Chapter 4—Prices and Consumption (continued)
6. Interrelations Among the
Prices of Consumers’ Goods
Thus, at any given point in time, the consumer is confronted with the previously existing money prices of the various consumers’ goods on the market. On the basis of his utility scale, he determines his rankings of various units of the several goods and of money, and these rankings determine how much money he will spend on each of the various goods. Specifically, he will spend money on each particular good until the marginal utility of adding a unit of the good ceases to be greater than the marginal utility that its money price on the market has for him. This is the law of consumer action in a market economy. As he spends money on a good, the marginal utility of the new units declines, while the marginal utility of the money forgone rises, until he ceases spending on that good. In those cases where the marginal utility of even one unit of a good is lower than the marginal utility of its money price, the individual will not buy any of that good.
In this way are determined the individual demand schedules for each good and, consequently, the aggregate market-demand schedules for all buyers. The position of the market-demand schedule determines what the market price will be in the immediate future. Thus, if we consider action as divided into periods consisting of “days,” then the individual buyers set their rankings and demand schedules on the basis of the prices existing at the end of day 1, and these demand schedules determine what the prices will be by the end of day 2.
The reader is now referred back to the discussion in chapter 2 above, sections 9 and 10. The analysis, there applied to barter conditions, applies to money prices as well. At the end of each day, the demand schedules (or rather, the total demand schedules) and the stock in existence on that day set the market equilibrium price for that day. In the money economy, these factors determine the money prices of the various goods during that day. The analysis of changes in the prices of a good, set forth in chapter 2, is directly applicable here. In the money economy, the most important markets are naturally continuous, as goods continue to be produced in each day. Changes in supply and demand schedules or changes in total demand schedules and quantity of stock have exactly the same directional effect as in barter. An increase in the market’s total demand schedule over the previous day tends to increase the money price for the day; an increase in stock available tends to lower the price, etc. As in barter, the stock of each good, at the end of each day, has been transferred into the hands of the most eager possessors.
Up to this point we have concentrated on the determination of the money price of each consumers’ good, without devoting much attention to the relations among these prices. The interrelationships should be clear, however. The available goods are ranked, along with the possibility of holding the money commodity in one’s cash balance, on each individual’s value scale. Then, in accordance with the rankings and the law of utility, the individual allocates his units of money to the most highly valued uses: the various consumers’ goods, investment in various factors, and addition to his cash balance. Let us here set aside the question of the distribution chosen between consumption and investment, and the question of addition to the cash balance, until later chapters, and consider the interrelations among the prices of consumers’ goods alone.
The law of the interrelation of consumers’ goods is: The more substitutes there are available for any given good, the more elastic will tend to be the demand schedules (individual and market) for that good. By the definition of “good,” two goods cannot be “perfect substitutes” for each other, since if consumers regarded two goods as completely identical, they would, by definition, be one good. All consumers’ goods are, on the other hand, partial substitutes for one another. When a man ranks in his value scale the myriad of goods available and balances the diminishing utilities of each, he is treating them all as partial substitutes for one another. A change in ranking for one good by necessity changes the rankings of all the other goods, since all the rankings are ordinal and relative. A higher price for one good (owing, say, to a decrease in stock produced) will tend to shift the demand of consumers from that to other consumers’ goods, and therefore their demand schedules will tend to increase. Conversely, an increased supply and a consequent lowering of price for a good will tend to shift consumer demand from other goods to this one and lower the demand schedules for the other goods (for some, of course, more than for others).
It is a mistake to suppose that only technologically similar goods are substitutes for one another. The more money consumers spend on pork, the less they have to spend on beef, or the more money they spend on travel, the less they have to spend on TV sets. Suppose that a reduction in its supply raises the price of pork on the market; it is clear that the quantity demanded, and the price, of beef will be affected by this change. If the demand schedule for pork is more than unitarily elastic in this range, then the higher price will cause less money to be spent on pork, and more money will tend to be shifted to such a substitute as beef. The demand schedules for beef will increase, and the price of beef will tend to rise. On the other hand, if the demand schedule for pork is inelastic, more consumers’ money will be spent on pork, and the result will be a fall in the demand schedule for beef and consequently in its price. Such interrelations of substitute goods, however, hold true in some degree for all goods, since all goods are substitutes for one another; for every good is engaged in competing for the consumers’ stock of money. Of course, some goods are “closer” substitutes than others, and the interrelations among them will be stronger than among the others. The closeness of the substitution depends, however, on the particular circumstances of the consumer and his preferences rather than on technological similarity.
Thus, consumers’ goods, in so far as they are substitutes for one another, are related as follows: When the stock of A rises and the price of A therefore falls, (1) if the demand schedule for A is elastic, there will be a tendency for a decline in the demand schedules for B, C, D, etc., and consequent declines in their prices; (2) if the demand schedule for A is inelastic, there will be a rise in the demand schedules for B, C, D, etc., and a consequent rise in their prices; (3) if the demand schedule has exactly neutral (or unitary) elasticity, so that there is no change in the amount of money expended on A, there will be no effect on the demands for and the prices of the other goods.
As the money economy develops and civilization flowers, there is a great expansion in the types of goods available and therefore in the number of goods that can be substituted for one another. Consequently, there is a tendency for the demands for the various consumers’ goods to become more elastic, although they will continue to vary from highly elastic to highly inelastic. In so far as the multiplication of substitutes tends to render demand curves for individual goods elastic, the first type of interaction will tend to predominate. Furthermore, when new types of goods are established on the market, these will clearly draw monetary demand away from other, substitute products, and hence bring about the first type of reaction.
The substitutive interrelations of consumers’ goods were cogently set forth in this passage by Philip Wicksteed:
It is sufficiently obvious that when a woman goes into the market uncertain whether she will or will not buy new potatoes, or chickens, the price at which she finds that she can get them may determine her either way. . . . For the price is the first and most obvious indication of the nature of the alternatives that she is foregoing, if she makes a contemplated purchase. But it is almost equally obvious that not only the price of these particular things, but the price of a number of other things also will affect the problem. If good, sound, old potatoes are to be had at a low price, the marketer will be less likely to pay a high price for new ones, because there is a good alternative to be had on good terms. . . . If the housewife is thinking of doing honour to a small party of neighbours by providing a couple of chickens for their entertainment at supper, it is possible that she could treat them with adequate respect, though not with distinction, by substituting a few pounds of cod. And in that case not only the price of chickens but the price of cod will tend to affect her choice. . . .
But on what does the significance . . . [of the price difference between chicken and cod] depend? Probably upon the price of things that have no obvious connection with either chicken or cod. A father and mother may have ambitions with respect to the education or accomplishments of their children, and may be willing considerably to curtail their expenditure on other things in order to gratify them. Such parents may be willing to incur . . . entertaining their guests less sumptuously than custom demands, and at the same time getting French or violin lessons for their children. In such cases the question whether to buy new or old potatoes, or whether to entertain friends with chicken or cod, or neither, may be affected by the terms on which French or music lessons of a satisfactory quality can be secured.
While all consumers’ goods compete with one another for consumer purchases, some goods are also complementary to one another. These are goods whose uses are closely linked together by consumers, so that movements in demand for them are likely to be closely tied together. An example of complementary consumers’ goods is golf clubs and golf balls, two goods the demands for which tend to rise and fall together. In this case, for example, an increase in the supply of golf balls will tend to cause a fall in their prices, which will tend to raise the demand schedule for golf clubs as well as to increase the quantity of golf balls demanded. This will tend to increase the price of golf clubs. In so far, then, as two goods are complementary to each other, when the stock of A rises, and the price of A therefore falls, the demand schedule for B increases and its price will tend to rise. Since a fall in the price of a good will always increase the quantity of the good demanded (by the law of demand), this will always stimulate the demand schedule for a complementary good and thus tend to raise its price. For this effect the elasticity of demand for the original good has no relevance.
Summing up these interrelations among consumers’ goods:
All goods are substitutable for one another, while fewer are complementary. When they are also complementary, then the complementary effect will be mixed with the substitutive effect, and the nature of each particular case will determine which effect will be the stronger.
This discussion of the interrelation of consumers’ goods has treated the effect only of changes from the stock, or supply, side. The effects are different when the change occurs in the demand schedule instead of in the quantity of stock. Suppose that the market-demand schedule for good A increases—shifts to the right. This means that, for every hypothetical price, the quantity of A bought, and therefore the amount of money spent on A, increases. But, given the supply (stock) of money in the society, this means that there will be decreases in the demand schedules for one or more other goods. More money spent on good A, given the stock of money, signifies that less money is spent on goods B, C, D . . . The demand curves for the latter goods “shift to the left,” and the prices of these goods fall. Therefore, the effect of the substitutability of all goods for one another is that an increased demand for A, resulting in a rise in the price of A, will lead to decreased demand schedules and falling prices for goods B, C, D . . . We can see this relation more fully when we realize that the demand schedules are determined by individual value scales and that a rise in the marginal utility of a unit of A necessarily means a relative fall in the utility of the other consumers’ goods.
In so far as two goods are complementary, another effect tends to occur. If there is an increase in the demand schedule for golf clubs, it is likely to be accompanied by an increase in the demand schedule for golf balls, since both are determined by increased relative desires to play golf. When changes come from the demand side, the prices of complementary goods tend to rise and fall together. In this case, we should not say that the rise in demand for A led to a rise in demand for its complement B, since both increases were due to an increased demand for the consumption “package” in which the two goods are intimately related.
We may now sum up both sets of interrelations of consumers’ goods, for changes in stock and in demand (suppliers’ reservation demand can be omitted here, since this speculative element tends toward correct estimates of the basic determinant, consumer demand).
Table 10 indicates the reactions of other goods, B, C, D, to changes in the determinants for good A, in so far as these goods are substitutable for it or complementary to it. A + sign signifies that the prices of the other goods react in the same direction as the price of good A; a – sign signifies that the prices of the other goods react in the opposite direction.
In some cases, an old stock of a good may be evaluated differently from the new and therefore may become a separate good. Thus, while well-stored old nails might be considered the same good as newly produced nails, an old Ford will not be considered the same as a new one. There will, however, definitely be a close relation between the two goods. If the supply schedule for the new Fords decreases and the price rises, consumers will tend to shift to the purchase of old Fords, tending to raise the price of the latter. Thus, old and new commodities, technologically similar, tend to be very close substitutes for each other, and their demands and prices tend to be closely related.
Much has been written in the economic literature of consumption theory on the “assumption” that each consumers’ good is desired quite independently of other goods. Actually, as we have seen, the desires for various goods are of necessity interdependent, since all are ranged on the consumers’ value scales. Utilities of each of the goods are relative to one another. These ranked values for goods and money permit the formation of individual, and then aggregate, demand schedules in money for each particular good.
Why does a man purchase a consumers’ good? As we saw back in chapter 1, a consumers’ good is desired and sought because the actor believes that it will serve to satisfy his urgently valued desires, that it will enable him to attain his valued ends. In other words, the good is valuable because of the expected services that it will provide. Tangible commodities, then, such as food, clothing, houses, etc., and intangible personal services, such as medical attention and concert performances, are similar in the life of the consumer. Both are evaluated by the consumer in terms of their services in providing him with satisfactions.
Every type of consumers’ good will yield a certain amount of services per unit of time. These may be called unit services. When they are exchangeable, these services may be sold individually. On the other hand, when a good is a physical commodity and is durable, it may be sold to the consumer in one piece, thereby embodying an expected future accrual of many unit services. What are the interrelations among the markets for, and prices of, the unit services and the durable good as a whole?
Other things being equal, it is obvious that a more durable good is more valuable than a less durable good, since it embodies more future unit services. Thus, suppose that there are two television sets, each identical in service to the viewer, but that A has an expected life of five years, and B of 10. Though the service is identical, B has twice as many services as A to offer the consumer. On the market, then, the price of B will tend to be twice the price of A.
For nondurable goods, the problem of the separate sale of the service of the good and of the good itself does not arise. Since they embody services over a relatively short span of time, they are almost always sold as a whole. Butter, eggs, Wheaties, etc., are sold as a whole, embodying all their services. Few would think of “renting” eggs. Personal services, on the other hand, are never sold as a whole, since, on the free market, slave contracts are not enforceable. Thus, no one can purchase a doctor or a lawyer or a pianist for life, to perform services at will with no further payment. Personal services, then, are always sold in their individual units.
The problem whether services should be sold separately or with the good as a whole arises in the case of durable commodities, such as houses, pianos, tuxedos, television sets, etc. We have seen that goods are sold, not as a total class, e.g., “bread” or “eggs,” but in separate homogeneous units of their supply, such as “loaves of bread,” or “dozens of eggs.” In the present discussion, a good can be sold either as a complete physical unit—a house, a television set, etc.—or in service units over a period of time. This sale of service units of a durable good is called renting or renting out or hiring out the good. The price of the service unit is called the rent.
Since the good itself is only a bundle of expected service units, it is proper to base our analysis on the service unit. It is clear that the demand for, and the price of, a service unit of a consumers’ good will be determined on exactly the same principles as those set forth in the preceding analysis of this chapter.
A durable consumers’ good embodies service units as they will accrue over a period of time. Thus, suppose that a house is expected to have a life of 20 years. Assume that a year’s rental of the house has a market price, as determined by the market supply and demand schedules, of 10 ounces of gold. Now, what will be the market price of the house itself should it be sold? Since the annual rental price is 10 ounces (and if this rental is expected to continue), the buyer of the house will obtain what amounts to 20 x 10, or 200 ounces, of prospective rental income. The price of the house as a whole will tend inexorably to equal the present value of the 200 ounces. Let us assume for convenience at this point that there is no phenomenon of time preference and that the present value of 200 ounces is therefore equal to 200 ounces. In that case, the price of the house as a whole will tend to equal 200 ounces.
Suppose that the market price of the house as a whole is 180 ounces. In that case, there will be a rush to buy the house, since there is an expected monetary profit to be gained by purchasing for 180 ounces and then renting out for a total income of 200 ounces. This action is similar to speculative purchasers’ buying a good and expecting to resell at a higher price. On the other hand, there will be a great reluctance by the present owners of such houses (or of the house, if there is no other house adjudged by the market as the same good), to sell at that price, since it is far more profitable to rent it out than to sell it. Thus, under these conditions, there will be a considerable excess of demand over supply of this type of house for sale, at a price of 180 ounces. The upbidding of the excess demand tends to raise the price toward 200. On the other hand, suppose that the market price is above 200. In that case, there will be a paucity of demand to purchase, since it would be cheaper to pay rental for it instead of paying the sum to purchase it. On the contrary, possessors will be eager to sell the house rather than rent it out, since the price for sale is better. The excess supply over demand at a price over 200 will drive the price down to the equilibrium point.
Thus, while every type of market price is determined as in the foregoing sections of this chapter, the market also determines price relations. We see that there is a definite relationship between the price of the unit services of a durable consumers’ good and the price of the good as a whole. If that relationship is disturbed or does not apply at any particular time, the actions of individuals on the market will tend to establish it, because prospects of monetary gain arise until it is established, and action to obtain such gain inevitably tends to eliminate the opportunity. This is a case of “arbitrage” in the same sense as the establishment of one price for a good on the market. If two prices for one good exist, people will tend to rush to purchase in the cheaper market and sell more of the good in the more expensive market, until the play of supply and demand on each market establishes an “equilibrium” price and eliminates the arbitrage opportunity. In the case of the durable good and its services, there is an equilibrium-price relation, which the market tends to establish. The market price of the good as a whole is equal to the present value of the sum of its expected (future) rental incomes or rental prices.
The expected future rental incomes are, of course, not necessarily a simple extrapolation of present rental prices. Indeed, since prices are always changing, it will almost always be the case that rental prices will change in the future. When a person buys a durable good, he is buying its services for a length of time extending into the future; hence, he is more concerned with future than with present rates; he merely takes the latter as a possible guide to the future. Now, suppose that the individuals on the market generally estimate that rents for this house over the next decade or so will be much lower than at present. The price of the house then will not be 20 x 10 ounces, but some correspondingly smaller amount.
At this point, we shall define the “price of the good as whole” as its capital value on the market, even though there is risk of confusion with the concept of “capital good.” The capital value of any good (be it consumers’ or capital good or nature-given factor) is the money price which, as a durable good, it presently sells for on the market. The concept applies to durable goods, embodying future services. The capital value of a consumers’ good will tend to equal the present value of the sum of expected unit rentals.
The capital value at any time is based on expectations of future rental prices. What happens when these expectations are erroneous? Suppose, for example, that the market expects the rental prices of this house to increase in the next few years and therefore sets the capital value higher than 200 ounces. Suppose, further, that the rental prices actually decline instead. This means that the original capital value on the market had overestimated the rental income from the house. Those who had sold the house at, say, 250, have gained, while those who bought the house in order to rent it out have lost on the transaction. Thus, those who have forecast better than their fellows gain, while the poorer forecasters lose, as a result of their speculative transactions.
It is obvious that such monetary profits come not simply from correct forecasting, but from forecasting more correctly than other individuals. If all the individuals had forecast correctly, then the original capital value would have been below 200, say, 150, to account for the eventually lower rental prices. In that case no such monetary profit would have appeared. It should be clear that the gains or losses are the consequences of the freely undertaken action of the gainers and losers themselves. The man who has bought a good to rent out at what proves to be an excessive capital value has only himself to blame for being overly-optimistic about the monetary return on his investment. The man who sells at a capital value higher than the eventual rental income is rewarded for his sagacity through decisions voluntarily taken by all parties. And since successful forecasters are, in effect, rewarded, and poor ones penalized, and in proportion to good and poor judgment respectively, the market tends to establish and maintain as high a quality of forecasting as is humanly possible to achieve.
The equilibrium relation between the capital value on the market and the sum of expected future rents is a day-to-day equilibrium that tends always to be set by the market. It is similar to the day-to-day market equilibrium price for a good set by supply and demand. On the other hand, the equilibrium relation between present capital value and actual future rents is only a long-range tendency fostered by the market’s encouragement of successful forecasters. This relation is a final equilibrium, similar to the final equilibrium prices that set the goal toward which the day-to-day prices tend.
Study of capital value and rental prices requires additional supply-demand analysis. The determination of the unit rental price presents no problem. Price determination of the capital value, however, needs to be modified to account for this dependence on, and relationship to, the rental price. The demand for the durable good will now be, not only for direct use, but also, on the part of others, demand for investment in future renting out. If a man feels that the market price of the capital value of a good is lower than the income he can obtain from future rentals, he will purchase the good and enter the renting-out market as a supplier. Similarly, the reserved demand for the good as a whole will be not only for direct use or for speculative price increases, but also for future renting out of the good. If the possessor of a durable good believes that the selling price (capital value) is lower than what he can get in rents, he will reserve the supply and rent out the good. The capital value of the good will be such as to clear the total stock, and the total of all these demands for the good will be in equilibrium. The reserved demand of the buyers will, as before, be due to their reserved demand for money, while the sellers of both the good as a whole and of its unit services will be demanding money in exchange.
In other words, for any consumers’ good, the possessors have the choice of either consuming it directly or selling it for money. In the case of durable consumers’ goods, the possessors can do any one of the following with the good: use it directly, sell it whole, or hire it out—selling its unit services over a period of time. We have already seen that if using it directly is highest on his value scale, then the man uses the good and reserves his stock from the market. If selling it whole is highest on his value scale, he enters the “capital” market for the good as a supplier. If renting it out is highest on his value scale, then he enters the “renting” market for the good as a supplier. Which of these latter alternatives will be higher on his value scale depends on his estimate of which course will yield him the higher money income. The shape of the supply curves in both the capital and rental markets will be either rightward- and upward-sloping or vertical, since the greater the expected income, the less will be the amount reserved for direct use. It is clear that the supply schedules on the two markets are interconnected. They will tend to come into equilibrium when the equilibrium-price relation is established between them.
Similarly, the nonpossessors of a good at any given time will choose between (a) not buying it and reserving their money, (b) buying it outright, and (c) renting it. They will choose the course highest on their value scales, which depends partially on their demand for money and on their estimate of which type of purchase will be cheaper. If they decide to buy, they will buy on what they estimate is the cheaper market; then they can either use the good directly or resell it on the more expensive market. Thus, if the capital value of the house is 200 and a buyer estimates that total rental prices will be 220, he buys outright at 200, after which he may either use it directly or enter the rental market as a supplier in order to earn the expected 220 ounces. The latter choice again depends on his value scale. This is another example of the arbitrage action already explained, and the effect is to link the demand curves for the two types of markets for durable goods.
Here it must be pointed out that in some cases the renting contract itself takes on the characteristics of a capital contract and the estimating of future return. Such is the case of a long-term renting contract. Suppose that A is planning to rent a house to B for 30 years, at a set annual price. Then, instead of continual changes in the rental price, the latter is fixed by the original contract. Here again, the demand and supply schedules are set according to the various individual estimates of the changing course of other varying rents for the same type of good. Thus, if there are two identical houses, and it is expected that the sum of the varying rents on house A for the next 30 years will be 300 ounces, then the long-term renting price for house B will tend to be set at 10 ounces per year. Here again, there is a similar connection between markets. The price of presently established long-term rents will tend to be equal to the present value of the sum of the expected fluctuating rents for identical goods. If the general expectation is that the sum of rents will be 360 ounces, then there will be a heavy demand for long-term rent purchases at 300 ounces and a diminished supply for rent at that price, until the long-term rental price is driven to 12 ounces per year, when the sum will be the same. And here again, the ever-present uncertainty of the future causes the more able forecasters to gain and the less able ones to lose.
In actuality, time preference exists, and the present value of the future rentals is always less by a certain discount than the sum of these rentals. If this were not so, the capital value of very durable goods, goods which wear out only imperceptibly, would be almost infinite. An estate expected to last and be in demand for hundreds of years would have an almost infinitely high selling price. The reason this does not happen is that time preference discounts future goods in accordance with the length of time being considered. How the rate of time preference is arrived at will be treated in later chapters. However, the following is an illustration of the effect of time preference on the capital-value of a good. Assume a durable good, expected to last for 10 years, with an expected rental value of 10 ounces each year. If the rate of time preference is 10 percent per annum, then the future rents and their present value are as follows:
As the date of time recedes into the future, the compounded discount becomes greater, finally reducing the present value to a negligible amount.
It is important to recognize that the time-preference factor does not, as does relatively correct forecasting of an uncertain situation, confer monetary profits or losses. If the time-preference rate is 10 percent, purchasing the aforementioned good for 59.4 ounces, holding it, and renting it out for 10 years to acquire 100 ounces does not constitute a monetary profit. Present money was at this premium over future money, and what this man earned was simply the amount of future income that the market had evaluated as equal to 59.4 ounces of present money.
In general, we may sum up the action of entrepreneurs in the field of durable consumers’ goods by saying that they will tend to invest in the outright purchase of (already existing) durable consumers’ goods when they believe that the present capital value of the good on the market is less than the sum of future rentals (discounted by time preference) that they will receive. They will sell such goods outright when they believe that the present capital value is higher than the discounted sum of future rentals. Better forecasters will earn profits, and poorer ones will suffer losses. In so far as the forecasting is correct, these “arbitrage” opportunities will tend to disappear.
Although we have analyzed the arbitrage profits and losses of entrepreneurship in the case of selling outright as against renting, we have yet to unravel fully the laws that govern entrepreneurial incomes—the incomes that the producers strive to obtain in the process of production. This problem will be analyzed in later chapters.
In our preoccupation with analysis of the action of man in the monetary economy, it must not be thought that the general truths presented in chapter 1 remain no longer valid. On the contrary, in chapter 1 they were applied to isolated Crusoe-type situations because we logically begin with such situations in order to be able to analyze the more complex interrelations of the monetary economy. However, the truths formulated in the first chapter are applicable still, not only through logical inferences applied to the monetary nexus, but also directly to all situations in the monetary economy in which money is not involved.
There is another sense in which the analysis of the first chapter is directly applicable in a money economy. We may be primarily concerned in the analysis of exchange with the consumer’s allocation of money to the most highly valued of its uses—based on the individual’s value scales. We must not forget, however, the ultimate goal of the consumer’s expenditures of money. This goal is the actual use of the purchased goods in attaining his most highly valued ends. Thus, for the purposes of analysis of the market, once Jones has purchased three pounds of butter, we have lost interest in the butter (assuming there is no chance of Jones’ re-entering the market to sell the butter). We call the retail sale of the butter the sale of the consumers’ good, since this is its last sale for money along the path of the butter’s production. Now the good is in the hands of the ultimate consumer. The consumer has weighed the purchase on his value scale and has decided upon it.
Strictly, we must never lose sight of the fact that this purchase by the consumer is not the last stopping point of the butter, when we consider human action in its entirety. The butter must be carried to the man’s home. Then, Jones allocates the units of butter to their most highly valued uses: buttered toast, butter in a cake, butter on a bun, etc. To use the butter in a cake or sandwich, for example, Mrs. Jones bakes the cake and prepares the sandwich and then brings it to the table where Jones eats it. We can see that the analysis of chapter 1 holds true, in that useful goods—horses, butter, or anything else—in the hands of the consumer are allocated, in accordance with their utility, to the most highly valued uses. Also, we can see that actually the butter when last sold for money was not a consumers’ good, but a capital good—albeit one of lower order than at any other previous stage of its production. Capital goods are produced goods that must be combined still further with other factors in order to provide the consumers’ good—the good that finally yields the ultimate satisfaction to the consumer. From the full praxeological point of view, the butter becomes a consumers’ good only when it is actually being eaten or otherwise “consumed” by the ultimate consumer.
From the standpoint of praxeology proper—the complete formal analysis of human action in all its aspects—it is inadmissible to call the good at its last retail sale to the consumer a “consumers’ good.” From the point of view of that subdivision of praxeology that covers traditional economics—that of catallactics, the science of monetary exchanges—however, it becomes convenient to call the good at the last retail stage a “consumers’ good.” This is the last stage of the good in the monetary nexus—the last point, in most cases, at which it is open to producers to invest money in factors. To call the good at this final monetary stage a “consumers’ good” is permissible, provided we are always aware of the foregoing qualifications. We must always remember that without the final stages and the final allocation by consumers, there would be no raison d’être for the whole monetary exchange process. Economics cannot afford to dismiss the ultimate consumption stage simply because it has passed beyond the monetary nexus; it is the final goal and end of the monetary transactions by individuals in society.
Attention to this point will clear up many confusions. Thus, there is the question of consumers’ income. In chapter 3, we analyzed consumers’ money income and the universal goal of maximizing psychic income, and we indicated to some extent the relation between the two. Everyone attempts to maximize the latter, which includes on its value scale a vast range of all consumers’ goods, both exchangeable and nonexchangeable. Exchangeable goods are generally in the monetary nexus, and therefore can be purchased for money, whereas nonexchangeable goods are not. We have indicated some of the consequences of the fact that it is psychic and not monetary income that is being maximized, and how this introduces qualifications into the expenditure of effort or labor and in the investment in producers’ goods. It is also true that psychic income, being purely subjective, cannot be measured. Further, from the standpoint of praxeology, we cannot even ordinally compare the psychic income or utility of one person with that of another. We cannot say that A’s income or “utility” is greater than B’s.
We can—at least, theoretically—measure monetary incomes by adding the amount of money income each person obtains, but this is by no means a measure of psychic income. Furthermore, it does not, as we perhaps might think, give any exact indication of the amount of services that each individual obtains purely from exchangeable consumers’ goods. An income of 50 ounces of gold in one year may not, and most likely will not, mean the same to him in terms of services from exchangeable goods as an income of 50 ounces in some other year. The purchasing power of money in terms of all other commodities is continually changing, and there is no way to measure such changes.
Of course, as historians rather than economists, we can make imprecise judgments comparing the “real” income rather than the monetary income between periods. Thus, if Jones received 1,000 ounces of income in one year and 1,200 in the next, and prices generally rose during the year, Jones’ “real income” in terms of goods purchasable by the money has risen considerably less than the nominal monetary increase or perhaps fallen. However, as we shall see further below, there is no precise method of measuring or even identifying the purchasing power of money and its changes.
Even if we confine ourselves to the same period, monetary incomes are not an infallible guide. There are, for example, many consumers’ goods that are obtainable both through monetary exchange and outside the money nexus. Thus, Jones may be spending 18 ounces a month on food, rent, and household maintenance, while Smith spends only nine ounces a month. This does not necessarily mean that Jones obtains twice as much of these services as Smith. Jones may live in a hotel, which provides him with these services in exchange for money. Smith, on the other hand, may be married and may obtain household and cooking services outside the monetary nexus. Smith’s psychic income from these services may be equal to, or greater than, Jones’, despite the lower monetary expenditures.
Neither can we measure psychic incomes if we confine ourselves to goods in the monetary nexus. A and B might live in the same sort of house, but how can the economist-observer deduce from this that the two are deriving the same amount of enjoyment from the house? Obviously, the degree of enjoyment will most likely differ, but the mere fact of the income or property will provide no clue to the direction or extent of the difference.
It follows that the law of the diminishing marginal utility of money applies only to the valuations of each individual person. There can be no comparison of such utility between persons. Thus, we cannot, as some writers have done, assert that an extra dollar is enjoyed less by a Rockefeller than by a poor man. If Rockefeller were suddenly to become poor, each dollar would be worth more to him than it is now; similarly, if the poor man were to become rich, his value scales remaining the same, each dollar would be worth less than it is now. But this is a far cry from attempting to compare different individuals’ enjoyments or subjective valuations. It is certainly possible that a Rockefeller enjoys the services of each dollar more than a poor, but highly ascetic, individual does.
Wicksteed, Common Sense of Political Economy, I, 21–22.
The exception is those cases in which the demand curve for the good is directly vertical, and there will then be no effect on the complementary good.
We omit at this point analysis of the case in which the increase in demand results from decreases of cash balance and/or decreases in investment.
Strictly, this is not correct, and the important qualification will be added below. Since, as a result of time preference, present services are worth more than the same ones in the future, and those in the near future more than those in the far future, the price of B will be less than twice the price of A.
It needs to be kept in mind that, strictly, there is no such thing as a “present” price established by the market. When a man considers the price of a good, he is considering that price agreed upon in the last recorded transaction in the market. The “present” price is always, in reality the historically recorded price of the most immediate past (say, a half-hour ago). What always interests the actor is what various prices will be at various times in the future.
On the different uses of the term “value,” see Appendix B, “On Value,” below.
The concept of monetary profit and loss and their relation to capitalization will be explored below.
Cf. Fetter, Economic Principles, pp. 158–60.
For a discussion of the value of durable goods, see the brilliant treatment in Böhm-Bawerk, Positive Theory of Capital, pp. 339–57; Fetter, Economic Principles, pp. 111–21; and Wicksteed, Common Sense of Political Economy, I, 101–11.