Liberty Matters

Fetter on the Meaning of Price, Market, and Equilibrium

In his erudite essay on Fetter's contributions and relationship to the Austrian tradition, Matt McCaffrey points out an important but heretofore little-noted feature of Fetter's theoretical work, namely, that it was "motivated by two practical goals." These are, according to McCaffrey, "simplifying economic terminology and bringing economic definitions more in line with their common-language uses." This is my point of departure in this comment. I will argue that by rigorously defining a few basic terms in economics, Fetter clarified the foundations of the causal-realist approach to price theory pioneered by Menger.
What Is a Price?
Fetter (1915, 45-46) was keen to formulate a rigorous and realistic definition of price because "to understand the general nature of all price movements and the principles determining all prices ... is a large part of the task of economic study." Fetter (1915, 55) viewed the "price" to be explained by economic theory as "the actual price, which is the market price at that time and place." The actual price is therefore a brute fact of history, an event occurring at a specific moment in time as the outcome of interaction among specific persons. For Fetter (1912, 809), therefore, the definition of price "should be, as far as possible, objective and be expressed in terms of concrete experience."
In his pursuit of a realist definition of price, Fetter (1912) wrote a long article, entitled "The Definition of Price," in which he surveyed and classified 117 definitions of price presented by authors writing in English, German, and French. He began with Adam Smith's definition of price and extended his survey through the first decade of the 20th century. Fetter (1912, 809) dismissed five of the six classes of definitions that he identified because they failed to define price "in terms of the thing given in exchange, one of the most familiar, the most concrete, and the most simple facts in modern man's economic experience." Fetter (1912, 812) was especially adamant that price, even when expressed in monetary units, was not an abstract quantity or ratio without reference to real things, insisting:
[I]t is necessary to indicate in concrete terms in every case ... the kind and quantity of goods comprising price.... No abstract quantitative expression of price has any meaning. The price is so many or so much—what? and for what measure? Wheat is so many cents per bushel, cloth so many pence per yard.[8]
Fetter (1912, 812) thus concluded by endorsing Menger's realist definition of price:
Price is the quantity of goods given or received in exchange for another good. We can hardly improve upon Menger's wording: "Prices are the quantities of goods appearing in exchange": (though we might add) when viewed as payment for the goods against which they are exchanged.[9]
It is noteworthy that both Mises and Rothbard followed in the causal-realist Mengerian tradition of defining price as concrete quantities of goods actually exchanged. For Mises (1998, 390):
The market price is a real historical phenomenon, the quantitative ratio at which at a definite place and at a definite date two individuals exchanged definite quantities of two definite goods.
Rothbard (2009, 103, 234) formulated his definition so as to leave no doubt that "price" derived from the actual rate of exchange between two concrete goods:
If two cows exchange for 1,000 berries, then the price of the cow in terms of berries ... is 500 berries per cow.... The price is the rate of exchange [two cows for 1,000 berries] between two commodities expressed in terms of one of the commodities.... Now suppose, that in a money economy, three horses exchange for 15 ounces of gold (money). The money price of horses in this exchange is five ounces per horse. [Emphases in the original.]
What Is a Market?
For Fetter, a market cannot be defined without reference to the concept of price. Price and market are inextricably intertwined. The market refers essentially to the subjective factors that cause the coming into being of the objective phenomenon of price. As Fetter explained (1915, 60):
The very essence of the idea of the market is the meeting of minds in agreement on price. Within a group of buyers and sellers thus meeting, one price prevails at least for a moment.
Although they are cause and effect, market and price exist contemporaneously. Without a market there is no price and without a price there is no market. Just as market is the cause of price, so price is the proof of market. According to Fetter (1915, 59):
So far as there is truly a meeting of minds, all trades taking place at any one time are at the same ratio. It is the essential proof of a true market that there is but one price at any moment.
Fetter (1915, 58) emphasized that physical proximity of buyers and sellers is not a requirement of a market as long as they are all "in communication, so that there can be a common understanding between them." Furthermore, because each market is constituted by a "meeting of minds," a market, like its price, is a historical event that exists in time and has a beginning and an end. For Fetter (1915, 68), a temporal succession of different prices of a given good evinces not a changing market but a succession of different markets, comprising changed valuations, endowments of goods, and choices of market participants:
Price seems to be a continuous fact, altho [sic] there is properly speaking no continuous price: there is merely a succession of separate prices, as shown by the trades from moment to moment. We watch price change as in a moving picture made up of many instantaneous photographs.... Trade and succession of prices appearing are the index and the resultant of the continuous changes in the economic conditions, desires and choices of the members of the community.
These considerations led Fetter (1915, 59) to define "a complete or typical marketa group of closely communicating traders" as " whose valuations however diverse before they meet, unite for a moment into a single price (as regards the goods actually traded)." Thus, for Fetter, the "law of one price" is the logical implication of an actual market and not merely an equilibrating tendency.
Fetter addresses the concept of an "imperfect market" in which "different prices may exist at the same moment near each other." But this does not upset the law of one price. Fetter (1937a, 493-95; 1915, 60) attributes what he calls "the apparent non-uniformity of market prices" exclusively to cases of mistaken identity on the part of the observer. Retail, wholesale, and large jobbers' markets may be misidentified as a single market. Exchanges taking place at off-market prices may involve special favors or gifts. Physically identical goods for which non-uniform prices are paid may themselves be non-uniform, differentiated by locational convenience, sellers' reputation, customer service, etc. Finally sellers and buyers may temporarily lose communication with one another resulting in wildly divergent prices when "the market has all gone to pieces," as happens in the frenzy to liquidate assets during a financial panic.
A certain ambiguity, however, arises when Fetter (1915, 65) discusses "trading outside of the market." According to Fetter (1915, 66), if someone who, "failing to realize his possibilities," trades in isolation from the body of the market, then what we would today call a "false trade" may occur causing the "actual" market price to deviate from the "logical" or "theoretical" market price. But this does not contradict the tight logical nexus that Fetter establishes between a single price and a single market. For the fact that an individual, due to ignorance, fails to communicate with all but one other trader, means that he is not part of the momentary "meeting of the minds" that constitutes a complete market and determines the actual market price. Hence, it is irrelevant that he does not pay the same price as the "market price" or that the actual market price is different from a counterfactual theoretical market price that does include his valuations. As Fetter (1915, 66, fn. 5) himself pointed out, "when [the isolated exchange] occurs, there is immediately a new theoretical price," which presumably coincides with the actual market price under factual conditions. Fetter's strong version of the law of one price as the logical implication—rather than merely a tendency—of an actual market stands.  
What Is Equilibrium?
The concept of "economic equilibrium" for Fetter (1910, 133) is not just a property of the static state but "must be thought of as present in all dynamic societies." Fetter carefully distinguished among three meanings of the equilibrium. In the first sense, which concerns us here, equilibrium is not an imaginary construct but a real and observable state of rest, the inevitable outcome of the formation of a real market and a real price.[10] It is, wrote Fetter (1915, 67), "[t]he present market price, the equilibrium of buyers and sellers at the moment." By virtually identifying equilibrium with the market price, Fetter is here echoing Menger (1981, 192), who referred to "the prices of goods" as "the symptoms of an economic equilibrium in the distribution of possessions between the economies of individuals."
For Fetter (1910, 133) then:
Any price, no matter how temporary and unstable, is one that for the moment brings into equilibrium the quantities bought and sold, produced and wanted at that price.
The equilibrium price in this sense is thus the price that exhausts all gains from trade and brings about an end to the market in question and a momentary state of rest. As Fetter (1915, 66) explained, it is
that price common to all trades at a given moment, at which no less urgent bidder on either side of the market can trade while any more urgent bidder is excluded. Such a price brings the desires underlying demand and supply to an equilibrium; no buyer is willing to bid more and no seller is willing to take less.
In emphasizing the importance of this realistic concept of moment-to-moment equilibrium, Fetter was treading in the path pioneered by Menger and followed by succeeding generations of Austrians. Thus, Böhm-Bawerk (1959, 2: 231) dubbed this concept of exchange equilibrium "momentary equilibrium" and Mises (1998 241), "the plain state of rest." Menger (1981, 188) referred to "points of rest" where "no exchange of goods takes place because an economic limit to exchange has already been reached."
It is clear that Fetter's achievement in rigorously defining the concepts of price, market, and equilibrium and in elucidating their essential unity was based on and significantly advanced Menger's causal-realist approach to price. What is still in question and needs to be carefully investigated by doctrinal scholars is to what extent Fetter directly or indirectly influenced the price theory—aside from interest and rent theory—propounded in the works of Mises (1998), Rothbard (2009), and other modern Mengerian price theorists.[11] For this exciting new research program we have Matt McCaffrey to thank. 
[8.] Also see Fetter ( 1915, 45; 1937a, 482; )
[9.] However, Fetter's addition to Menger's definition in the passage above may not be necessary and may be due to Fetter's reading of the German. In the English-language edition of Principles (Menger 1981, 191) originally published in 1950, Menger's definition of price is rendered less ambiguously as "the quantities of goods actually exchanged." (Emphasis added.)
[10.] For Fetter (1910, 133-34), the second concept of equilibrium was akin to a Marshallian market-day equilibrium, what Fetter called "an abstractly conceivable normal market price, within a brief period, around which actual prices fluctuate in becoming adjusted to the underlying conditions of the period." Fetter (1937b, 517-18) referred to a third concept of equilibrium—like the second, also an imaginary construct—which depicted a long-run equilibrium of the economy as a whole:
A perfect equilibrium of valuations and of prices is a theoretical ideal, an abstraction never fully realized. It is an end toward which the forces of human desire and choice at each moment are always tending without ever fully attaining.... Each new total set of conditions involves a new theoretically correct equilibrium.
[11.] Rothbard (2009), for example, cites Fetter on leisure, cost, formation of equilibrium price, and monopoly-price theory.