Front Page Titles (by Subject) CHAPTER 6: MONEY AND MARKETS - Economics, vol. 1: Economic Principles
The Online Library of Liberty
A project of Liberty Fund, Inc.
CHAPTER 6: MONEY AND MARKETS - Frank A. Fetter, Economics, vol. 1: Economic Principles 
Economics, vol. 1: Economic Principles, (New York: The Century Co., 1915).
Part of: Economics, 2 vols.
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
The text is in the public domain.
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
MONEY AND MARKETS
§ 1. Money and evaluation. § 2. Origin of money. § 3. The use of money and money-prices. § 4. The standard price unit. § 5. Representative quality of money. § 6. The sale at auction. § 7. Bids in relation to valuations. § 8. Effect of multiplicate units of supply. § 9. Successive price levels through uncertainty. § 10. Auctions with reserve valuations. § 11. Origin of markets. § 12. Transportation and the extent of markets. § 13. Communication and markets. § 14. One price in a market. § 15. Imperfect market conditions.
§ 1. Money and evaluation. In the last chapter it was seen why a process of delicate price fixing can not go on in a state of true barter. The lack of correspondence between the amounts of the two goods, makes very exact estimates of the value of goods in barter difficult and often impossible. Therefore, in the earlier stages of society, no careful estimate of value is made by the individual. Children do not make it. The typical trade of the small boy is a “trade even”; Johnny exchanges his gingerbread for Jimmie’s jack-knife. It marks an epoch in the industrial development of the boy when he begins to keep store with pins, and no longer trades candy for apples, but both for pins, which have become the means of trade in his boy world. He then can express values in much more exact terms. In our society most children begin early to grow familiar with this conception of some thing used as a means of trading other goods; but travelers find some savage tribes still in the earlier childish stage of development, unable to grasp the thought, or understand the use, of money. When through lack of money there is a failure to adjust valuation, there is a loss of the possible advantage in each trade. There is a further waste of time and of effort to find something that will be accepted in barter, and the loss offsets a large part of the gain even when the barter is effected.
§ 2. Origin of money. These difficulties are met by the use of money. Some kind of good in general use comes to be accepted as a medium of trade. Money is simply one kind of wealth which is taken, not for itself, but to pass along. Each person takes it in the belief that it will enable him to distribute his purchasing power in a more effective way. Money was not an invention, as are some mechanical devices, suddenly hit upon, but it was invented in the sense that the use as money of this or that object grew into a social custom as its convenience was tested by practice. Money is used in some degree everywhere except in the most primitive tribes. Historically viewed, the money first used in any community seems in every case to have been an object capable of giving immediate enjoyment to its possessor: salt, furs, rare feathers, bronze for weapons, silver and gold for ornaments, etc. This valuable good then gradually comes to be used as money, adding to its value-in-use this quality of value-in-exchange.
§ 3. The use of money and money-prices. A money-economy is a social organization, or an economic community, where money is generally used as the means of payment, in contrast with a barter-economy where trade is carried on without the use of money. In either case it is a matter of degree, and actually both methods are found in use in any modern community in varying proportions. The numerous problems arising with the use of money in a money-economy make up an important sub-division of economics, which must in the main be reserved for later study. Our present purpose, however, is merely to get in mind a few fundamental ideas regarding the use of money as a standard of current prices.
Goods had value long before such a thing as money was known in the world. All the essential features of the valuation process are possible without reference to money. But the great bulk of the trade of the world is effected through the instrumentality of money (and credit), and prices are nearly always quoted in money terms. So, altho there may be valuation and even a certain amount of trade (and therefore prices) without the use of money, it is natural for us to look for concrete illustrations of trade and of price to the money transactions which are taking place around us all the time—the familiar purchase of a good for money. Moreover, while the explanation of the more complicated problem of market prices without reference to money is quite possible, it is simplified by having these prices expressed in money terms.
§ 4. The standard price unit. In every civilized country to-day, some one valuable metal, either gold or silver, is selected as the standard money material, and a certain number of grains of the metal, of a certain degree of fineness, duly stamped by governmental authority, is the standard coin or monetary unit. This unit in the United States is called a dollar, consisting of 23.22 grains of “fine gold” (or 25.8 grains of “standard gold” nine tenths fine); in Great Britain it is the pound, containing 113.001605 grains of fine gold; in Germany it is the mark, containing 5.5312 grains; and in France it is the franc, containing 4.4803 grains. The coinage of the dollar gold piece was discontinued in the United States in 1890, and gold is coined in multiples of a dollar in quarter and half eagles, eagles ($10.00), and double eagles. Other pieces of metal and paper, properly stamped, are also called dollars, but the value of each of those is always now maintained practically equal to the value of the gold dollar.1 When we discuss market prices to-day in America in terms of money, we may think, therefore, of the price as being a quantity of gold, some multiple of a piece weighing 25.8 grains.
§ 5. Representative quality of money. Buying and selling by means of money is not essentially different from a case of barter in which gold (or other standard money) is one of the two goods in the trade. Except in the rarest cases, the price-good, money, is taken by the seller for its power-in-exchange for other goods, not as metal to be used in the arts. The money is taken for its representative quality (see above, section 2); it represents to the trader the desirability of the things that it can be expected to buy. Money becomes in the thought of the traders something like an algebraic symbol, but it stands for different things and groups of things to different traders, and to each its significance changes from one moment to another, according as he chooses to use it in buying different goods.
When numerous things are bartered, the ratio in one transaction is unrelated with that in another. Tho there might be at the same time and place a hundred acts of barter, as sheep for cloth and wheat for shoes, etc., in large part each act of barter stands by itself in the thoughts of men. There is no common unit of comparison for prices. But if sheep, cloth, wheat, and shoes are each in turn sold and bought with the money unit, money becomes a common unit of expression not only for prices on the market, but for the various individuals’ valuations of goods. The habit of comparing goods in terms of money grows, and for convenience men frame their own valuations in monetary terms, as they approach a trade to bid and ask, and buy and sell.
§ 6. The sale at auction. Let us now approach the price problem as it presents itself when groups of traders come together, and where bids are expressed in some common unit of price. We will consider first the simplest case of price fixing in a group, that of the auction sale. In auctions on the Dutch plan the auctioneer first names a high price and then successively lowers the price until some buyer takes it. Balancing his hopes and fears, some one bids it in, because he fears that when a lower price is named some one else will take it. In auction sales on the English plan the auctioneer asks, “What am I bid?” and after getting “a starter” he stimulates the desire of the bidders by praise of the sale-goods, keeps the crowd good natured and optimistic by artful story telling, arouses the spirit of rivalry in the bidders, and excites their fears by skilful threats of “going, going,” until, shrewdly watching their faces, he feels that the limit is reached. Then he lets fall the hammer, “knocking the article off” to the “lucky buyer.” The auctioneer in all this is himself under some pressure, and the success of the sale as a whole depends much on his skill. He dare not delay long for a higher bid on any one article, for unless the bidders continue to believe that things can be had at low prices (i.e., at less than new goods will ordinarily bring) the interest flags and the crowd melts away.
§ 7. Bids in relation to valuations. Note how the prices paid are related to the valuations of the bidders. Suppose that an ax is to be sold at auction, and each one of the ten prospective buyers as he comes to the market has his outside valuation, as follows:
When B 3 has bid 50 he has reached his limit and only two other bidders remain. B 2 may then hope to be successful at 51, but B 1 “goes one higher” at each bid until the bid of 54, at which point B 2 drops out. The price in an auction sale is the next unit above the next to the highest bidder’s maximum valuation.2 When there are several urgent bidders for a single article, or for a number of articles less numerous than the bidders, the price sometimes goes considerably above what is “normal.” For example, if several farmers in the neighborhood have lost or sold horses and a horse is offered at auction just as the spring plowing needs to be done, they may bid so eagerly as to carry the price above that for which an equally good animal could be bought in the next county, or in a near-by city. The buyer can afford to pay as much more as the cost to himself of a few days’ delay and loss of his time when “time is money.” If the normal price is 60, the actual price, which is the market price at that time and place, might be 70 or 80.3
§ 8. Effect of multiplicate units of supply. Suppose that instead of one ax, there were ten axes, all of about the same quality. At rural auction sales in America, those present look over the articles before the sale begins, and try to find who has come to buy, what they would like to get, and what they are likely to bid. If every prospective bidder judged the situation with entire accuracy, then when there were nine axes the exact price would be 21, just enough to exclude the lowest bidder; if there were eight axes the price would be 26 (and so on up to 54 if there were but one ax).
What would happen if there were ten axes offered to ten bidders and no one else would be tempted to bid at any price, however low (i.e., complete inelasticity of demand at prices below 20)? The first thought may be that the price may be twenty. But we are here coming to the margin of satisfaction of desires where values disappear. If the more eager bidders know the situation and refrain from bidding, each buyer might in turn get an ax for one unit, the smallest possible bid. This is the case when things sell for a “song.” On Saturday nights at the produce markets such goods as strawberries, vegetables, and fish will be sold at any price. In fact, it rarely happens that demand is entirely inelastic, for at an abnormally low price each of the more eager bidders may be tempted to get more of the sale-goods than he had expected, and still others who had no thought of buying will do so if only with the purpose of selling later. The man who bought a cheap coffin at an auction because “it would be handy to have in the house” was a bit of an extremist, yet it is proverbial that anything can be sold if the price is low enough.
§ 9. Successive price levels through uncertainty. It is evident that a mistake in the judgment of traders must alter the price somewhat with any number of sale-goods. There may be a succession of price levels. When there were ten axes, the first five might sell at close to 40, the next three at close to 30, and the last two at 20; the more eager bidders being uncertain of the number of other bidders and afraid to risk waiting for the lower price. This drop in price is a very common incident at auctions, to the chagrin of the earlier buyers; but the opposite is possible, and bidding may become more spirited and the price rise as the last article is put up for sale.
§ 10. Auctions with reserve valuations. An auction is advertised to be “without reserve” when everything is to be sold for the highest bid, no matter how low it is. The seller agrees in advance to have no minimum selling valuation. Price in such a case may be abnormally low, much lower than in a trade where a lower limit is set by the ability and readiness of each would-be seller to keep all or part of the supply if the price is not as high as his valuations. Buyers’ bids alone then determine the price at anything above zero. In most cases of trade, each trader virtually stands ready “to bid in” his own goods at his valuations rather than to sacrifice them; and even in some auctions the right is expressly reserved of withdrawing articles for which the bids remain unduly low. In some cases friends or confederates, “cappers,” make pretended bids, or sometimes bid in the goods if the price is too low.
§ 11. Origin of markets. We have in the auction sale, with its gathering of buyers, something near to the idea of a market. In all parts of the world, civilized or uncivilized, are found places where both buyers and sellers of various kinds of goods come together to trade. These meeting places (or meetings) were called markets because they were first found on the border (mark) between tribes, villages, or clans, as a common ground where strangers met to trade. The notion of trade did not develop within the family and the tribe. There the idea of common ownership seems to have ruled, and the communities seem to have been led to trade by the abundance or the want of certain natural resources in their environment; thus shore tribes had a surplus of salt and fish, forest tribes had meat and skins, tribes living near good mineral deposits had flints and bronze, while each wanted what the other had. Markets developed on neutral ground whither came buyers and sellers, some of whom became regular merchants. Buyers found a better selection of goods, both as to kind and as to quality, and merchants found many would-be purchasers for what they had to sell. Throughout the Middle Ages purchases were made by the more prosperous husbandmen in great quantities once or twice a year at the fairs or markets. As both buyers and sellers came from widely separated places, the feature of combination (or monopoly) was not common and the conditions of a competitive market were present.
In America as towns or villages appeared where some men could give most of their time to producing something besides food, local markets sprang up whither farmers came to exchange with village artisans. Every little country store in America is in some measure a market, where the merchant trades with the farmer, the townpeople with the merchant, and neighbors with each other. The larger cities become the great markets, toward which are sent all the surplus products of farms and of the mills in smaller cities to be distributed to the consumers.
§ 12. Transportation and the extent of markets. Markets are limited by the means of transportation enabling goods to be brought from the place of their origin and delivered to the place of their use. A dense population engaged mainly in commerce and manufactures can be maintained only at points where there are means of bringing in a large supply of food, and of carrying back manufactured goods. 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 more distant points.
§ 13. Communication and markets. Buyers and sellers need not be physically present at one place, but they must be in communication, so that there can be a common understanding between them. In earlier times, however, there were no easy means of gathering information such as trade bulletins, newspapers, special commercial agencies, and no rapid means of transmitting intelligence, such as the steamship, the railroad, the postal service, the land telegraph, the ocean cable, and the wireless telegraph. The traders once had to be together at one place in order that each should know what the others were willing to do. All this is now changed and for many purposes men in Paris, in New York, in London, and in Calcutta are separated by only a few moments for trading.
As a result of these changes, the old periodical fairs and markets have almost disappeared, and 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 that are widely separated and that are members of a world-market. Various products produced in the same locality may seek different markets. While the market for fruit and eggs may be in the village near the farmhouse, that for most of the wheat of the same farm may be in Liverpool.
§ 14. One price in a market. If the many buyers and sellers coming together at a market-place were to meet as isolated couples, without knowledge of the others, the trades would be made at a great variety of ratios, possibly no two trades at the same. But the coming together of buyers and sellers into a single trading group has a remarkable effect on the ratio at which the trades take place between individual buyers and sellers. So far as there is truly a meeting of minds, all the trades taking place at any one time are at the same ratio. It is the essential proof of a true market that there is but one price at any moment. A complete or typical market may therefore be defined as a group of closely communicating traders whose valuations, however diverse before they meet, unite for a moment into a single price (as regards the goods actually traded). A typical market exists and a market price results when there is: (a) a group of buyers and sellers; (b) a judgment by each trader of both groups, as to the conditions of the market; (c) free bidding on both sides.
§ 15. Imperfect market conditions. When, however, these conditions are not fulfilled perfectly, different prices may exist at the same moment near each other. Retail and wholesale merchants may be purchasing goods in the same room at the same time at very different prices, but there are here two distinct and well recognized markets. Even within what is ordinarily the same market, differences may for brief times exist. On the occasion of a break in stocks, excited traders within ten feet of each other make bids that differ by thousands of dollars; but the expression used to describe this explains the cause: “the market has all gone to pieces.” The very essence of the idea of market is the meeting of minds in agreement on a price. Within a group of buyers and sellers thus meeting, one price prevails at least for the moment. The more nearly the actual conditions approach to the ideal of a market, the less are prices fixed by individual higgling, and the more impersonal they become, the buyers and sellers being compelled to adjust their bids to the needs of the market, and being unable to vary them greatly one way or the other.
[1 ]By proper safeguards regarding their quantity and their ready exchangeability for gold.
[2 ]This may be called the theoretically exact price, under the assumed conditions. Of course inattention, forgetfulness, etc., on the part of the bidders alter the conditions and therefore the price (both theoretical and practical).
[3 ]This is a case of complementary goods (see above, Chap. 5), the horse being needed to make use of other goods. It also evidently involves time-value, which see later, Part IV.
[* ]Let the buyers be arranged in order of the amount of their maximum valuations, from left to right from the intersection of the coordinates. The dotted horizontal lines represent the successive levels of the bids, rising until the price is fixed at 54, just above the next to the highest bid.
[* ]If each of numerous like articles were put up for sale separately and each were supposed by buyers to be the last, there would result a succession of prices. Each price would be lower than the preceding, each just high enough to exclude the next to the highest remaining bidder. If, however, it was known that there were several like articles but not just how many, there might result a succession of price levels. The dotted curve connects the maximum valuation of the several buyers; successive prices form a curve somewhat lower. A tenth unit would sell only at a price between zero and 20.