economics with Applications to Practical Problems

<h2>CHAPTER 5</h2> <h3>EXCHANGE IN A MARKET</h3> <h4>§ I. EXCHANGE OF GOODS RESULTING FROM DEMAND</h4> <div class="sidenote">Reciprocal demand becomes exchange</div> <p>1. <i>Exchange in the usual economic sense is the transfer of two goods by two owners, each of whom deems the good taken more than a value-equivalent for the one given.</i> The comparison of goods that has been discussed above is a kind of exchange. When a person chooses one thing rather than another, one form of gratification may be said to be mentally exchanged for another. This is exchange in that person's mind, or subjective exchange. But the word "exchange" as usually employed means an exchange of goods between persons. It is objective exchange, and when the word is used without modification, it is to be understood in the objective sense. In the last chapter were analyzed the motives of the individual man. Robinson Crusoe on his desert island would in very many ways be acted upon by the same motives in reference to economic goods that men are in society. Yet, it is exchange in society and the complicated problems arising from this transfer of goods from person to person that constitute nearly the whole of the subject-matter of political economy.</p> <p>Exchange is seen to arise out of the differences in the situations of men with reference to goods. The different subjective valuations give rise to demand, and demand leads to exchange. In early societies differences in natural products were the most usual causes of exchange. Salt, though so essential to life, is found in few places. The metals early became<span class="pagenum"><SPAN name="Page_31" id="Page_31">[Pg 31]</SPAN></span> indispensable for weapons of defense or for the chase, and were sought far and wide. Rare shells, feathers, jewels, and the precious metals appealed in early times to a universal desire for ornament. Products like these are the objects of a rude sort of exchange in the first simple efforts made to adjust possessions to wants. Within the tribe, differences in the skill and ability of men to produce arrow heads or weapons or ornaments, bring about the exchange of goods.</p> <div class="sidenote">Mutual advantage in exchange</div> <p>2. <i>The advantage of exchange consists in the raising of the want-gratifying power of goods to both parties.</i> It generally was assumed by medieval thinkers that if one party to an exchange gained, the other must lose. The mistaken idea prevailed that value is something fixed in the good, and unchangeable. Where the exchange is voluntary (and only that kind is here being considered), it is mutual advantages which make the exchange rational. Many false conclusions on practical questions still result from a failure to grasp this simple truth. It follows from this that the act of exchange is itself useful, for goods having a small importance to men are given a higher importance by being brought into better relations with wants. Merchants, peddlers, traders, and common carriers of all sorts, therefore, are adding to the utility of goods. This idea has been only slowly apprehended, but is now one of the least disputed propositions in economics.</p> <div class="sidenote">Demand is supply in another aspect</div> <p>3. <i>Barter is the exchange of goods without the use of money.</i> Either one of the goods traded in cases of barter may be considered as sold, and either one as bought, according as the matter is looked at from the standpoint of the one or the other party to the exchange. Demand, therefore, is supply, and supply is demand when the point of view is shifted from one party to another. The fisherman's demand for venison is expressed in terms of fish; the hunter's demand for fish is expressed in terms of venison. But to the fisherman the venison is the supply offered to<span class="pagenum"><SPAN name="Page_32" id="Page_32">[Pg 32]</SPAN></span> him. The term "marginal utility" of a good, therefore, does not refer merely to the demand of the consumer; for it expresses by a single phrase the idea both of demand and of supply. The utility of the goods composing the supply is expressed in terms of the goods that represent demand and vice versa. The only way in which man can give definite, concrete, numerical expression to his desire for goods is to state it in terms of other goods. In expressing numerically, in terms of other objects, an estimate of the utility of an apple, a horse or a house, one inevitably gives expression to a ratio of exchange; demand for one good is the offer of another good.</p> <h4>§ II. BARTER UNDER SIMPLE CONDITIONS</h4> <div class="sidenote">In isolated exchange the price is not economically fixed</div> <p>1. <i>In isolated exchange, where only two traders engage in barter, their estimates give respectively the upper and the lower figures of the ratio at which the trade can take place.</i> Let us recall the fact that a difference in the <i>relative</i> estimates that men place on goods is the first essential of exchange. Those estimates may be expressed in a ratio; we may say that A will give four apples for one orange, would be glad to give fewer, but will not give more; while B will give one orange for three apples, would be glad to get more apples, but will not take fewer. The outside limits of the ratio at which the exchange must take place will, therefore, be one orange for three or four apples.</p> <p>A, seller of apples, offers 4 (or fewer) apples for 1 orange.</p> <p>B, buyer of apples, demands 3 (or more) apples for 1 orange.</p> <p>There is, in entirely isolated exchange, therefore, a lack of definiteness in the price, much depending on what Adam Smith called the "higgling of the market." In the old-time American horse trade much depended on "bluff"; in such cases it was as important to be able to judge character as to judge horses. A thorough analysis of the trade, however,<span class="pagenum"><SPAN name="Page_33" id="Page_33">[Pg 33]</SPAN></span> would probably show that the bargain is concluded at a point which exactly balances the hopes of gain and fears of loss of one of the parties.</p> <div class="sidenote">Competitive bidding narrows the limits of price</div> <p>2. <i>Where one-sided competition exists, the ratio of the exchange will be somewhere between the estimates of the two buyers most eager for the last portion offered</i>. By competition is here meant the independent seeking of the same thing at one time by two or more persons. Where there is one market price paid by a number of buyers, it may be that no two of the subjective estimates are alike; the exchange value may differ from all of their estimates, and yet must correspond closely to two. Auction sales well illustrate the principle. If there is one ax to be sold and ten possible buyers for an ax, and there is no combination among them, the bidding will go on until the estimate of the buyer next to the most eager, has been reached. The most eager buyer can then secure the ax by bidding just a little above his next competitor. But if there are ten axes and ten buyers who know that there will be ten axes offered, the more eager buyers will refuse to bid much above the less eager ones. A shrewd auctioneer, therefore, often conceals the fact that there is more than one of an article, and having sold it off, brings out a second or a third one of the same kind, thus keeping the buyers in ignorance of the supply and getting somewhere near the estimate of the most eager buyer in each case. Advertisements of "a limited supply," "the last chance," "positively the last appearance," are meant to stimulate the demand of the patrons, and to lead them to buy at once. In general, therefore, where competition exists on one side, price is fixed with greater definiteness than in isolated exchange. Not so much depends on shrewd bargaining, on bluff, or on the stubbornness of an individual. Far more depends on forces outside the control of any one man. The bidders are impelled by self-interest to outbid their competitors, and thus the limits within which the market price must fall are narrowly fixed.</p> <p><span class="pagenum"><SPAN name="Page_34" id="Page_34">[Pg 34]</SPAN></span></p> <div class="sidenote">Buyers fix price of perishable goods</div> <p>If things already brought to market must be sold at any price that can be secured, the buyers may be said to fix the price. This does not mean that they can buy it for any sum that they wish, but it means that when each one is trying to get it as cheap as possible, their bids finally determine how much it will sell for. In such cases, therefore, the competition is for the moment one-sided.</p> <p>If a part of the supply can be withdrawn and kept without great loss, this will be done if the price is low. Strawberries, fish, and meat may be sold Saturday night at any price that will secure purchasers, but every thing that can be kept with little or no depreciation will be withheld from sale for a time. It may even be of advantage to the seller to destroy a part of the supply, when the increased price of the smaller amount will give a larger total.</p> <div class="sidenote">The margin of advantage and the marginal pair</div> <p>3. <i>Where two-sided competition exists, the bidding goes on until a price is reached where the least eager seller and the least eager buyer have the narrowest possible motive to exchange</i>. As the market ratio varies from those in the minds of the individuals when they come to the market, there is left a considerable margin to some and a very small one to others. This difference between the market value and the ratio of exchange at which any given individual would continue to exchange for the good may be called the <i>margin of advantage</i>. Moreover, the buyers will have a margin and the sellers a margin, and as that margin narrows there is less and less motive to continue the exchange until, finally, the margin disappearing, the buyer or seller, withdrawing from the market, ceases to be an exchanger, at least for that particular part of the goods.</p> <p>The least eager buyer and the least eager seller may be called the <i>marginal pair</i>. They are the buyer and the seller respectively having the narrowest margin of advantage. Their outside estimates are nearest to the market ratio. If the market ratio shifts slightly in either direction, one of them will drop out of the exchange. It is evident that a buyer<span class="pagenum"><SPAN name="Page_35" id="Page_35">[Pg 35]</SPAN></span> who is taking ten units may be on the margin with reference to the tenth unit, and yet may continue to be one of the most eager buyers to secure one unit. Thus, the marginal buyer is to be thought of as that person who, logically considered, is the least eager, or on the margin, with reference to a particular unit of supply, however eager he may be with reference to any other unit of supply. It would be well to recall here the discussion of the nature of wants and the variation in the intensity of demand.</p> <div class="figcenter"> <ANTIMG src="images/i35.jpg" width-obs="600" height-obs="537" alt="" /> <span class="caption"><i>Units of Goods</i></span></div> <div class="sidenote">Market values built on individual estimates</div> <p>4. <i>Market values are built up on subjective valuations.</i> The idea of market values, therefore, is that of the want-gratifying power of goods as expressed in terms of other goods, where there are various buyers and sellers. They are not an average of the subjective valuations, nor are they made up of the extremes. They correspond closely with the subjective estimates of two of the exchangers. The other parties to the exchange are willing to accept the market ratio, for it offers them more inducements than it does to either one of the marginal pair.</p> <p><span class="pagenum"><SPAN name="Page_36" id="Page_36">[Pg 36]</SPAN></span></p> <h4>§ III. PRICE IN A MARKET</h4> <div class="sidenote">One price in a market</div> <p>1. <i>A market is a body of buyers and sellers in such close business relations that the actual price conforms closely to the valuation of the marginal pair.</i> The word "price" which we have used, may be defined as value expressed in terms of some commonly exchanged commodity. The term is used more broadly of anything given in exchange. The very terms of this definition imply that there can be but one price in a market. This is a somewhat abstract but a useful economic proposition. Very often within sound of each other's voices traders are paying different prices for a good. On the occasion of a break in the stock-market, excited traders within ten feet of each other make bids that differ by thousands of dollars. Retail and wholesale merchants may be purchasing goods in the same room at the same time at very different prices. But within a group of buyers and sellers where competition is approximately complete, price is fixed with some degree of exactness. The more nearly the actual conditions approach to the ideal of a market, the less are prices fixed by higgling, and the more impersonal they become, the buyers and sellers being compelled to adjust their bids to the needs of the market, and not being able to vary them greatly one way or the other.</p> <div class="sidenote">The earlier markets</div> <p>2. <i>Markets are steadily widening through the improvement of means of communication and transportation.</i> The earliest markets were established on the borders between tribes, villages or nations as a common ground where strangers met to trade. At such markets were brought together from sparsely settled districts a comparatively large number of merchants and customers. Buyers had the opportunity of wide selection both in kind and quality, and the sellers found a large body of customers gathered at one point. Throughout the Middle Ages purchases were made by the more prosperous husbandmen in great quantities once a<span class="pagenum"><SPAN name="Page_37" id="Page_37">[Pg 37]</SPAN></span> year at the fairs or markets. As both the buyers and sellers came from widely separated places, there was, in most respects, no combination, and the conditions of a competitive market were present.</p> <div class="sidenote">The growth of markets</div> <p>The number of buyers and sellers that can constitute a single market is limited both directly and indirectly by the means of transportation. A dense population cannot usually be maintained without easy means of transportation to bring in a large supply of food, and to carry back manufactured goods great distances. The remarkable growth in the means of commerce since the application of steam to water traffic, and the invention of the railroad, have made it possible for goods to be gathered from most distant points. A market implies a common understanding among traders. Modern means of communication such as newspapers, post-offices, telegraph and cable, trade bulletins, commercial travelers, the consular service, and many forms of special agencies, are diffusing information widely. As a result of these changes, there has been a widening of the village-market to the markets of the province, of the nation, and finally of the world. While a part of every one's purchases continues to be made in the neighborhood, a greater and greater portion of the total business is done by traders who are widely separated and who are indeed members of the world market. Various articles produced in the same locality may seek different markets. The market for wheat may be in Liverpool, while that for fruit and eggs is in the village near the farm-house. If a given product of any community is sold in different markets, the net prices secured must be very nearly equal.</p> <div class="sidenote">The conceptions normal and market price</div> <p>3. <i>Normal price is spoken of in contrast to market price when the actual market price results from exceptional circumstances and probably will not be maintained.</i> The term "normal price," much used in economic discussion, is the price which, apart from exceptional conditions, is expected to prevail, and to which actual prices seem constantly striving<span class="pagenum"><SPAN name="Page_38" id="Page_38">[Pg 38]</SPAN></span> to adjust themselves. As actual prices are nearly always either more or less than so-called normal price, and only momentarily ever correspond with it, the term "normal" would appear to be something of a misnomer. Moreover, as the circumstances of production change, this normal price itself is altered so that what is normal one day may be quite abnormal the next. The thought of "normal price" is an abstract one, but despite the inaptness of the word it is not without some practical validity. In determining whether he shall continue to produce certain goods, the business man is practically guided by his view of normal price. An example of departure from normal price as above defined, is found in the price of food when an expected ship has failed to arrive at a port with its cargo of grain. A scarcity amounting almost to famine might thus exist in a seaboard city, and the market price would rise; but as this would be due to an accident and would afford a larger gain than usual to those who happened to have a supply of grain, men would say that the market price was above the normal price. The arrival of the expected ship would cause the market price to return to the normal.</p> <div class="sidenote">Review of the argument</div> <p>In review, we see that the market value of goods grows out of the different personal estimates made by men. Market value itself being a complex and difficult problem, it can be mastered only by dividing it. First, therefore, must be studied the more general and obvious motives of men, the nature of wants and their effects on man's subjective estimates. The same simple motives that influence the subjective valuations made by individual men, may be traced to the conditions of the complicated market. It is their workings that are seen in the obscurest problems of market price.</p> <hr class="chap" /> <p><span class="pagenum"><SPAN name="Page_39" id="Page_39">[Pg 39]</SPAN></span></p> <div style="break-after:column;"></div><br />