Articles of Interest
Frank A. Fetter, Chapter 18: Markets and Prices
Primitive forms of trade
"Value-in-use" and "value-in-exchange"
Priority of values-in-use
Marginal valuation in trading
Rarely, however, would either trader part with all of his stock of any good that has use-value to him, because, for example, as the fisherman's stock of fish shrinks, the valuation per unit of the remainder in terms of furs, increases; and as he gets more furs their valuation per unit decreases in terms of fish. And so it is, conversely, with the hunter. Each party will stop trading at the point where his valuation of the goods he can get is no more than his valuation of the goods he has to give in return. This would be marginal trade, and the last or least urgent uses to which any of the like units of goods were put would be the marginal uses. Observe, however, that each of the units of like goods in a person's possession at a moment have then the same value as every other unit. The term "marginal valuation" always implies the equal valuation of a number of like things at the same time. Evidently, there is marginal valuation both of the sale good (the thing the buyers is acquiring) and the price-good (his purchasing power); but during the trade the two valuations move in opposition directions, one down and the other up, both for the buyer and for the seller, until the two valuations come to equilibrium at some ratio.
Figure X. Marginal Valuations in Trading
Let it be assumed that the fisherman before meeting the hunter had 20 fish and no pelts and the hunter 7 pelts and no fish, and that the latent valuations of each party for successive marginal units of pelts in terms of fish were as shown in the graph. It follows that, rather than not trade at all, the fisherman would have been willing in a single trade to give a total of 5 fish for 1 pelt. 8 for 2 pelts, or 9 for 3 pelts; likewise, the hunter would have been willing to accept a total of 1 fish for 1 pelt, 3 for 2 pelts, or 9 for 3 pelts. If only one pelt were traded, the fisherman would have continued to value pelts higher than did the hunter, and the hunter to value pelts lower than did the fisherman. But if 9 fish are traded for 3 pelts, the marginal valuations (pelts in terms of fish) of both parties are brought close to equilibrium. Observe that exchange alters the use-valuation (pelts in terms of ish) of both parties, and brings use-valuation to each party is 1 pelt = 3 fish. This is the ratio of exchange toward which the trading would tend, and the goods would then be distributed thus: the fisherman would have 11 fish and 3 pelts; the hunter would have 9 fish and 4 pelts. However (as discussed in the section on higgling), this situation might not be exactly arrived at in isolated trade.
Higgling in isolated trade
In trade that takes place between two persons far removed from any other persons or opportunities to trade, the ratio of exchange many vary widely. In such a situation there is no competition on either side, on the side of the buyer or of the seller (see below p. 523 on competition). The least advantageous ratio of exchange that could induce a buyer or a seller, respectively, to trade one or more units of goods is called reserve valuation with respect to that specific number. Each party may be much in the dark regarding the needs, purchasing power, and reserve valuations of the other party; or one may be much better informed, or more able to wait, or have other means of getting what he wants. After much time spent in "dickering" or "chaffering" or "higgling," the trade may be made at a ratio which leaves barely any gain in valuation (motive to trade) to one party, while making it very advantageous to the other. Every isolated trade presents the condition of this sort of monopolistic power and of its exercise, especially when the two parties are not equally matched in their information and in the strength of their economic resources. But probably more often a medium ratio is agreed upon which makes the trade very desirable to both parties.
Latent competition in isolated trade
Even if there is no actual competition in isolated trade at a certain place and time, it can rarely happen that a certain amount of latent, or potential, competition is entirely lacking. Back in the thought of either of the two parties, or of both of them, may be the knowledge that another neighbor is willing to trade, or that like goods can be bought or sold on better terms the next market day in the neighboring town. Thus the valuations of each trader have elastic limits determined usually not by desperate need but by somewhat vague alternative valuations in exchange, varying according to his willingness to wait, his ability to travel to market, and his chance of getting substitute goods more or less suitable. Thus in many trades which appear to be purely isolated, a sort of latent, invisible competition is present to moderate the ratio of exchange arrived at, and to keep it from diverging very for from a fair medium, which "splits the difference" between the first and perhaps extremer demands of each party.
At this point it may be helpful to define the word "price" which has already appeared in our discussion. Price is the amount of goods which a buyer gives for the sale-good. In simple barter, price may be any sort of goods the seller will take; but where money is in general use, price, unless otherwise specified, is always understood to mean a certain sum of money or valuable things expressed in terms of money (monetary price). Price may mean either the whole amount of money given in a trade (total price) or more commonly the amount given per unit of sale-good (unit price). These meanings arc usually indicated clearly by the context.
Simple auctions with competitive bidding
The range left for higgling over price in a trade is narrowed by actual competition on one side or other of the trade. The simplest case is presented by an auction at which a single unit of a good is offered for sale where several persons are present to bid for it. This is one-sided competition, namely, on the side of the buyers. The reserve valuation of each bidder may have been fixed by a friend or a customer for whom the bidder is acting. In other cases it is more or less definitely decided in advance by the bidder himself, subject to change on new information and often increased under the spur of rivalry or the persuasive arts of the auctioneer. Under the hypnotism of the crowd a bidder may be led to buy a "white elephant" which his cooler judgment tells him he really does not want at all, or to pay prices higher than those at which the goods can easily be bought elsewhere. Many purchases in more developed markets often show similar results. An auction which advertises that all goods are to be sold to the highest bidder is called an auction sale without reserve. Such an announcement helps to attract more bidders to attend the auction, for they hope to buy cheap; and the sellers on their part hope in this way to make a quick sale at a fairly satisfactory price. In sales without reserve the buyers still have reserve valuations, and in competition they usually fix the price within pretty narrow limits. However, it often happens that the auctioneer has confederates in the crowd, known as "cappers," who deceive the outside public by making higher bids and even by bidding-in articles that otherwise would be sold at real bargain prices. This is a fake auction.
Auction price of a single article
Suppose five persons come to an auction, each hoping to buy a table at a bargain price although having higher reserve valuations which they would pay rather than go away without buying. Let us put in tabular form the reserve valuations of person A along with those of four other weaker or less eager bidders, B, C, D, and E.
A's reserve valuation is $10
B's reserve valuation is $ 9
C's reserve valuation is $ 8
D's reserve valuation is $ 7
E's reserve valuation is $ 6
Figure XI Auction Price Determined by Competing Buyers' Bids
Evidently the weaker bidders, B, C, D, and E, would have no chance in the end to get the table. For if the bidding starts at, say, $5 or $6, the weaker bidders are forced to drop out one after the other, finally leaving A as the successful bidder. But at what price? Assuming that bids may be advanced at not less than ten cents at a time, the answer is: either $9.00 or $9.10; for if A happens to bid $9.00 before B does, B would not outbid him, and the sale will be at that price; but if B first bids $9.00, then A can outbid him and buy at $9.10. Similarly, if bids must be advanced $1.00 at a time, the price at which the article is sold might be either $9.00 or $10.00. The general rule is that the range of uncertainty of competitive price is limited to the smallest permissible advance in bids, the lower limit being the bid of the second most eager bidder, the upper limit being one unit bid higher. The valuation of the bidder excluded last evidently does help to fix the price, for if in this case B were absent, the price would be $8.00 or $8.10.
Auction price of two or more like goods
If two tables (just alike and in equally good condition) are to be sold as advertised, A and B acting independently, without collusion, may each buy a table for $8.10 (or $8.00), just enough to eliminate C provided they size up the situation correctly. Either A or B would drop out when bids on the first table reached $8.00 or $8.10, enough to outbid C, each knowing that C would not pay more than that for the remaining table. So, if there are three tables for sale, they might all be sold at $7.00; and so on, in due order of the reserve valuations. It may happen, however, that one or all of the more eager bidders may miscalculate and either drop out too soon or go on bidding too long. For example A and B may both guess wrong, and may hold back, letting C take the first table at $8.00, and then A would have to bid up the one remaining table to $9.00 to keep B from getting it. Often in this way at auctions a unit put up for sale later sells for either more or less than the earlier units. The perfect theoretical result is possible in practice only where there is perfect knowledge of conditions by those who are to be successful in buying. However, it is true in very large measure that the order of bidding and the point at which various bidders drop out, along with other circumstances, pretty well reveal the real situation in a genuine auction.
Buyers' competition in informal markets
The essential conditions of competitive bidding for a single article or for the sale-goods of a single seller are presented in every neighborhood without a formal auction. It is so whenever a person having something to sell lets it be publicly known, gets from several persons their best offers, and finally accepts the highest if it is not less than his own reserve valuation for the good. In this way thousands of houses, building lots, forms, factories, horses, wagons, automobiles, pianos, all kinds of new and old furniture, and innumerable other goods are constantly being sold, The advertising columns of the newspapers assist greatly in this process. Thus every neighborhood is an informal, loosely organized competitive market for the sale of goods to the highest bidder, a sort of perpetual auction. It works more or less imperfectly for lack of full information, and often a person is heard to say: "I wish I had known that article was for sale; I would gladly have given far more for it than the price at which it sold." In that case the seller regrets his selling too hastily.
Two-sided competition in informal markets
We have been speaking only of the competition between buyers, but it is evident that what has just been said is equally true if the words "seller" and "sale" be substituted for "buyer" and "purchase." For, while in many cases several buyers are competing with each other to acquire a certain sale-good from a single seller, at the same time several sellers may be competing to sell to a single buyer. Whenever a person lets it be known by telling his neighbors, by advertising in the papers, by going to an agent, or in any other way, that he wishes to buy a certain article, say a house, those having a house for sale offer it at a certain price. The buyer weighs these offers against each other, making due allowance according to his own needs and his scale of valuation for differences in location, size, construction, artistic design, condition, and conveniences, and finally makes a purchase at what he deems to be the lowest price, all things considered. Sometimes the difference between the best offer and the next best is very small, and one or the other seller may reduce his offer or modify the terms. Many such transactions may be going on separately at the same time, and they tend to merge into a continuous system of trades where both buyers and sellers respectively are competing. The individuals of each group are thus enabled to get the prevailing price, more favorable for most of them than their own extreme reserve valuations (buying or selling respectively) to which they might be forced in an isolated trade.
The retail districts of towns and cities afford countless examples of this sort of perpetual, informal auction markets, where customers are constantly comparing goods and prices, through reading advertisements, "window shopping," or making sample purchases. And on their part, merchants are seeking with all the arts of salesmanship each to convince as many buyers as possible that all things considered, his goods are the best and the cheapest. The very considerable differences, real or apparent, in retail prices will be commented upon later.
Regular markets with two-sided competition
Now let us consider a somewhat more formally organized market where there is two-sided competition. In the Middle Ages the regional fairs, held once or oftener each year in many parts of Europe, were well-conducted markets to which merchants and buyers came from great distances. Regular markets also were held weekly or oftener in many market towns, where the products of the neighborhood fields and shops were offered for sale.1 In many rural villages and county seat towns in the United States, and even in some large cities, farmers' markets still are of considerable importance. Fully organized and regulated markets are maintained in many cities of the world for the sale of such staple products as wheat, corn, cotton, furs, the rarer metals, and many other commodities, either at wholesale or retail; and exchanges or bourses are organized for the marketing of investment securities.
Demand in regular markets
In regular markets each trader (or the trader's broker or agent) has a buyer's or a seller's reserve valuations. Buyers must have acceptable purchasing power with which they are trying to get some of the sale-goods and sellers must have goods with which they are seeking to get the buyers' purchasing power. Demand is not mere desire; rather it is the quantity of goods desired at a certain price by some one or more persons who have the necessary means of payment. The hungry boy outside the baker's window does not represent demand unless he has a nickel. Observe that the buyers' reserve valuations are the highest prices which they might be induced to pay for each marginal unit; and every is of course willing to buy for anything less, down to zero. The total number of units which buyers collectively stand ready to buy at any particular price is the market demand at that price. Thus if only one unit is for sale and the highest reserve valuation is 10, the demand at that price is only one, and this outbids the next highest valuation of 9 and all lower ones. If successively more units are offered for sale at the same time, other bidders are able to buy within their reserve valuations. The total demand at any price may come from buyers some of whom are ready to take several units at that price. The total number of units that any one buyer will take at a certain price is his individual demand, and the sum of all individual demands is the market demand at that price. But at any one moment there is only one actual price and one actual demand (the number of units which will be taken at that price). All other demands are merely latent (potential or hypothetical); they are the amounts that might be taken under different conditions. The general rule, or law, of demand is: Individual latent valuations for specific kinds and amounts of goods remaining the same, the market demand for them is greater when the price at which they can he bought is lower, and less when the price is higher. This is shown in Figure Xll for the valuations in the auction problem, with the addition of other bidders at prices 5.5, 5, and 4, respectively.
Figure XII Graph of Additional Latent Demand and Increasing Cumulative Demand at Each Lower Price
Supply at various prices
The explanations given in the last section regarding the market demand all apply to the market supply with such changes of wording ("supply" for "demand," "seller" for "buyer," and so on) as are necessary to fit the reversed conditions. The owner of goods in a market may be assumed to have, in respect to each margin use of his goods, a seller's reserve valuation. Some of these valuations may be as low as zero or even negative — the nuisance valuations of surplus goods — whereas after most of his stock had been sold he might have a very high valuation on the remaining units. These differing valuations for like units of goods are merely latent and do not exist at the same time as actual valuations. (It matters not for our present purpose how supply valuations are determined or caused; that will be discussed in the following chapter.) A seller's reserve valuations are not the most that he would like to get, but merely the least he will take for each successive marginal unit. He will always take a higher price if he can get it — and at the same time he will mark up his valuation of all the intramarginal units. The price for which a buyer can buy, or a seller can sell, becomes for each then and there his exchange valuation.
Figure XIII Graph Showing Latent Supply at Various Prices When Sellers' Valuations Range from Price $2 to $7, as Indicated in the Figure
Conditions determining sellers' valuations
Many influences enter into the determination of sellers' valuations under the actual conditions in the market at any specific time. The first and most general is their estimate of how much the buyers are willing, or may be induced, to pay. Apart from charity and friendship, sellers will not take less than they can get buyers to pay. Even under conditions of keen competition, sellers usually try to get "all the traffic will bear," a statement often assumed to be true only under conditions of monopoly in varying degrees. The true contrast is this: when and where sellers must meet real competition, the traffic will not bear so much, for at the competitive price level the goods will be supplied by other competitors.
Under any conditions the sellers, in their estimate of what they can get, take account of the amount of goods of the specific commodity which will be coming upon the market at various prices, of the ability and willingness of buyers to postpone demand for a time, and of the amounts, prices, and qualities of substitute goods to which demand will shift at certain price levels. After considering their estimate of the most they can hope to get from buyers, sellers will also consider their own need for money, what they intend to do with it, and their own ability to hold out for a higher price.
Finally sellers must weigh their alternative valuations of these goods if sold elsewhere or later, and also (in a going business and not merely in a distress sale) the alternative opportunities for investing and employing their own services and their capital in making other products or even in shifting to an entirely different industry and occupation. These alternative valuations of their own goods are described more fully in the next chapter which deals with business costs.
How demand and supply are equalized by price
When we were looking at the demand curve and were assuming that the goods were to be sold without reserve, we saw that the price would follow the demand curve down step by step, with the increasing supply of goods. Now we are looking at the supply curve (which is made by connecting the points representing the height of the reserve valuations) and we sec that as more and more units are demanded, they will be supplied only at higher and higher sellers' marginal valuations. As the sellers' marginal valuations increase, the number of buyers who can pay that price decreases, until at some level of price supply and demand are just equal.
The result of this adjustment may he seen in Figure XIV — where the latent demand and supply curves are superimposed on each other. Latent valuations being as here assumed, demand would be 9 units at a price of 4, and at that price a supply of only 5 units would be forthcoming. What happens? There being four more buyers than sellers at a price of 4, some of them will fail to obtain any goods, and it may be those buyers with the higher latent valuations unless they become more active bidders. So they compete with higher bids. At a price of 4.5 one buyer drops out and one seller comes in; the disparity of demand (8) and supply (6) is reduced to 2. The bids rise to 5, at which price another buyer drops out and another seller comes in, making demand and supply just equal, 7 units purchased and 7 units sold at $5 per unit.
Or suppose that the market starts with a price of $7, at which price demand will be 4 units and supply will be 9, a disparity of 5 units. Then competition among sellers would reduce the price successively to $6, and then to $5, at which price there would be 7 units to exchange with no further competition among sellers to lower the price or among buyers to raise the price. The price of $5 (under the assumed latent valuations) is therefore the true equilibrium price in such a market situation. Such a price may also be called the theoretically correct price in that state of demand and supply in a free market.
Figure XIV Demand and Supply Equalized at the Competitive Price
Passive and active changes in latent valuations
In any state of latent valuations, actual demand and supply and price may be said to be functions of each other in the mathematical sense, because a change in any one causes a change in the others and a resultant new equilibrium. But changes begin with either demand or supply, and price is merely the passive result, as we have just seen. Change on the side of demand and of supply may occur one at a time, or both together and, in the latter case, may be in the same direction or in opposite directions.
We may distinguish between an initial, or active, change in demand, and resultant, or passive change of supply and vice versa. An active change in demand or in supply is always the result of a change in latent valuations. For example, referring to Figure XV, if the intensity of latent desire for successive units of the commodity as shown on curve DD falls d1d1 without any change in the supply curve, the theoretical price would fall from $5 to $4, and the actual supply from 7 to 5 units, moving along the curve of latent supply. An increase of latent demand valuations to d2d2, on the other hand, would move the equilibrium price to $6 and cause the latent supply of S units to become actual at that price. This is shown in Figure XV. Similarly, active change may be initiated on the side of supply valuations, to be followed by the passive adjustment of demand and of price to a new equilibrium. (See Chapter XX on elasticity of demand.)
Figure XV Showing How Active Changes in Demand Result in Passive Changes in Supply, to Equalize Supply with Demand at the New Price
Features of a free market price
A true price in a free market, where a considerable number of traders are together, is marked by certain distinctive features:
1. It is a price uniform to all buyers, that is, all buyers pay the same price at the market place, and all sellers get the same net realized price on sales at the same time.
2. It is a uniform price prevailing at the place of sale and does not include transportation charges to or from other places, so-called "absorption of freight," which causes the net realized prices of the sellers to be nonuniform.
3. It is a price that permits the greatest number of goods to be traded — a number greater than is possible at any other price. A higher price will reduce the number of units to be bought, and a lower price will reduce the number of units for sale.
4. It is a price which benefits both parties in every trade, there being always the best balance between supply and demand set by the difference between the latent reserve and the actual exchange-valuation.
5. It has other advantages, both of an economic and of a moral nature. Being public and uniform, a free market price saves the time and the energy of both buyers and sellers, who would otherwise market and shop around to buy; it reduces the temptations to unfair treatment in isolated trade; and it tends to make the process of trade more open and honorable.
In a market that is not free — that is where various forces prevent the individual traders from trading freely according to their own valuations — the price which results is lacking in some or all of the features here listed. This appears in the later discussion of monopoly, but certain explanations are in order here.
Apparent nonuniformity of market prices
The principle of uniform price in a true market may appear under actual conditions to be subject to many exceptions. But let us examine them more closely. Frequently when actual prices really are not uniform, the conditions of a true free market are not present, because through custom, force, graft, authority (taxes, tariffs, special public privileges, monopoly, and so on) some traders, either buyers or sellers, are prevented from approaching the market freely and freely trading in it. Other apparent cases of nonuniform prices result from friendship and special favor, where, therefore, they are not truly prices but in the nature of private gifts. Again many "special low prices" and "bargain sales" of various kinds are largely a pretense. Often what is called a market is not a unit but is broken up into such subdivisions as retail trade, wholesale trade, large jobbers and small, manufacturers, and their customers, and the like to each of which different groups of traders belong through custom and business practice. One trader may belong in turn to different markets, as, for example, a merchant buying at wholesale and selling at retail.
Nonuniformity of retail prices
The most striking apparent deviations from the principle of uniform prices appear in retail trade. At stores not far apart different prices are paid for what appear to be the same kinds of goods. A good many of these cases are the result no doubt of the imperfect knowledge of buyers as to prices and qualities; but in many other cases the explanation is a very different one. The physical commodities such as clothes, furniture, flowers, and drugs, are not all that the customers are buying; they are also buying services, attention, and conveniences (psychic incomes) of various kinds. Physical goods bought under different conditions are not just the same goods; the prices are nonuniform, it is true, but so are the goods nonuniform. Various conditions make some buyers willing to pay more and enable some merchants to sell for more than others. The reputation for high and consistent quality of merchandise is valued more highly by customers having deep pocketbooks. Convenience of location either on the main street or in the neighborhood, thus saving time, makes some buyers willing to pay more. On the other hand, some buyers, but not all, are willing to walk down a side street, or go to a less accessible location for a small concession in price which the merchant can afford to make.
Influence of quality of services in selling
A better quality of clerical services, corresponding with higher salaries and better treatment of employees by some merchants, makes some stores more pleasant places in which to buy, a difference especially values by those who do not have to weigh the price so carefully. A very evident difference of service exists between stores granting credit along with free delivery of goods to buyers' homes and stores conducted on the "cash and carry" plan without even the convenience of telephone orders. The attractive displays of some stores, the lavish variety of styles, and the extensive entertainments, attract some buyers more than the lowest prices to. Really informative advertising tells the public where they will find what they want and thus saves them time and trouble; and much other advertising creates prestige for certain stores or for certain brands of goods which builds into the minds of the public a "good will" to buy without higgling over the pennies.
In such ways the retail market considered as a whole is broken up into a variety of submarkets, where goods of the same, or nearly the same, physical quality, are sold at different prices. But when account is taken of the numerous differences of taste, and of the valuations in accompanying services and conveniences, the differences in price may prove to be apparent rather than real. The price paid is a complex of the price for the bare physical commodity plus the prices of accompanying services. It often happens that when a customer buys he knows full well that he could get the article for less if he were willing to wait or to take the added trouble, and when he has more time he may seek the market with the lower price. Substantial differences in retail prices in the same community cannot persist without some such differences in the conditions of sale.
Mutual influence of prices
Thus far we have spoken of the market prices of distinct commodities as if they were determined independently, one at a time. The explanation of the prices of each separate kind of goods would be very incomplete if it stopped at this point. In many ways the demand, the supply, and the current price of each kind of goods are related to those of other goods in the same and in other markets. This mutual influence of prices exists not merely among goods of the same specific kind or of the same general kind, but frequently among goods very unlike in physical conditions and in uses. Price is the numerical expression of the market valuation not merely of one sales-good but, indirectly, of many others. For example, if one cow is exchanged for ten sheep (by barter) this links the exchange-valuation of sheep with that of any other goods for which a cow may be exchanged. When, as generally, price is expressed in terms of money, the general medium of exchange of each separate price is still more easily related numerically with all other market valuations at that time and place. When the price of a bushel of wheat is one dollar and that of a ton of coal is four dollars, a ton of coal is worth four bushels of wheat and anything else for which four bushels will exchange.
The price system
All prices are constantly being compared and constitute an interrelated system of prices in the market place and in the minds of individuals. It was seen in the last chapter that each individual's valuations form something of a system. So too in a market, in a larger way the various contemporary prices are systematically related. This was implied though not explicitly discussed in all the preceding account of the nature of demand and supply. Every system of present prices is also more or less related to those of future periods. Further, the system of prices in one market is more or less related to the present and future systems of prices in all other contemporary markets with which dealings are carried on, and to any from which goods are shipped.
The understanding of what a system of prices means is essential to the solution of many of the problems of commerce and public price policy. In the following chapter will be shown further the way in which the demand and the supply schedules of single commodities are related to those of other commodities in the individual budgets and in the valuations of all traders in the markets. In concluding this chapter, let us indicate briefly how the price system at any one place is linked in a larger geographical system with the prices of other localities.
Markets and market areas
The location of goods in relation to the place where they are desired is a fact which obviously affects their valuation. The trouble and expenses of all sorts (freights, commissions, fees, profits) for moving them from one place to another are expressed in terms of price as the costs of commerce. Costs of this kind are incurred in moving things from the places where they are produced to a central market to be sold and, after they are sold, again in taking them away from that place to the places where they are desired for final use. The movement of goods from numerous decentralized sources of production (such as farms, mines, small shops, and so on) to be sold in a central market may be called centripetal (seeking a center). The movement of goods sold and bought to be shipped outward in various directions toward their final destinations is centrifugal (fleeing, or moving away from a center). The whole geographical region from which things are sent centripetally to market is that market's buying market area; and that to which the goods are shipped centrifugally from a market is its selling market area. These two areas, in relation to a certain market, may more or less overlap (goods bought from one class of customers being sold to another class in the same territory) as when, for instance, butter and eggs and other produce bought by merchants from farmers and sold to local consumers. Often, however, in more distant trade the two areas are largely mutually exclusive. For example, Chicago as a wheat market buys mostly from the area west of it and ships eastward almost solely.
Any area which regularly ships certain products only outward (as food from the agricultural states) is a surplus area; and an area to which certain goods are regularly brought for use (as grain to New England and other eastern states), is a deficit area, in respect to those goods. Inasmuch as trade is reciprocal giving or exchange, every deficit area for one product must regularly or finally be a surplus area for other goods or services which it sells to obtain purchasing power to pay for the goods it buys. In other words, the total valuation of exports must in the long run equal the total valuation of imports — a simple fact generally overlooked in much popular discussion of tariffs and trade.
Market prices and delivered prices
The net realized price at the point of production (that is, the "form price" of agricultural products or the mill price of factory products) is less than the delivered price by the amount of the costs of transportation. In turn the delivered price to the buyer from a centrifugal market is greater by the costs of transportation than the uniform market price resulting from competition. A delivered price is really the sum of two prices, one, that of the commodity, the other that of the transportation. The net realized price at point of origin, the market price, and the so-called delivered price at final destination must be carefully distinguished to escape confusion in the discussion of prices.
Whenever the prices of certain goods in two or more markets differ by more than transportation costs, there is a motive for shipment and (subject to friction and lag) intermarket shipments will occur. This is regularly the case in trade between regions, either domestic or foreign which differ much in climate, natural resources, skilled labor, wealth, or industrial technique. The market prices in different markets under these conditions are thus kept from diverging from each other for more than brief periods by more than intermarket costs of transportation. The prices in the several markets differ, but they form a geographical system of prices. A clear understanding of this principle is helpful in studying not only market prices, but also the location of industries, the direction of commerce, the operation of import tariffs and export bounties, tax policies in general, and other problems.
Price competition on the geographical margin
If the prevailing prices of like goods in two geographically separate free markets are either the same or differ by less than the costs of transportation, no regular shipments from one market to the other can occur without loss to the shipper. However, the prices in the two markets are not without mutual influence in the intermediate territory. The prices in adjoining market areas are related in intimate and interesting ways, creating certain zones of competition and determining with mathematical accuracy sales in relation to prices and transportation costs. Consider the case of industrial products produced at two centrifugal markets and shipped to surrounding territories. When all buyers in the intermediate area are free to buy in either market at uniform market prices, they will buy where they incur the lower delivered cost. This, as has been observed, is the sum of two prices, the market (base) price at place of sale plus the transportation costs. The area from which buyers come to market A (Figure XVI) is its tributary market area, bounded by a line of indifference where delivered costs are equal from the two markets, beyond which, in the direction of market B, the delivered cost from B is lower than from A. If base prices are the same at both markets and freight rates are proportional to distance, the market areas of the two markets are delimited by a line perpendicular to the straight line connecting them. The enterprises in neither market can sell beyond that line unless their uniform market price is reduced below that of the other market.
Figure XVI The Relation of Market Base Prices, Freight Charges, and Normal Market Areas — in Other Words, the Economic Law of Market Areas
Assuming that the market price in A is $10 and in B is $12, and that freights are proportional to distance, being $4 between the two markets: then the delivered cost of C and E is $14, and at D (on a line between the two Markets) is $13. It is equal from both markets that every point in the hyperbolic curve CE. The areas between two competitive markets are naturally delimited in this way, but under monopolistic arrangements for selling by a formula, as by the basing point plan, geographical relations are distorted. This plan first became known as Pittsburgh Plus in the sale of steel, but has since been adopted in numerous industries.
The economic law of market areas
Any temporary change of local conditions, or certain lasting advantages in materials and methods, may easily establish a brief or permanent price differential between the price on one market as compared with that of the other. But until the difference in base price equals or exceeds the total cost of transportation from A to B, regular shipments cannot profitably be made all the way from A to B, and some area is left tributary to B, the market with the higher base price. Smaller decentralized enterprises have thus a chance to survive against the competition of larger producers unless the latter reduce their uniform base price by as much as the whole cost of transportation between the two competing enterprises, or unless they make a discriminating price by cutting below their regular price in more distant sales (a problem of monopoly touched upon in a later chapter).
The economic law of market areas is a statement of the mathematical relationship of the price differential between two locally separate markets with the area in which it can sell (or from which it can buy). Assuming freight rates to be proportional to distance in every direction in straight lines, the boundary between the market areas of two geographically competing markets is a hyperbolic curve; the difference of freight from the two markets respectively to each point on this curve being just equal to the difference in the prices of the goods in the two markets. The selling market with the lower price and the buying market with the higher price attract traders from greater distances. For example, if the base price at A is five dollars less per unit than that at B, then A can sell in every
direction toward B to the points where the freight charge from A begins to exceed that from B by more than five dollars.
Summary and conclusions
The aim of this chapter is to show further how the exchange of goods, and finally a whole system of prices, develops out of individual valuations and serves to bring them into closer accord.
Trade opens up new opportunities for choice and the reapportionment of the goods in a man's possession to meet his desires. Trade is the social aspect of choice. Alongside of value-in-use appears value-in-exchange, as a new sort of importance felt in goods. It is, however, derived from the value-in-use that some other person attaches to the good which makes him willing to part with other goods to obtain it.
The simplest form of trade, barter between two isolated individuals, depends on the marginal principle of valuation. In the simple auction the competition between two or more traders on one side of the bidding narrows the range of higgling and uncertainty as to price. The essential conditions of an auction are present in every informal grouping of traders in a community, but they are more completely developed in highly organized markets.
Demand and supply, the quantities of goods ready to be traded at certain prices, are the results of individual valuations and are brought into equilibrium by the agreement of traders (for the moment) upon a market price. The main features of markets are described, and real or apparent departures from uniform market prices are considered.
Prices, like individual valuations, are mutually influenced, and the prices of particular goods tend to unite into a larger system of prices that are mutually related in many ways. The geographical relationships of competitive markets and prices are summed up in the economic law of market areas.
The study of exchange valuation and prices from the angle of use-values of consumers has prepared the ground for the consideration in the next chapter of the ways in which middlemen's market valuations arise on the side of supply.
Böhm-Bawerk, Eugen von. The Positive Theory of Capital. D.E. Stechert and Co. New York. 1923. Reprint. Pp. 428.
Fetter, Frank A. "The Economic Law of Market Areas." The Quarterly Journal of Economics. May, 1924. Vol. 38. Pp. 520–529.
——. Economic Principles. The Century Co. New York. 1915. Pp. x, 523. See especially Chaps. 5–8.
——. The Masquerade of Monopoly. Harcourt, Brace and Co. New York. 1931. Pp. xii, 464. See especially Chap. 20.
Grierson, P.J. Hamilton. The Silent Trade. W. Green and Sons. Edinburgh. 1903. Pp. x, 112.
Schultz, Henry. Statistical Laws of Demand and Supply. The University of Chicago Press. Chicago. 1928. Pp. xix, 228.
Questions and Problems
1. Distinguish between the nature and origin of "value in use" and "value in exchange." What concrete things can you name which have both of these qualities? Which have only the one quality?
2. How can trade be advantageous to both parties if it is fair?
3. Explain the phrases: "individual market demand" and "collective market demand."
4. Give illustrations of the difference between desire and demand.
5. What is meant by the law of demand? How do you explain this rule of buyers' valuations?
6. Explain the phrases: "individual market supply" and "collective market supply." Why does the supply curve slope upward to the right?
7. Explain the phrase "higgling area."
8. Why does market price tend to settle at the point at which demand and supply are equal?
9. Summarize the distinctive features of market price under conditions of competition.
10. What examples can you cite of nonuniform retail prices? How do you account for such nonuniformity?
11. Explain the meaning of the phrase, "the price system."
12. What examples can you find in your community of a "centripetal market," a "centrifugal market"?
13. Distinguish between the "market" and the "market area." What factors govern the size of the market area of any enterprise?
14. Explain and illustrate the economic law of market areas. Does this law apply to centripetal markets as well as to centrifugal markets?
15. Explain the price relationships which prevail in a centrifugal market; in a centripetal market.
- 1. A further description of medieval fairs and markets may be found in the reading references for this chapter.