The Online Library of Liberty

A project of Liberty Fund, Inc.

• Translator's Preface
• Author's Preface
• Introduction
• Book I: The Nature and Conception of Capital
• Book I, Chapter I: Man and Nature
• Book I, Chapter II: The Nature of Capital
• Book I, Chapter III: Historical Development of the Conception
• Book I, Chapter IV: The True Conception of Capital
• Book I, Chapter V: The Competing Conceptions of Capital
• Book I, Chapter VI: Social and Private Capital
• Book II: Capital As Instrument of Production
• Book Ii, Chapter I: Introductory
• Book Ii, Chapter II: Capitalist Production
• Book Ii, Chapter III: The Function of Capital In Production
• Book Ii, Chapter IV: The Theory of the Formation of Capital
• Book Ii, Chapter V: Formation of Capital In a Community
• Book Ii, Chapter VI: Possible Objections
• Book III: Value
• Book Iii, Chapter I: The Two Conceptions of Value1
• Book Iii, Chapter II: Nature and Origin of Subjective Value
• Book Iii, Chapter III: The Amount of Value
• Book Iii, Chapter IV: The Marginal Utility
• Book Iii, Chapter V: Complications
• Book Iii, Chapter VI: What Determines Marginal Utility
• Book Iii, Chapter VII: Alternative Uses
• Book Iii, Chapter VIII: Subjective Exchange Value
• Book Iii, Chapter IX: The Value of Complementary Goods
• Book Iii, Chapter X: The Value of Productive Goods. Value and Costs.
• Book IV: Price
• Book Iv, Chapter I: The Fundamental Law
• Book Iv, Chapter II: Isolated Exchange
• Book Iv, Chapter III: One-sided Competition
• Book Iv, Chapter IV: Two-sided Competition
• Book Iv, Chapter V: The Law of Supply and Demand
• Book Iv, Chapter VI: The Individual Determinants of Price
• Book Iv, Chapter VII: The Law of Costs
• Book V: Present and Future
• Book V, Chapter I: Present and Future In Economic Life
• Book V, Chapter II: Differences In Want and Provision For Want
• Book V, Chapter III: Underestimate of the Future
• Book V, Chapter IV: The Technical Superiority of Present Goods
• Book V, Chapter V: Co-operation of the Three Factors
• Book VI: The Source of Interest
• Book Vi, Chapter I: The Loan and Loan Interest
• Book Vi, Chapter II: The Profit of Capitalist Undertaking. Principles of Explanation.
• Book Vi, Chapter III: The Profit of Capitalist Undertaking. Complications.
• Book Vi, Chapter IV: The Profit of Capitalist Undertaking. the Labour Market.
• Book Vi, Chapter V: The Profit of Capitalist Undertaking. the General Subsistence Market.
• Book Vi, Chapter VI: The Profit of Capitalist Undertaking. the General Subsistence Market—(continued)
• Book Vi, Chapter VII: Interest From Durable Goods
• Book Vi, Chapter VIII: Interest From Durable Goods—(continued)
• Book Vi, Chapter IX: Results
• Book Vi, Chapter X: Interest Under Socialism
• Book VII: The Rate of Interest
• Book Vii, Chapter I: The Rate In Isolated Exchange
• Book Vii, Chapter II: The Rate In Market Transactions
• Book Vii, Chapter III: The Rate In Market Transactions—(continued)
• Book Vii, Chapter IV: The Market For Capital In Its Full Development
• Book Vii, Chapter V: The Market For Capital In Its Full Development—(continued)
• Appendix to Page 327 [book Vi, Chapter V]: Amount of Subsistence Fund Necessary Before Entering On a Production Period of Given Length

BOOK IV

PRICE

Book IV, Chapter I

The Fundamental Law

Exchanges are not made simply for amusement. People who take the—not always trifling—trouble to exchange the goods which they possess for other goods, do so for a rational and material end, and, in nine hundred and ninety-nine cases out of a thousand, this end is to better their economical condition by the exchange.1 Whether this end be attained, and in what degree it be attained, depends naturally on the current conditions of exchange, particularly on the prices which the parties get as equivalent for their goods. It is, therefore, a perfectly natural thing that the motive which gives rise to exchange in general, namely, the striving after economical advantage, should maintain a commanding influence in the fixing of the exchange prices.

In what follows I mean to inquire how prices are determined under the assumption that all who take part in the exchange act exclusively from the motive of pursuing their immediate economical advantage in it. The law which we shall arrive at in this way I have already,2 for very good reasons, called the fundamental law of the formation of price. I am perfectly aware that, in practical life, this law does not exactly obtain. For, although the motive of self-advantage is almost never absent, and is almost always the most prominent motive, still, in price transactions, other motives do very often get mixed up; such motives as humanity, custom, friendship, vanity, or the influence of outside institutions, such as government taxation, union regulations, boards for fixing wages, and the like, give them another direction than that they would have taken if exclusively dominated by self-advantage. Such motives, indeed, scarcely ever get the upper hand of the other to the extent of making us conclude an exchange which would cause us positive economic loss; but they often make us decide to be content with a less amount of advantage than we should have got in steadily pursuing our interests.

I have on the same occasion3 expressed myself with all clearness on the theoretical and practical importance of the admixture of these other influences, and I shall only now briefly sum up what I then said. In actual life this admixture of motives causes certain modifications of the fundamental law of the formation of price, and the statement of these modifications cannot be neglected in any accurate and complete theory of it. But if all that is wanted is to grasp the characteristic features of the formation of price, it is enough to put forward the "fundamental law" above mentioned. For just as, among the motives that determine price, that of striving after self-advantage in exchange has the lions share, so does the lion's share in the theoretic explanation of the phenomena of price fall to the "fundamental law " here stated. And it is sufficient for us in our present task, as we have not to pursue the theory of price as an end in itself, but only so far as is necessary to establish the theoretical connection between the elementary phenomena of subjective value and the complicated phenomena of interest. In this law we obtain a principle which is not minutely accurate, but is amply sufficient for the further development of the theory of capital.

Before going on to state the peculiar laws of price, it may be desirable to preface them by some considerations that may, more accurately, unfold the content of the fundamental motive which forms the assumption and basis of the whole of the following inquiry.

In exchange transactions the decisions made always turn on two points; these are—(1) whether, in a given state of things, a man should exchange or not; and (2) if he decide to exchange, what form he should try to give to the terms of the exchange. Now in making these decisions it is obvious that the man who looks to his own immediate advantage and nothing else, will act according to the following rules. First, he will exchange only if the exchange brings him an advantage. Second, he will rather exchange for a greater advantage than for a less. Third, he will rather exchange for a small advantage than not exchange at all.

It scarcely need be shown that these three rules are dictated by our fundamental motive, and constitute the practical substance of it; what does require elucidation is an expression that recurs in them all, "to exchange with advantage."

The meaning of the expression obviously is—to exchange in such a way that the exchanger gains more in wellbeing from the goods he gets than he loses in the goods he gives; or, since the importance that goods have for life and wellbeing is expressed in their subjective value, to exchange in such a way that the goods received possess a greater subjective value than the goods parted with. If A owns a horse and is willing to exchange it for ten casks of wine, it can only be because the ten casks of wine have a greater value for him than his horse has. But, naturally, the other party to the contract thinks exactly in the same way. He, on his part, will not give up the ten casks of wine if he does not get for them a good that has a greater value for him. He will exchange his ten casks for A's horse only if the wine is worth less to him than the horse is.

From this we get an important rule. An exchange is economically possible only between persons who put a different value, even an opposite value, upon the commodity and upon the price equivalent.4 The buyer must put a higher, the seller a lower, estimate on the commodity than he does on the equivalent. Indeed the interest which the two parties have in the exchange, and the gain they get from it, increases as the difference between their estimates increases; if the difference decreases their gain decreases; and if the difference disappears, and their estimates coincide, no exchange is, economically, possible between them.5

It is easy to see that, under the regime of the division of labour, there must be innumerable chances of opposing estimates, and therefore innumerable opportunities of exchange. That is to say, as each producer makes only one or two kinds of articles, and these far in excess of his own personal requirements, he has at once a superfluity of his own products and an absence of all others. He will, therefore, ascribe to his own product a low subjective value, and to other products a relatively high subjective value. But, conversely, the other producers will ascribe a high value to all products which they have not, and a low value to their own products of which they have too many, and here we have in the fullest degree that relation of opposite valuations which is most favourable to the effecting of exchange.

Another idea that comes out in what has been said we may follow to its logical consequences. To one consulting his own advantage an exchange, as we saw, is economically possible only when he estimates the good to be acquired more highly than the good possessed. Now, obviously, this will more readily occur the less value he puts on his own commodity, and the more value he puts on the equivalent. A man who values his horse, subjectively, at £50, and values a cask of wine at £10, has, economically, a much greater possibility of exchange—or, as we shall say in future for brevity's sake, is much more "capable of exchange"—than another who values his horse at £100 and a cask of wine at £5. The former, obviously, can proceed with the exchange if six casks are offered him for his horse, while the latter must hold back unless something over twenty casks is offered him. If a third party again values his horse at £40 only, and a cask of wine at £15, obviously he would be economically capable of concluding an exchange if even three casks were offered him. Generally speaking, then, that exchanger is the "most capable" who puts the least value on his own commodity in comparison with that offered him in exchange, or, what is the same thing, puts the highest value on the other commodity in comparison with the commodity which he offers in exchange for it.

Now that we are sufficiently acquainted with the meaning and content of our "fundamental motive," we may proceed with our proper work, and consider what are the normal effects which this fundamental motive exerts on the formation of price. In this part of our work the method already pursued by several distinguished economists seems to me by far the most convenient: first, by typical illustrations to show how, under certain definite assumptions, price is and must be determined, and then to separate the accidental surroundings of the illustration from what is universal and typical, and formulate the latter into laws. I shall begin with the simplest typical case, the determination of price in isolated exchange between a single pair of exchangers.

Book IV, Chapter II

Isolated Exchange

A peasant, whom we shall call A, requires a horse. His individual circumstances are such that he attaches the same value to the possession of the horse as he does to the possession of £30. A neighbour, whom we shall call B, has a horse for sale. If B's circumstances also are such that he considers the possession of the horse worth as much as, or worth more than £30, there can, as we saw, be no exchange between them. Suppose, however, that B values his horse at considerably less, say at £10. What will happen?

First, it is certain that there will be an exchange; in the assumed circumstances each of the contracting parties can make a considerable profit by the exchange. If, for instance, the horse changes hands at £20, A, who considers it worth £30, makes a profit of £10, and B, who gets £20 for an article worth only £10 to him, gets the same amount of profit. They will, therefore, in any case, according to the proposition "rather a small gain than no exchange," agree on making an exchange at a price advantageous to both of them. The question now is: How high will this price go? As to this it may be said definitely: The price must at all events be less than £30, otherwise A would have no economical advantage, and would have no motive for going on with the exchange. And it must at all events be higher than £10, or there would be no use in the exchange to B, and perhaps even loss. But the particular point between £10 and £30 at which the price will be fixed cannot be determined beforehand with certainty. Any price between the two is, economically, possible; a price of £10:1s. or a price of £29:19s. Here, then, is room for any amount of " higgling." According as in the conduct of the transaction the buyer or the seller shows the greater dexterity, cunning, obstinacy, power of persuasion, or such-like, will the price be forced either to its lower or to its upper limit. If both parties have equal skill in bargaining, the price will be fixed approximately midway; that is to say, about £20.

There is no difficulty in putting this briefly in the form of a general proposition. In isolated exchange—exchange between one buyer and one seller—the price is determined somewhere between the subjective valuation of the commodity by the buyer as upper limit, and the subjective valuation by the seller as lower limit.

Book IV, Chapter III

One-Sided Competition

First: of one-sided competition of Buyers. Accommodating the conditions of our illustration to the requirements of the new typical case, let us assume that A₁ finds a competitor, whom we shall call A₂, already in the field, and that he also has the intention of purchasing the horse. The circumstances of this competitor are such that he counts the possession of the horse worth as much as £20. What will happen now? Each of the competitors wishes to buy the horse, but only one, of course, can buy him. Each of them wishes to be that one. Each, therefore, will try to persuade B to sell the horse to him, and the means of persuasion will be to bid a higher price. Thus ensues the familiar phenomenon of mutual overbidding. How long will this last? It will last till the rising bids have reached the valuation of the least capable competitor, who, in this case, is A₂. So long as the bids are under £20, A₂, acting on the motto "rather a small gain than no exchange," will try to secure the purchase by raising his offer, which attempt, naturally, A₁ acting on the same principle, will counteract by raising his offer. But A₂ cannot go beyond the limit of £20 without losing by the exchange. At this point his advantage dictates "better no exchange than a loss," and he leaves the field to his competitor.

This is not to say that the price A₁ pays must be just £20. It is possible that B, knowing A₁ to be in urgent want of a horse, will not be content with £20, and will try, by holding back and by skilful bargaining, to extort a price of £25, £28, or even £29:19s. The one thing certain is that the price cannot exceed £30 (the valuation of A₁ who concludes the purchase) and cannot be under £20 (the valuation of A₂, the excluded competitor).

Assume now that, in addition to A₁ and A₂, three other buyers, A₃, A₄, A₅, compete for the horse, and that their circumstances are such that they count the possession of the horse equivalent to £22, £25, and £28 respectively. It is easy to show, in the same way, that, in the ensuing competition, A₃ will bid to the limit of £22, A₄ to £25, and A₅ to £28; that the most capable competitor, A₁, will always be the successful one; and that the price will be fixed between £30 as higher limit, and £28—the valuation of the most capable of the excluded competitors—as lower limit.

The results of this investigation may therefore be expressed in the following general proposition:—

In one-sided competition of buyers—where there is one seller and more than one buyer—the most capable competitor will be the purchaser; that is, the one who puts the highest value on the commodity he wishes to buy in comparison with the good he wishes to sell; and the price will lie somewhere between the valuation of the purchaser as higher limit, and the valuation of the most capable among the unsuccessful competitors as lower limit—always understood that the price can in no case be lower than the subsidiary lower limit of the seller's own valuation. Comparing this proposition with the result arrived at under the former typical case, we see that competition of buyers has the effect of narrowing the sphere within which price is determined, and narrowing it in the upward direction. Between A and B the limits within which price was determined were £10 and £30; by the added competition the lower limit was moved up to £28.

Second: of one-sided competition of Sellers. This forms the exact converse of the foregoing. Entirely analogous tendencies lead to entirely analogous results—only in an opposite direction. The statement of this need not detain us long.

Suppose that our friend A is the only buyer, and that five dealers, whom we shall call B₁, B₂, B₃, B₄, and B₅, are competing to sell him a horse. We assume that all the horses are equally good, but B₁ values his horse at £10, B₂ values his at £12, B₃ at £15, B₄ at £20, and B₅ at £25. Each of the five rivals tries to utilise the present as the sole opportunity of sale, and endeavours to secure a preference over his competitors by underselling, as in the former case by overbidding. But as no one will care to offer his commodity for less than what it is worth to himself, B₅ will cease offering at £25, B₄ at £20, B₃ at £15; then B₁ and B₂ will compete for a while till, finally, at £12 B₂ finds himself "economically excluded,"6 and B₁ alone keeps the field. The price at which he remains a seller must necessarily be higher than £10—otherwise there would be no use in the exchange, and therefore no motive for it—but neither must it be higher than £12, otherwise B₂ will continue his competition.

In general terms, then, we have the following proposition. In one-sided competition of sellers—where there is one buyer and more than one seller—the most capable competitor will be the actual seller; that is, the one who puts the lowest value on the good he wishes to sell in comparison with the commodity he wishes to buy; and the price will lie somewhere between the valuation of the seller as lower limit, and the valuation of the most capable among the unsuccessful competitors as higher limit.7 Compared, therefore, with the case of isolated exchange, where, according to the first formula, the price had to lie between £10 and £30, the sphere within which price is determined will be narrowed by the competitions of sellers, and narrowed in the downward direction.

Book IV, Chapter IV

Two-Sided Competition

The case of two-sided competition is the most common in economic life, as it is the most important in the development of the Law of Price. It demands, therefore, our most careful attention.

The typical situation which the present case assumes may be represented by the following scheme. It shows us ten buyers and eight sellers, each of them wishing to buy or sell a horse, and it tells us at the same time the degree of the subjective valuation put upon the horse by each of the exchangers. It will be seen that the figures which represent these valuations are very different, and this exactly corresponds with facts. Indeed, the individual relations of want and provision for want, which regulate subjective value, are so very various that it would be difficult to find two persons who had an entirely similar opinion about the value of any one thing.

To complete the scheme, it must be added that all the competitors appear simultaneously in the one market; that all the horses offered for sale are of equal quality; and, finally, that the buyers and sellers make no mistake about the actual state of the market, such as would prevent them from really pursuing their own egoistic interests.8 We ask now, What will happen in this situation?

The circumstances of A₁ are such that he considers a horse to be worth £30 to him; it would therefore be to his advantage to buy even at £29; and it is quite certain that any of the eight sellers would be glad to sell him a horse at a price so advantageous to them. But, evidently, A₁ would be a very poor business man if he rashly bought at such a high price. For his self-interest demands from the exchange not merely a profit, but the greatest possible profit. Instead, then, of buying at the highest price—which, all the same, he might do in the worst possible case—he will prefer to begin by offering a price as low as his least capable rivals, and will only raise his offer when, and in the degree that, it is necessary to save himself from being shut out of the market.

In the same way B₁ who, economically, could quite well sell at a price of £11, and at that price could very easily find buyers, will carefully hold back from offering his horse at the lowest figure which he would accept, and will not reduce his price below what he must take if he is to keep his place in the competition. It may be assumed, then, that the transaction will begin with the buyers holding back and offering low prices, and with the sellers holding back and asking high prices.9

Suppose the buyers begin with an offer of £13. It is at once clear that—putting aside the case of gross error as to the condition of the market—the buying cannot be concluded at this price. For at £13 all the ten buyers would be willing to buy, since all of them put a greater value on the horse than £13; but, at that price, only two horses, those of B₁ and B₂, could (economically) be offered for sale. Now evidently B₁ and B₂ would be very poor sellers if they did not make use of the active competition of buyers to raise their price, and the others would be as poor buyers if they let the best chances of purchasing be snatched away by two of their members without attempting to obtain the preference by bidding a price somewhat higher, but still advantageous to themselves. Exactly, then, as in the case discussed in last chapter, the surplus buyers will be weeded out by means of mutual overbidding. How long will this weeding process go on?

At any price under £15 all ten buyers can compete. From that point the least capable competitors must, one after another, withdraw from the competition. At £15 A₁₀ is knocked out, at £17 A₉, at £18 A₈, at £20 A₇. But as the bids rise on the one side, the number of those sellers who, economically, become capable of selling increases on the other side. At any price above £15 B₃ may seriously think about selling, above £17 B₄ and above £20 B₅. Thus the marked disproportion, which existed at first between the horses demanded and the horses actually offered for sale, is gradually reduced. At £13 there was an effective demand for ten horses, and only two could, economically, be offered; while, at any price over £20, only six horses are demanded and five offered, the majority of buyers over sellers being thus reduced to one. So long, however, as the rival buyers are in the majority, and this fact is accurately known in the market, there can be no final settlement. For, on the one hand, the sellers have always the chance, and the temptation, to take advantage of the excess of buyers and stand out for higher prices; and, on the other hand, the mutually opposed interests of the rival buyers compel them to bid still higher against each other. Obviously, A₆ would scarcely consult his own interests if he were calmly to look on while his five rivals went off with the five cheapest horses, and left him no chance of an exchange, and, therefore, no chance of a profit.10 But, at the same time, no one of these rivals would allow A₆ to purchase one of the five horses most "strongly" offered for sale. For, if so, the man who withdrew in favour of A₆ might indeed purchase a horse, but only under less favourable conditions—the conditions, that is, offered by the most conservative sellers B₆, B₇, and B₈, and at a price which, at least, exceeds the subjective valuation of £21:10s. that B₆ puts on his horse. Thus if the buyers know their own interests, the whole body of them will feel impelled to continue their bidding against each above the level of £20.

Finally, the situation becomes essentially different when the rising bids have reached the limit of £21. At that price A₆ is compelled to cease bidding, and there are now only five sellers against five buyers. These buyers can all be satisfied simultaneously, and there is no occasion for further competition among themselves: on the contrary, as against the sellers, their common interest is to close at the lowest possible price. The bidding of buyers against each other, which hitherto has prevented the final settlement, now comes to an end, and the bargains may be concluded at the price of £21. But they need not be concluded at that price. The sellers may possibly be stiff and refuse £21, in hope of a still higher offer. What will happen in this case? First of all, the buyers, rather than have a fruitless errand and go away without making any exchange, will bid higher. But their limit is now very near at hand. If the sellers stand out for a price above £22, A₅ must give up all idea of purchase, and there will be five sellers against four buyers. One of the sellers, then, will have to fall out, and as no one would care to be that seller there will—from motives quite analogous to those which before prompted the surplus buyers to overbid each other—ensue a mutual underselling among the surplus sellers, till such time as the fifth seller meets a buyer: this will be the case somewhere under the limit of £22.11

Indeed, in the present case, the limit must go still lower. So long as a price over £21:10s. was possible; there would be a sixth possible seller in the person of B₆; this would give the sellers a majority of one over the five buyers, and compel them to offer under each other, if they are not to be shut out from the exchange. In this competition the weakest must first go to the wall, and this fate will overtake B₆ the moment that his rivals are content to take a price below the level of £21:10s.—at which figure the number of competitors on either side will be equalised, and the level of price found at which the competition may cease. Thus assuming, as we do in this illustration, that each competitor knows what is the condition of the market, and intelligently follows his own interests, the limits within which the price must necessarily be determined are narrowed to £21 and £21:10s.; those being the only limits within which there occurs the relation favourable to the final settlement—that all who are able to take a share in the business find it their advantage to do so, while all who do not find it their advantage, the unsuccessful competitors, have no power to prevent the others from coming to terms.12

Let us try now to apply the results of these lengthy analyses to our theory of price.

We notice, first, that what decides success in two-sided competition is, as in the case of one-sided competition, the degree of "capability" for exchange. On either side it is the most capable competitors who come to terms, namely, those buyers who put the highest value on the commodity (A₁ to A₅), and those sellers who put the lowest value (B₁ to B₅), while all less capable competitors are excluded. And, indeed, if we look more closely, we shall find that the series of successful competitors includes all competing pairs, arranged by capability, between whom there exists the relation necessary for exchange, viz. that the buyer considers the commodity worth more than the seller does. In our illustration A₅ considers B₅'s horse worth more than B₅ himself does, and, accordingly, they can exchange with each other.13 A₁, on the other hand, values the horse of B₁ at £21 only, while B₆ values it at £21:10s., and therefore they cannot come to terms—and still less can those competitors who are less capable.

Very closely related to the grounds on which are decided the successful competitors in the struggle of competition are, secondly, the grounds on which is decided the market price that results from this struggle. This price—to recur to our illustration—cannot, in any case, be higher than the valuation of A₅, nor less than that of B₅; otherwise the fifth buyer in the one case and the fifth seller in the other would not have come to terms. But, again, the price cannot in any case be higher than the valuation of B₆, nor less than that of A₆; otherwise in the former case a sixth buyer would begin competing with the other five buyers, and in the latter case a sixth seller competing with the other five sellers; the equilibrium would thus be destroyed, and the overbidding and under-offering would inevitably be continued till such time as the price was forced within the limits already indicated.

To put these results in general form:—In two-sided competition the market price is determined within a latitude of which the upper limit is constituted by the valuation of the last buyer who actually exchanges (the last buyer) and that of the most capable seller excluded (the first excluded seller), and the lower limit by the valuation of the least capable seller who actually effects a sale (the last seller) and that of the most capable buyer excluded (the first excluded buyer). The meaning of this double limitation is that, in every case, it is the narrower limit that decides.14 If, finally, we substitute the short and significant name of "Marginal Pairs" for the detailed description of the four parties whose competition determines the price, we get this very simple formula: The market price is limited and determined by the subjective valuations of the two Marginal Pairs.

This suggests a number of reflections.

The first thing that strikes us is the analogy between the formation of price and the formation of subjective value. We saw that the subjective value of any good, unaffected by the more important uses to which single members of the same stock might be put, was a "marginal value"—a value determined by the good's marginal utility, or that utility which stands on the very limit of the economically permissible. Now we see that every market price is a "marginal price"—a price determined by the economical relations of those competing pairs which, also, stand on the very limit of exchangeability. It is easy to see that the analogy here is no chance coincidence, but one that results from closely-related and internal causes. In the case of subjective valuation, the motive of economical advantage demanded that the available stock of goods should be employed in satisfying the wants that stood highest on each man's scale, the last of the wants thus supplied indicating the "marginal utility." In the case of the formation of price, the motive of the competitors' economical advantage demands that the pairs which are most capable on the scale of competitors should come to terms, and one of these again is the last, the "marginal pair." In the former case, the provision for all satisfactions more important than the marginal utility was assured without the particular good whose value was the subject of discussion, and the only utility dependent on this latter good was the last, the marginal utility. In the latter case, all the contracting pairs more capable than the marginal pairs may come to terms at prices higher or lower, and here again it is only the fate of the last, the marginal pair, that depends on the price just reaching a definite height, neither greater nor less. And, finally, as in the former case the importance of the last dependent want, in virtue of its dependent relation, gave the good its value, so, in the latter case, the economical circumstances of the last dependent pair—here also in virtue of their dependent relation—confer on the commodity its price.

But this analogy does not exhaust the connections between price and subjective value. Of still greater consequence is the fact that price, from beginning to end, is the product of subjective valuations. Look back over what we have said. It is the relation of the subjective valuation of commodity and price-equivalent which decides the persons who may consider it worth their while to compete, either as buyers or sellers; that is to say, decides which parties are "capable of exchange." It is the same relation which decides on the degree of each competitor's capability of exchange. With perfect exactness it decides for each man the figure at which his advantage calls him to join in the competition, and it decides, at the same time, the limit at which he is beaten and obliged to withdraw from it. As further result, it decides the parties who, among the most capable competitors, actually come to terms; it decides to which pair falls the rôle of being marginal pair; and, finally, it decides on the price at which the bargains are concluded in the market. Thus, as a fact, in the whole course of the formation of price—so far as it is conducted on purely egoistic principles—there is not a single phase nor feature which is not traceable, wholly and entirely, to the position of subjective valuations as its cause. And this is at bottom perfectly natural. For, as we know, these subjective valuations point out whether any importance, great or little, attaches to a good as regards our economic wellbeing, and how great the importance is; and, consequently, these valuations, wherever we acquire or part with goods solely with regard to our economic wellbeing, mark out the natural, indeed the only possible compass of our transactions. We are, therefore, fully justified in defining price as the resultant of subjective valuations put upon commodity and price-equivalent within a market.15

Of course it is a resultant of a peculiar kind. The amount of price is not the resultant of the sum, or of the average of all the valuations that come to the surface: in the formation of price these take very different shares. One class of them has no effect on price at all; viz. those valuations made by all the unsuccessful competitors except the most capable pair. It is all the same whether there are no such valuations, or whether there are scores of them in the market: they make not the slightest difference on the resultant price. In our illustration, whether there are unsuccessful buyers A₇ to A₁₀ or not, whether the category of the unsuccessful is composed of them alone, or of a hundred others besides,—so long as they cannot bid more than £20, it is easy to show that the resultant price will always run between £21 and £21:10s. The excluded competitors may increase the congestion of the market, but they are not factors in that condition of the market which determines the formation of price.16

A second group plays a very peculiar part in this resultant, viz. that consisting of the valuations of all the contracting parties who actually come to terms, exclusive of the last. What they do is simply to bind and neutralise each other. Recur again to our typical illustration. If we inquire what, for instance, the presence of A₁ contributes to the formation of price, we find that he takes up one member of the opposing series, namely, B₁, with the result that now the formation of price proceeds exactly as if neither A₁ nor B₁ were in the market. Similarly it is not difficult to see that the efficiency of A₂, A₃, and A₄ simply consists in cancelling the efficiency of B₂, B₃, and B₄: if they are in the competition the resultant price falls between £21 and £21:10s.; if they were all absent A₅ and B₅ would still make their exchange at a price between £21 and £21:10s. And it is worth emphasising that the degree of the subjective valuations made in this group is quite indifferent to the result. A₁, for instance, whose valuation, in our scheme, is put down at £30, would cancel B₁ not less thoroughly if his valuation amounted to only £25 or £22; and, conversely, suppose that his estimate were £200 or £2000, of this enormous amount absolutely nothing would affect the resultant price except the sum, in any case, absorbed in neutralising B₁.

If, however, the valuations of this group have no direct influence on the formation of price, it cannot be said that they are quite without effect. When the valuations of A₁ to A₄ cancel those of B₁ to B₄ they have a twofold result. First, they prevent any stronger seller than B₅ getting into the marginal pair which immediately determines the price. And second, they prevent the strongest sellers from cancelling the next strongest buyers—as they might do if not cancelled already—and they thus prevent any weaker member of the buying series than A₅ from getting into the marginal pair.17 The part played by all those exchanging pairs who are stronger or more capable than the last may therefore be accurately characterised in the following words: Their valuations contribute nothing directly to the formation of the resultant price, but they do indirectly, in so far as they neutralise each other, and thus reserve the rôle of marginal pair for another couple.

Finally, the real decision of price lies exclusively with a third group, and that a small one—the valuations of the two marginal pairs. All weaker competitors being, absolutely, without influence, and all stronger ones cancelling each other, they and they alone are the directly effective components, and the market price is their resultant.

At first sight it may appear strange that so few person, and those so little conspicuous, should decide the fate of the whole market, but on closer examination this will be found quite natural. If all are to exchange at one market price, the price must be such as to suit all exchanging parties; and since, naturally, the price which suits the least capable contracting party suits, in a higher degree, all the more capable, it follows, quite naturally, that the relations of the last pair whom the price must suit, or, as the case may be, the first pair whom it cannot suit, afford the standard for the height of price.18

Book IV, Chapter V

The Law of Supply and Demand

The zone within the limits of which the struggle of competition forces the formation of price is, as we have seen, characterised as lying between the subjective valuations of the marginal pairs, and on this characteristic feature we have formulated our law of price. But this zone has a second characteristic feature: it is that in which exactly as many commodities are offered for sale as are wanted to purchase;19 or, to use the common expressions, in which supply and demand are quantitatively in equilibrium. In our scheme, at a price which did not rise to £21 more horses were demanded than were offered; at a price which rose above £21:10s. more horses were offered than were demanded; while in the zone indicated by our law of marginal pairs—that between £21 and £21:10s.—the position requisite to end the competition was reached, and at that price exactly as many horses were asked as were offered.

Now, if it should be thought preferable, the formulation of the law of price may be based on this second characteristic feature, and it will then take the following shape: The market price is found in that zone in which supply and demand quantitatively balance each other. This formula is as correct as the other. It indicates the same zone in another way. But it is less expressive (1) in so far as it only points to the level of the determining zone in a roundabout way, while, by our formula, the limits of this zone are directly and positively indicated; (2) as it has to contend to some extent with the difficulty of having to use the expressions Supply and Demand,—for the protean ambiguity of these terms is sure to bring innumerable errors and misconceptions in their train, just as it has brought the terms themselves into thoroughly bad repute with many,20 Still, these drawbacks may very well be overcome by critical attention; and there is no objection, in my opinion, to treat the theory of price under the good old catchwords Supply and Demand, if care is only taken to avoid the errors and misunderstandings which so plentifully surround them, and to inform the old forms and formulas with new and clear knowledge.21

In one special case this second formulation of our law of price is even the more exact of the two. In the vast majority of cases, the zone within which supply and demand just balance each other exactly coincides with the zone whose limits are marked out by the valuations of the marginal pairs. But there is one quite definite coincidence of circumstances in which it may happen that the equilibrium between supply and demand does not make its appearance within the whole of the last-mentioned zone, but only within a distinctly narrower part of that zone; and, in such cases, the price is always fixed within these narrower limits. The very peculiar coincidence of circumstances which produces this result occurs very rarely indeed in economic life, but, among the cases where it does occur, there is one that is very important for the theoretical explanation of interest, and for that reason, in spite of its somewhat "exotic" character, I must devote a few words to it.

The casuistical conditions of this case are the following. First, there must be considerable latitude between the valuations of the marginal pairs. This condition is most thoroughly fulfilled where all the competing exchangers come to terms (there being, therefore, no excluded competitors), and when, at the same time, the buyers, as a body, value the commodity considerably higher than the sellers do. If there are, for instance, ten buyers who each value the commodity at £10, and ten sellers who each value it, subjectively, at £1, obviously all the ten pairs can come to terms, and the zone which lies between the valuations of the last buyer and the last seller represents the wide latitude between £1 and £10. Secondly, that this latitude should be narrowed down, the further circumstance must be present, that the desire of the buyers is directed to an unlimited number of goods, while, at the same time, the total amount of means of purchase must be strictly limited, and the buyers must be determined to spend the whole of this sum in purchase of the commodities in question—in the purchase of fewer goods if the price be high, in the purchase of a proportionately larger number of goods if the price be low. To put it in terms of our illustration. Say that each of the ten buyers is resolved to spend the sum of £100 in buying cotton goods; that is to say, at any price under £10 he will buy as many pieces as he can obtain for £100. And suppose that against this total competing demand of £1000 there is a supply of 200 goods, which their owners are inclined to let go at any price above £l. It is easy to see that the price must be fixed at £5 the piece. For if the price were to be less, say £4, the 200 pieces offered would be purchased for £800, and £200 of the available means of purchase would remain unemployed. Here the owners, acting on the motto "rather a small gain than no exchange," will continue bidding up against each other, and so raise the price to £5, at which figure the whole capital of £1000 finds employment. If, on the other hand, the price were to be put still higher, say £8, only 125 pieces of cotton goods could be bought with the £1000 available, and 75 would remain unsold. Now, obviously, no seller (considering that the price remains profitable to him till it is brought down as low as £1) would willingly forego taking part in the exchange, and thus the sellers, in fear of being shut out, would offer below each other, and the price would be pressed down to the equilibrium point of £5. Inside the wider zone, then, of £1 to £10—that determined by the valuations of the marginal pairs—the necessity for equilibrium between supply and demand determines the price with much more exactitude, and fixes it at £5, that being the point at which, if the competitors follow their own interests without let or hindrance, the market price must be fixed.

As we have already said, the extremely peculiar coincidence of circumstances necessary to this result occurs very seldom, but, as it happens, the cases where it does occur are very notable. One of these is the formation of the price of Money—which, however, does not concern us here.22 A second is the formation of price in the Labour market, and this is the case which we shall have to take up later on, on account of its close connection with the origin and height of Interest. It should, however, be carefully noted that, even in these two cases, the conditions under which this special form of the law of price appears are seldom met with in economic life in entire isolation. Thus the practical importance of such cases is still further diminished, and, if the recognition of them cannot well be ignored in the course of any theoretical exposition, still, as regards the infinite majority of cases, the first formulation of the law of price—that which determines the height of price by the subjective valuations of the marginal pairs—may be relied on with perfect confidence. This formulation is always correct, and, for the infinite majority of cases, is sufficiently exact. Moreover, without losing its practical usefulness in the majority of cases, it permits of being still further simplified. Before going on to this, however, some other explanations are necessary.

Book IV, Chapter VI

The Individual Determinants of Price

In the chapter before last we saw that price is determined at a level fixed by the valuations of the marginal pairs. We have still to ask, What are the circumstances which determine whether this level itself is high or low?

The first few steps in the answer are very easy. It is clear at a glance that the two things which must have the decisive influence on the position of the marginal pairs are the number and the intensity of the desires or valuations on both sides. In this way. The level of the valuation of the marginal pairs will tend to be high when, on the side of the buyers, there are very high valuations, and, relatively, a great many of them, and when, on the side of the sellers, the low valuations are relatively few. For, in this case, the few low valuations of the sellers will be cancelled by a portion of the more numerous high valuations of the buyers, and since, after this is done, there are still buyers with a high valuation, while at the same time the only remaining sellers also have a high valuation, the marginal pairs on both sides are composed of persons with high valuations. On quite analogous grounds the level of the valuation of the marginal pairs will tend to be low when, on the side of the buyers, there are (relatively) few high valuations, and on the side of the sellers there are (relatively) many low valuations.

If we single out the individual factors from the combined action of which, as we have shown, the valuation level of the marginal pairs results, we get the following individual determinants of price:23 —

• 1. The number of desires directed towards the commodity (Extent of Demand).
• 2. The figures which the buyers put upon their valuations (Intensity of Demand).

The latter, however, is not a simple matter. The figures in which valuations are expressed are in no wise simple expressions of the absolute amount of subjective value which the commodity has for the valuer. They only express a relation obtained by comparing two different valuations—that of the commodity and that of the equivalent price. When we said in our scheme that A values a horse at £30, that is not to say or prove anything of the absolute importance of a horse to A's wellbeing; all that it expresses is the relation in which the value of the horse to A stands to the value of the money to A. It simply says that A values the horse thirty times more highly than he values one pound sterling. If, therefore, we wish—and this is the task in which we are at present engaged—to lay down the elementary factors in the formation of price, we must put down, instead of the combined amounts which make up the figures of our valuation, the elements out of which they are combined. These elements are two—first, the absolute amount of subjective value which the commodity has for the valuer; and second, the absolute amount of the subjective value which the unit of the equivalent price has for the valuer. And, indeed, they obviously work towards combination in this sense, that the figures are high in direct ratio to the absolute value of the commodity, and in inverse ratio to that of the equivalent, and vice versâ.

Thus, in our scheme of the determinants of price, instead of the valuation figures, we have to lay down as the determinants of these figures—

• (a) The subjective valuation of the commodity by the buyers (which itself, again, according to the law of marginal utility already laid down, depends on the relation of wants and provision for want); and
• (b) The subjective valuation of the equivalent price by the buyers. Since, under present conditions, it is money that mostly serves as equivalent, and since, as we saw in a former chapter, the unit of money has a smaller subjective value for the rich than for the poor, it is, in the last instance, the standard of comfort of the buyers which has the preponderating influence on the formation of this determinant.24

Continuing our enumeration we have—

• 3. The number in which goods are offered for sale (Extent of Supply).
• 4. The figures which the sellers put upon their valuations (Intensity of Supply).

As in the former case, this latter determinant may be split up into two simpler factors—

• (a) The subjective valuations of the commodity by the sellers.
• (b) The subjective valuations of the equivalent price by the sellers.

These two find their own further determination according to the law of marginal utility. But frequently this leads to a very noteworthy peculiarity. In the present condition of industry most sales are made by men who are producers and merchants by profession, and who hold an amount of their commodities entirely beyond any needs of their own. Consequently, for them the subjective use-value25 of their own wares is, for the most part, very nearly nil; and the figure which they put on their valuation (in which the subjective use-value is the standard element) also sinks almost to zero. Finally comes the result that, in such sales, the limiting effect which, according to our theoretical formula, would be exerted by the valuation of the last seller, practically does not come into play, and price is actually limited and determined by the valuations of the buyers alone. In other words: when goods are once produced, and the owner can do nothing with them for his own personal wants, they must, all the same, seek a market. To find this market the seller must, in the usual way, put his goods at a price low enough to find buyers for the whole stock he offers for sale. In the case of a stock of 1000 pieces, for instance, he will find his market at a price which is somewhat less than the valuation of the thousandth buyer, and somewhat higher than the valuation of the thousand and first. If, now, the relations of production and sale are normal, the whole stock offered will, almost invariably, be taken off by the demand at a price which is far above the minimum use-value of the commodity to the sellers, and which, beyond the full amount of costs, brings them a business profit. If the circumstances, however, are unfavourable, it may well happen that the seller must seek for his market at considerably lower levels of demand, and be content to take prices which show a loss when compared with costs of production. But, as a rule, even those forced prices are still above the subjective use-value of the commodity to the seller, and the function of this subjective use-value, as lower limit of price, does not come into operation. It is only if the price should sink almost to zero that it would be checked in its descent by this latter limit, the valuation of the seller, finally coming into play. But it can scarcely ever come to this: in almost all cases the competition of buyers is sufficient of itself to stop the downward movement at a higher point on the scale. Thus, in regard to the prices actually established within a large and organised market, the law of price undergoes a great simplification. Of the four valuations which, as "valuations of the two marginal pairs," limit the zone within which price is determined, the valuations of the seller, for the reasons mentioned above, fall out altogether. But, if the buyers are very numerous, the interval between the figures which two successive buyers put on their valuation is so small, that the zone limited by the figure of the last buyer and that of the first unsuccessful competitor, is narrowed almost to a point. And so far as this is the case it may be asserted, with sufficient exactness, of the economic exchange which goes on in large markets, that the market price is determined by the Valuation of the Last Buyer.26

Book IV, Chapter VII

The Law of Costs

In the sphere of price, as in the theory of subjective value, we find a law firmly rooted in economic literature and accredited by common experience. It tells us that the market price of goods reproducible at will tends to equalise itself, in the long-run, with Costs of Production. The following perfectly valid line of argument is usually adduced in proof of this. The market price of goods reproducible at will cannot, in the long-run, be maintained either much above or much below their cost. If at any time the price of an article rises appreciably above the cost, its production will be particularly profitable to the undertakers. This will not only induce the latter to extend their already flourishing businesses, but will encourage new undertakers to enter the same remunerative branch of industry. Thus the amount of product brought to market will be increased, and finally—according to the law of supply and demand—a fall in price will ensue. If, conversely, at any time the market price falls below costs, continued production will show a loss; many undertakers will reduce their output; the supply of the commodities will be reduced; and this, finally, in virtue of the law of supply and demand, must lead to a raising of the market price.

Round this law of costs has gathered a great mass of theoretical detail,27 which may, for our purposes, be left entirely on one side. Our whole interest is centred in the question as to the position which the law, so well accredited by experience, takes in the systematic theory of price. Does it run counter to our law of marginal pairs or not?

Our answer is that it does not. It is as little of a contradiction as we before found to exist between the proposition that the marginal utility determines the height of subjective value, and the other proposition that the costs determine it. The line of thought which, in both cases, leads to the solution of the apparent contradiction is the same, feature for feature; except that, in the present case, in virtue of the intervention of exchange,—in virtue, that is, of the translation of the phenomena out of individual economy into social economy,—there appear richer developments at every station on the line of thought.

In what follows I shall try, as briefly and clearly as possible, to describe the concatenation between Value, Price, and Costs; and I think I am not exaggerating when I say that, to understand clearly this connection, is to understand clearly the better part of Political Economy.

The formation of value and price takes its start from the subjective valuations put upon finished products by their consumers. These valuations determine the demand for those products. As supply, over against this demand, stand, in the first instance, the stocks of finished commodities held by producers. The point of intersection of the two-sided valuations, the valuation of the marginal pairs, determines, as we know, the price, and, of course, determines the price of each kind of product separately. Thus, for instance, the price of iron rails is determined by the relation of supply and demand for rails; the price of nails, by the relation of supply and demand for nails; and, similarly, the price of every other product made out of the productive good iron—such as spades, ploughshares, hammers, sheet-iron, boilers, machines, etc.—is determined by the relation between the supply and demand which obtains for these special kinds of products. To make this perfectly clear, let us assume that the relations between requirements and stocks of the various iron products—and, accordingly, their prices to begin with—are very various; that the price of a quantum of commodity which can be made out of one and the same unit of productive material28 —for instance, from a cwt. of iron—varies from 2s. for the cheapest to 20s. for the dearest class of products. These prices are the result of the position of the market at the moment, and we have first assumed that the stocks of products (the supply) are a given quantity. But they are only for the moment a given quantity. As time goes on, they are always getting supplemented from production, and this makes them a variable quantity. Let us follow the circumstances of this production. For the manufacture of iron fabrics producers, of course, require iron.29 Under the system of division of labour they must buy this in the iron market. The manufacturers represent this demand for iron. As regards the extent of the demand, it is clear that every producer will buy as much iron as he requires to produce that amount of the commodity which he may expect to sell among his customers. But how will it be as regards the intensity of the demand? Obviously no producer will give more for the cwt. of iron than he can get for it30 from his own customers in the shape of price; but, up to this point, even in the worst case, he can and will compete rather than let his production come to a standstill for want of raw material. The manufacturer, therefore, who can profitably employ the cwt. of iron if he gets 20s. from his customers will be a buyer in the iron market up to the price of 20s. as maximum; he who can profitably employ the cwt. of iron at 16s. will, naturally, not buy at a price over 16s., and so on. In this way the market price which each producer of iron wares gets for his particular wares (or the share of the market price which falls to iron according to the law of complementary goods) furnishes him with the concrete valuation which he has in his mind when joining in the demand for iron.

The supply, which stands over against this demand, consists of the stocks of iron held by the mine-owners and ironmasters. These stocks will pass, in methods familiar to us, into the possession of the most capable buyers, and at a price which, approximately, corresponds to the valuation of the last buyer.31 Suppose the stocks of iron are sufficient to meet the demand of all those buyers who value iron from 20s. down to 6s. per cwt., the valuation of the last buyer, and thus the market price of the iron, will stand at 6s.

And now we have to consider the causal connection which has ended in this price. It runs, in the clearest possible way, in an unbroken chain from value and price of products to value and price of costs—from iron wares to raw iron, and not conversely. The links in the chain are these. The valuation which consumers subjectively put upon iron products forms the first link. This helps, next, to determine the figures of the valuation—the money price at which consumers can take part in the demand for iron products. These prices, then, determine, in methods with which we are now familiar, the resultant price of iron products in the market for such products. This resultant price, again, indicates to the producers the (exchange) valuation which they in turn may attach to the productive material iron, and thus the figure at which they may enter the market as buyers of iron. From their figures, finally, results the market price of iron.

But still another and very important connection may be gathered from all this. It is that here we have simply the great law of marginal utility fulfilling itself. According to that law the available stock of goods is, successively, conducted into the most remunerative employments—put to the most advantageous uses,—and the last use to which the goods are put determines their value. In any individual economy the most remunerative uses are seen to be those which express the most urgent subjective wants, and the value which emerges, as result of these individual relations, is purely personal subjective value. In the more extended sphere of a market, on the other hand, everything is referred, no longer directly to subjective wants, but to those wants as mediated by money—money being, as it were, the neutral common denomination for wants and feelings of various subjects which are not immediately commensurable. Here emerge, as the most remunerative employments, not those which express the wants absolutely most urgent, but those which are represented by the highest money valuation; that is, the best paying employments;32 and the value which results is objective exchange value. Thus it is, first of all, with iron products. In their respective markets they pass to the best paying buyers, and the price which expresses the valuation of the last buyer determines their market value and price. But so it is also, in the second place, in a slightly roundabout way, with the "cost good," iron, itself. In the iron market it goes to the best paying producers, and the valuation of the last of these determines its price. But here the producers are simply mediators. In their conducting of the iron to the best paying consumers, the stock of iron really passes successively to the most remunerative forms of consumption, and the last of these forms provided for determines—through the valuation named by the last producer who enters the market as buyer—the market price of the cost good, iron. It is not this cost good, then, that dictates its fixed price to the products that proceed from it; on the contrary, it receives its own price by the medium of the price of its products, in conformity with the great law of marginal utility, according to which the available stock is forced into the most remunerative employments, and receives its price from the money valuations of the last of these.

But connected with this is a series of subsequent phenomena, which, obviously, have given rise to the opinion that costs exert a causal influence on the price of products. So long as the price of various products made from iron varies between 20s. and 2s., while the price of the unit of iron stands at 6s., it is an evidence that the economical principle which should guide the stocks of iron into the most remunerative employments is not fully carried out. Iron is being used in employments where the products fetch only 2s. or 3s., where, accordingly, the use is less than the "last" economically permissible; and, on the other hand, there are still numerous employments unprovided for, where the products would obtain a greater value than 6s. If, for instance, the market price of an iron product stands at 20s., it is a proof that only those consumers of that product who value it at 20s. and upwards are actually purchasing, while other consumers, whose valuations range from 18s. down to 6s., are not supplied in the market. Similarly with products whose market price stands at 16s.; there will be an unsatisfied layer of demand, with a use for the product corresponding to the prices 14s. down to 6s., and so on. Now this must be corrected—and the enterprise of undertakers will usually not be long in supplying the needed correction. The production of those iron wares, the price of which still stands above 6s., will, under the inducement of the premium offered by the difference between price and cost, be increased till all those employments where the utility is greater than the amount of 6s. are supplied. Of course this increase of supply has the effect of always reducing the level in which the "last" buyer is found, and thus the market price sinks, till such time as the money valuation of the last buyer, and with it the market price, comes to the normal level of 6s. Conversely, where iron has been put to employments whose products fetch less than 6s., the loss that ensues will prevent more iron being thus employed. This will be brought about by a temporary suspension or limitation of the production of those iron wares, the market price of which is under 6s. This limitation of supply will soon have the effect of raising the price to 6s., and now, as the state of the case demands, the commodity, iron, will only be attainable by those buyers who can use it to make products that will fetch at least 6s. Thus, from above and from below, all iron products come together at the price of 6s., the amount of their costs; but, quite evidently, the cause of this is not that the cost good, iron, can force its own arbitrary fixed price on its products, but that all the products involved, including the cost good, iron, conform to the law of marginal utility, find their way successively into the most remunerative employments, and together receive their price as regulated by the last of these.33

Empirical proofs of this may be had in abundance. It is a very well known fact that active building of railways raises the price of rails, and, through this, the price of iron; that the present strong demand for copper wire in electric lighting puts up the price of copper. In these cases it is evident that the upward movement of price takes its start from the final products, and is transferred from these to the cost goods. But the objection will probably suggest itself to many readers, that there are also cases where the movement of price is from costs to products. The stocks of iron, for instance, of which we have been speaking in our illustration, are not a fixed amount, but are smaller or greater according to the circumstances of iron production. Now if there is an extension of this production, and the supply of iron increases, its price will certainly fall, and that from causes peculiar to the iron; and this fall in prices will drag down the price of iron wares. Does the causal connection here not run from costs to price of products?

To answer this objection we have only to carry the concatenation, of which we have hitherto examined only a few links, back to its beginning. It is quite correct to say that stocks of iron are not a fixed amount, but the varying result of a production which is capable of being extended or limited at will. For the production of iron two things are necessary,—mines, and (to put it shortly) direct and indirect labour. The mines are a given quantity, and cannot be devoted to the production of anything but iron. On the other hand, the quantity of labour available as a whole for economical employment, is an amount given and limited by the current state of population, but this is not the case with that particular labour which is employed in the production of iron. Labour is a productive power capable of being employed in any number of ways, and all the branches of production carried on in the community compete for it. Who or what, now, is it that decides what exact proportion of the original productive powers at the disposal of industry, namely labour and uses of land, is employed in the production of iron, and who and what is it that decides on the value and price of the unit of those productive powers?

Here, then, for the last time, is repeated, in the elements of all economy, the movement which we saw in the case of final products and intermediate products. The original productive powers of the nation force themselves into the most remunerative employments one after another, and receive their value and price from the last of these. As little as, perhaps even less than, any other good have they any a priori fixed value: they receive it only from the opportunities of employment. Whether the day's work is worth 2s. or 6s. depends on the worth of the product which can be turned out in the day's work, and, indeed, on the "last" product—the one worst paid—for the production of which there is still enough labour of the necessary quality left, after all the better paid employments have been supplied.

Production may be compared to a giant pump. Every branch of want has its separate pipe sunk down to the great reservoir of the original productive powers, and competes with all the other branches of want in trying to draw its supply by suction from that reservoir. Every branch has a different power of suction, the power increasing with the number and the remunerativeness (that is to say, in the case of organised exchange, the money value) of the employments it embraces. In the nature of the suction pipes, too, there is a difference. Many are quite simple: others have independent intermediate lengths, that convey the pressure that comes from the want, as it were, by stages; and, in correspondence with that, the productive powers which supply the want are raised by stages.

The simile extends still further. Such wants as demand personal services for their satisfaction, attract labour quite directly, according to the payment which they can and will give for them. Such wants, again, as demand material goods for their satisfaction, get these supplied, first, by payment of a market price which is remunerative in itself, and then the remunerative price of the products must attract the productive powers to their manufacture. Sometimes this is done through one or two, sometimes through twenty or thirty, members. In our illustration, human demand asked and paid for iron wares: the market price of iron wares attracted people to the purchase of iron: the price of iron, finally, attracted the original productive powers to the production of iron. In the case of other consumption goods, the number of intermediate members, or, to keep to the terms of our comparison, the number of intermediate lengths in the suction pipe, may be double or twenty times as great. But the principle of the movement, and what chiefly interests us, the result, is always the same. Whether there are many or few intermediate members may hasten or hinder the result, but it cannot weaken or strengthen it; in the end every want, according to the power expressed by its money valuation, draws to itself, mediately or immediately, the productive powers required for its supply. To supply the wants of the rich innumerable productive powers are always active, even if, simultaneously, at other points of the economy, there is want both of men and goods. The reason of this is that the high figures, which the rich are able to offer for the satisfaction of their wants, never fail to exert and continue their attractive force through all the stages of production, right down to the reservoir of the original productive powers.

Thus all human wants exert, as it were, a suction power indicated by the figures of their valuation. Now, that layer of wants which is willing and able to pay, say, 20s. and upwards, for the day's work devoted (mediately or immediately) to its satisfaction, is soon entirely provided for. After it those layers, in succession, draw supply to themselves which can and will pay the day's labour with 18s., 16s., 14s., and 12s., even down to 10s., 8s., 6s., and 4s. If, at the limit of 4s., the entire stock of original powers is required and is taken, this decides two things:—All wants which will not, or cannot, pay the day's labour devoted to their service at 4s., remain unsupplied; and the market price of the day's labour will stand at the figure of the last buyer, namely, 4s. But if, as we may rather assume, the available quantity of labour is greater than this, the wants of still lower levels may be supplied. The last needs—mediate or immediate—which are supplied may be those that pay the day's labour at 2s. only; and, in conformity, the market price of labour also will be fixed at this lower figure of 2s. And, indeed, this market price will be a general one: the uppermost layer will not be paid 20s., and the lowest layer 2s. for the same work or the same commodity: the market price will be the same for all buyers.

And now we come in sight of the answer to the doubt suggested by our former illustration. Suppose that the price of the day's labour is 2s., and the price of a cwt. of iron, which takes three days to produce, is 6s. Suppose now that, all of a sudden, new and productive mines are opened, or some great improvement in process discovered, which makes it possible to produce the cwt. of iron in two days' labour. What is the consequence? So long as the iron and its products maintain the old price of 6s., only those wants in the department of iron wares are supplied which are able and willing to pay 6s. for two days' work; that is, to pay the day's labour at the rate of 3s., while all round, in all other departments of want and branches of production, that layer of want is supplied which pays only 2s. for the day's labour. On economic principles—which are willingly carried out by undertakers of industry, who are always ready to seize the chance of a profit when offered them—those opportunities of employment which pay the day's work at more than 2s., and have hitherto been misapplied, will now be supplied: more original productive powers will, accordingly, be invested in the production of iron; and the supply of iron and iron products will be increased till such time as, here as elsewhere, that level of wants which is willing to pay the day's labour at 2s. is satisfied, and therefore the cwt. of iron, which costs two days' labour, fetches 4s. Parallel with this, of course, the price of iron and iron products34 goes down to the level of 4s. And all this is not in opposition to, but in real fulfilment of our law of Marginal Utility, of which the law of costs, rightly understood, is only a special expression suitable to a special group of phenomena.

If—what is practically inconceivable—production were carried on in ideal circumstances, unfettered by limitations of place and time, with no friction, with the most perfect knowledge of the position of human wants requiring satisfaction, and without any disturbing changes of wants, stocks, or technique, then the original productive powers would, with ideal and mathematical exactitude, be invested in the most remunerative employments, and the law of costs, so far as we can speak of such a law, would hold in ideal completeness. The complementary groups of goods from which, in the long-run, the finished good proceeds, would maintain exactly the same value and price at all stages of the process; the commodity would be exactly equal to its costs; these costs to their costs, and so on, back to the last original productive powers from which ultimately all goods come. But this ideal symmetry is traversed by two disturbing causes.

The first of these I may call by the general name of Friction. Almost invariably there is some hindrance, great or small, permanent or temporary, to the due investment of the original productive powers in the employments and forms of consumption which are the most remunerative at the time. In consequence the provision for wants, and likewise the prices, are somewhat unsymmetrical. Sometimes it is that individual branches of want are, relatively, more amply supplied than others; so that, for instance, in woollens, those wants are supplied which pay the day's labour indirectly at 1s. 8d. only, while it may be that, in copper goods, no wants are satisfied which cannot pay 3s. for a similar day's labour. But sometimes it may be that groups of productive materials, successively transformed till they are changed at last into the finished commodity, are not equally valued at all stages of the process. If we compare the means of production to a stream, we might say that the stream is not, as it should be, of equal breadth at all stages of its course: from some disturbing cause or other there may be dams at certain particular points, and leakages at others; and these cause an unsymmetrical divergence of price compared with the prices obtained at stages before and after, or, as it is usually conceived and expressed, a divergence of the price of a product (or intermediate product) from its costs. Thus it is, in our illustration of the iron, when production is suddenly cheapened from 6s. to 4s. As a consequence the production of iron is at first increased, and presses down the price of raw material, while the products of iron may still for some time maintain a price greater than their costs. But gradually the increase of supply presses forward to the later stages of production,—passes from the production of raw materials to the manufacture of final products,—and by reducing the price here also to 4s. restores the disturbed symmetry between price and costs.

In practical life such frictional disturbances are innumerable. At no moment and in no branch of production are they entirely absent. And thus it is that the Law of Costs is recognised as a law that is only approximately valid; a law riddled through and through with exceptions. These innumerable exceptions, small and great, are the inexhaustible source of the undertakers' profits, but also of the undertakers' losses.

The second disturbing cause is the Lapse of Time—the weeks, months, years which must stretch between the inception of the original productive powers, and the presentation of their finished and final product. The difference of time, in exerting a far-reaching influence on our valuation of goods, makes a normal difference between the value of the productive groups standing at different points of the production process through which they must all pass; and is, therefore, a difference to be kept quite distinct from the unsymmetrical divergences caused by frictional disturbances. It is this second disturbing cause which gives rise to Interest. Our further task will be to intercalate the theory of interest in its place within the value and price theory already outlined.

[1.]Menger, Grundsätze, p. 153. Of course now and then exchanges may be made simply to show some person a kindness; perhaps to conceal a present, or a charity in the guise of an exchange. But such cases form only a quite insignificant minority.

[2.]Grundzüge, part ii., in Conrad's Jahrbücher, vol. xiii. p. 486.

[3.]Grundzüge, p. 480.

[4.]It will be observed that our author does not confine the word Price to Money price, but applies it to the equivalent good or goods obtained in exchange for what is, pre-eminently, the good—the object of demand from buyers, and of supply from sellers. The convenient word Preisgut I render by "price equivalent," or simply "equivalent."—W. S.

[5.]Say, e.g., that A values his horse at five casks of wine, while B values it at fifteen, then, if the horse goes for ten casks, each gains an amount of value represented by five casks of wine. If A values the horse at eight and B values it at twelve, each gains only a value of two casks. Finally, if both agree in valuing the horse at twelve casks of wine, B, of course, would be glad to get the horse for ten casks, or for any price under twelve casks, but A, naturally, would not give it him at that price. See Menger, Grundsätze der Volkswirthschaftslehre, p. 155.

[6.]Menger, p. 183.

[7.]Always without prejudice to the second or subsidiary upper limit formed by the valuation of the buyer, which the price can in no case go beyond. Where there is anything like full competition of sellers, however, this is seldom of practical importance.

[8.]If, e.g., a buyer erroneously imagines the number of horses brought to market to be much less than it really is, it may very well happen that he hastily consents to pay a higher price than he would have found necessary if he had given better attention to his own interests. The influence of errors like this on the formation of price must not, of course, be overlooked in a theory of price, but where we are merely trying to bring out the simplest fundamental law it is not necessary to go into such details. See Grundzüge, as before, part ii. p. 486.

[9.]The more experienced both parties are, and the more familiar with the condition of the market, the shorter will be the time spent in "trying the market" by preliminary offers. In an old and well-organised market competitors will save themselves the trouble of making offers that are not meant to be taken, and will make their first offers at least somewhere near that zone within which the market price will finally be fixed. The extreme limit of this curtailment is given in the "fixed prices" of sellers. In this case, trying the market is entirely dispensed with, and sellers undertake at one throw, as it were, to hit the very zone into which the condition of the market will force the price. They must try to hit this zone quite exactly; for if they put the price lower they lose their profit, while if they put it higher the buyers in the market get supplied by other competitors, and the sellers are left with their commodities. Fixed prices, however, are less common in the open market than in shops, where selling is never conducted under the full pressure of competition, and where, consequently, any mistake in the price asked is not so hazardous.

[10.]If the horses of B1 to B5 are sold, the most capable seller remaining is B6, who values his horse at £21:10s—that is, higher than A6. As we know, then, an exchange between A6 and B6 is economically impossible, and the same is true a fortiori of the less capable sellers B7 and B8.

[11.]It need scarcely be said that the gradual bidding up of buyers, and the gradual undur-offering of sellers, do not usually take place in two separate and succeeding stages, but generally occur simultaneously.

[12.]In the nature of things the result shown in our abstract scheme will be the more exactly realised in practice, the better known the total condition of the market is to all interested; that is to say, the more organic the market, and the more publicly the negotiations are conducted. Where, on the other hand, as is usually the case, transactions are conducted in groups that are, indeed, in communication, but are yet somewhat separated from each other either in space or time, the relations of competition that would prevail over an entire market will, naturally, not be quite active in the single groups, and this has for result that the prices formed in the single groups are frequently only more or less approximate to the ideal market price represented in our scheme, without necessarily exactly coinciding with it.

[13.]Or with one of the more capable competitors, but in no case with a weaker one. See more exactly on this point in my Grundzüge, p, 499.

[14.]In our illustration it is the valuation of the excluded parties A6 and B6. If, however, the valuation of A6, instead of being £21, had been £19, and that of B6, instead of £21:10s., had been £23, the limits would have been determined by the valuation of the last pair who actually came to terms: the price would have been fixed between £20 and £22.

[15.]Sax, who, in his theory of value and price, stands wholly and entirely on the foundation laid by Menger, repeatedly and with emphasis characterises market price as an "average of individual values" (Theoretische Grundlegung der Staatswirthschaft, p. 276 and passim). This expression, if given without commentary, is exceedingly unfortunate, indeed directly misleading. As may be seen from what follows above (and more exactly from what I wrote in my Grundzüge, pp. 505 and, particularly, 522), the characteristic thing, on the contrary, as regards the resultant price, is that it is not an "average" in the usual sense of the word.

[16.]At least under the assumption distinctly made in our inquiry, that the competitors who appear in the market have a correct knowledge of the condition of the market. If we depart from this assumption, the appearance of more than a hundred demanders might give rise to the erroneous opinion that there may be among them a great many persons of higher "capability," and this might mislead the few capable competitors who are present into rashly making higher offers.

[17.]To show this, suppose we leave A1 to A4 out of our illustration. The position of the parties, then, is as follows:—

Here we see that the last pair within which the economical conditions of exchange are present consists of A8 and B4. The buyers, therefore, are now represented in the decisive marginal pair by a weaker member, the sellers by a stronger one. Accordingly the limit of price, which in the last case stood between £21 and £21:10s., moves down to between £17 and £18.

[18.]Students of economic literature will not fail to notice an interesting relation in which the above theory stands to certain doctrines that have for long obtained full recognition. When Thünen—and with him the whole body of economic doctrine—said that the rate of interest was determined by the productivity of the "portion of capital last applied," and the rate of wage by the return of the "last worker employed in the undertaking"; or when, much earlier, the question as to which, among several costs, regulates market price was decided in favour of the "highest costs of production that were still necessary to provide for the market," i.e. in favour of the "last seller,"—we recognise in all these, without difficulty, adaptations to special cases of the same principle on which we have built the doctrine of marginal utility and the theory of the formation of price. The only thing is that at that time economists were not yet conscious of the universal importance of these peculiar lines of thought. They meant simply to state a couple of special rules of limited range, while in reality they had hit upon the dominating Leitmotiv, which underlies the entire mechanism of industry carried on under the guidance of self-interest, and which, therefore, runs through the entire formation of value and price.

[19.]I need scarcely say in so many words that it is not the number of persons wishing to buy and sell on which the formation of price depends, but the mass of commodities desired and offered, and that in the typical scheme it is only for simplicity's sake that I have assumed each person to desire and offer for sale only one commodity, whereby number of persona and mass of commodities go pari passu.

[20.]See my Grundzüge, p. 525.

[21.]On the relation of the above theory of price to the old doctrine of Supply and Demand, as well as on the truth and error contained in that doctrine, I have already written at length in my Grundzüge, pp. 524-534; here it is sufficient to refer to that work.

[22.]Without being a blind adherent of the "Quantity theory," I believe that, along with other important circumstances, the quantity of money, the amount of the supply of money, exerts a powerful influence on its purchasing power. But the supply of money has exactly the peculiarity described in the text, that, rather than let money lie entirely unused, holders will be content with a comparatively unremunerative employment, and that, at the same time, the entire given quantity of money strives to realise itself in the purchase of an unlimited quantity of commodities—the more the better.

[23.]I should like to say that I here bring forward the theory of the determinants of price only in the briefest of epitomes, because the details of it have no immediate interest for the theory of capital. Any one interested in the theory of price as such, I would refer to the full statement in Conrad's Jahrbücher, vol. xiii. pp. 508-524.

[24.]The older theory was misled by this into substituting, for the determinant "subjective valuation of the equivalent price," the "ability to pay" of the buyers, which is not exactly false, but is very one-sided. See the more exact statement in Conrad's Jahrbücher, pp. 520, 527.

[25.]This, and not subjective exchange value, is the important thing for the formation of price. See the Grundzüge, p. 516.

[26.]This may be a suitable place to finish the analysis of Scharling's argument, which I began on p. 160. Scharling explains (Conrad's Jahrbücher, vol. xvi. p. 542) that in all essential respects he can agree with my theory of price; only, he says, it does not go far enough. My "determinants," and even the determinants of these determinants, do not go to the very root of the explanation; there is still something wanting; and this something, this Schlussstein or "element which, in the last resort, determines the conditions for an exchange," Scharling thinks that he has found in the "exertion (Anstrengung) which is spared the man who wishes... to obtain possession of a good by the fact that the good is transferred to him, in the case in question, by the other party in the exchange" (p. 551). If Scharling here were to mean by Anstrengung the toil of production which must otherwise be expended, directly or indirectly, for the acquisition of the good, his proposition would be positively false (see above, p. 160 in note), and this, indeed, Scharling himself seems to see and, indirectly at least, to admit (pp. 531, 554). But he goes on to give this expression a wider meaning. Under it he now embraces, among other things, the exertion which it costs to induce an owner to part with his commodity (p. 554), or "to meet competitors" (p. 558), or "to meet other suitors by overbidding" (p. 558), or "to overcome the indisposition of the owner to part with the good" (p. 558), and so on. "The right of the owner to possess the good," explains Scharling in the most significant passage of this kind, "is the last hindrance which stands in the way of the buyer's acquisition of the same, and this is now the thing to remove. The exertion which is required for this determines the value, the conditions for the exchange" (p. 558). Now, what kind of "exertion" is this? Scharling himself speaks of it more than once with all desirable plainness (e.g. p. 555, line 15; p. 558, lines 5, 16, etc.) It consists simply in the offering of a sufficiently high or higher price, in a bidding up or bidding higher. And now I ask: First, is there any justification, material or linguistic, for calling the offering of a price an "exertion," and, specially, for calling the offering of a price of £20 twice as great an exertion as offering a price of £10? Second, is the "exertion" which consists in offering the purchase price, e.g. at an auction, spared the purchaser, or must he not rather take the exertion on himself if he is to obtain the good? And, third and principally, is it explaining the formation of price, or going round about the explanation in a manifest circle, to account for the height of price by the amount of the exertion which the meeting of competition and the inducing of the owner cost, and then explain this exertion again as the offering of a sufficiently high or higher price? Is this not rather to say directly;—the price is high when and because much must be paid to get the good, and it is low in another case when and because but little need be paid? Who will be inclined to accept this as "der Weisheit letzen Schluss," as the long-sought-for coping-stone of the theory of price?—And now one more remark in case of misunderstanding. I am very far from denying that "difficulty of attainment" or "amount of toil of production" may, and very often actually does, afford one single important secondary determinant for the relation of want and provision for want, thereby for the height of marginal utility, and so, finally, for the amount of value. But this determinant only works in the way, and within the limits, which I have indicated in my theory (see in particular the statement of the "exceptional case," where the amount of a pain or strain averted determines the value of a good, Grundzüge, p. 42, and especially the statement of the influence of costs of production on value and price, p. 61; then pp. 521, 532, 534). On the other hand, the more extensive claim that Scharling puts forward with so much emphasis (vol. xvi. pp. 551, 552), that difficulty of attainment by itself alone is the last universal determinant and measure of value, I can only most emphatically reject.

[27.]Thus the question as to costs of production or costs of reproduction; whether, in the case of a variety of costs, it is the highest, the lowest, or an average cost that is to be taken as standard; what elements are to be reckoned among costs, and so on.

[28.]To simplify the matter, we shall omit for the moment the co-operation of any other complementary means of production.

[29.]Again, for simplicity's sake, I leave out the other requisites of production.

[30.]It must be remembered that here we are making abstraction of the co-operation of other complementary means of production, as Labour, Tools, Coal, etc. If otherwise, of course, recording to the principles laid down above (p. 170) on the value of complementary goods, we should have to put a portion of the value of the product to the account of the other co-operating goods, and assign only a quota of the product's value to the iron. But, in that case, exactly the same relations, as are shown in the text to exist between the value of iron and the full value of the product, would hold between the value of the iron and that quota of the product's value.

[31.]See above, p. 221.

[32.]That these two, unfortunately, are not usually the same I have shown at length in Conrad's Jahrbücher, pp. 510-513, when discussing the causes and effects of this fact.

[33.]It is possible that the amount of costs may itself be shifted—raised, for instance—by the process of correction just described. It may happen, that is to say, that in order to satisfy the demand, hitherto unsatisfied, which is desirous of buying iron products at a higher price than 6s., so much iron is taken out of the iron market that the stock is no longer sufficient for the demand that is willing to pay just 6s. This latter, then, will, of course, be shut out by the stronger competitors, and the market price settles at a higher figure than 6s.—another proof that costs are not the fixed point to which the price of products adapts itself, but vice versâ.

[34.]It must not be forgotten that we are simplifying the matter by leaving out of account the co-operation of other complementary goods in the production of iron products. If we were to take these into consideration, and assume, for instance, that, to change the iron into the iron product, the expenditure of other two days of immediate or mediate labour was necessary, then 8s., as the price of iron product, would correspond to 4s. as the price of iron, and of this, according to the law of complementary goods, 4s. would be reckoned to the productive good, iron, as its share.