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2. Direct Exchange

4. Terms of Exchange

Before analyzing the problem of the terms of exchange, it is well to recall the reason for exchange—the fact that each individual values more highly the good he gets than the good he gives up. This fact is enough to eliminate the fallacious notion that, if Crusoe and Jackson exchange 5,000 berries for one cow, there is some sort of “equality of value” between the cow and the 5,000 berries. Value exists in the valuing minds of individuals, and these individuals make the exchange precisely because for each of them there is an inequality of values between the cow and the berries. For Crusoe the cow is valued more than the 5,000 berries; for Jackson it is valued less. Otherwise, the exchange could not be made. Therefore, for each exchange there is a double inequality of values, rather than an equality, and hence there are no “equal values” to be “measured” in any way.21

We have already seen what conditions are needed for exchange to occur and the extent to which exchange will take place on given terms. The question then arises: Are there any principles that decide the terms on which exchanges are made? Why does Crusoe exchange with Jackson at a rate of 5,000 berries for one cow, or 2,000 berries for one cow?

Let us take the hypothetical exchange of 5,000 berries for one cow. These are the terms, or the rate of exchange (5,000 berries for one cow). If we express one commodity in terms of the other, we obtain the price of the commodity. Thus, the price of one good in terms of another is the amount of the other good divided by the amount of the first good in exchange. If two cows exchange for 1,000 berries, then the price of cows in terms of berries (“the berry-price of cows”) is 500 berries per cow. Conversely, the price of berries in terms of cows (“the cow-price of berries”) is 1/500 cow per berry. The price is the rate of exchange between two commodities expressed in terms of one of the commodities.

Other useful concepts in the analysis of exchange are those of “selling” and “buying.” Thus, in the above exchange, we may say that Crusoe sold 1,000 berries and bought two cows in exchange. On the other hand, Jackson sold two cows and bought 1,000 berries. The sale is the good given up in exchange, while the purchase is the good received.

Let us again focus attention on the object of exchange. We remember from chapter 1 that the object of all action is to maximize psychic revenue, and to do this the actor tries to see to it that the psychic revenue from the action exceeds the psychic cost, so that he obtains a psychic profit. This is no less true of interpersonal exchange. The object in such an exchange for each party is to maximize revenue, to exchange so long as the expected psychic revenue exceeds the psychic cost. The psychic revenue from any exchange is the value of the goods received in the exchange. This is equal to the marginal utility to the purchaser of adding the goods to his stock. More complicated is the problem of the psychic costs of an exchange. Psychic costs include all that the actor gives up by making the exchange. This is equal to the next best use that he could have made of the resources that he has used.

Suppose, for example, that Jackson possesses five cows and is considering whether or not to sell one cow in exchange. He decides on his value scale that the following is the rank in value of the possible uses of the cow:

  1. 5,000 berries offered by Crusoe
  2. 100 bbls. of fish offered by Smith
  3. 4,000 berries offered by Jones
  4. Marginal utility of the cow in direct use

In this case, the top three alternatives involve the exchange-value of the cow, the fourth its value in direct use. Jackson will make the best use of his resource by making the exchange with Crusoe. The 5,000 berries of Crusoe will be his psychic revenue from the exchange, while the loss of the 100 barrels of fish constitutes his psychic cost. We saw above that, in order for exchange to take place, the marginal utility of the goods received must be greater than the marginal utility of the goods given up. We now see that for any specific exchange to occur, the marginal utility of the goods received must also be greater than the marginal utility forgone—that which could have been received in another type of exchange.

It is evident that Jackson will always prefer an offer of more units of one type of good to an offer of fewer units of the same good. In other words, the seller will always prefer the highest possible selling price for his good. Jackson will prefer the price of 5,000 berries per cow offered by Crusoe to the price of 4,000 berries per cow offered by Jones. It might be objected that this may not always be true and may be offset by other factors. Thus, the prospect of 4,000 berries from Jones may be evaluated higher than the prospect of 5,000 berries from Crusoe, if: (a) the psychic disutility of labor and time, etc., for delivery over a longer distance to the latter renders the prospect of sale to Crusoe less attractive despite the higher price in berries; or (b) special feelings of friendship for Crusoe or hatred for Jones serve to change the utilities on Jackson's value scale. On further analysis, however, these turn out not to be vitiating factors at all. The rule that the actor will prefer the highest selling price for his good in terms of the other good always holds. It must be reiterated that a good is not defined by its physical characteristics, but by the equal serviceability of its units to the actor. Now, clearly, a berry from a longer distance, since it must call forth the disutility of labor to move it, is not the same good as the berry from a shorter distance, even though it is physically the same berry. The very fact that the first is further away means that it is not as serviceable as the other berry, and hence not the same good. For one “price” to be comparable with another, the good must be the same. Thus, if Jackson prefers to sell his cow for 4,000 berries from Jones as compared to 5,000 berries from Crusoe, it does not mean that he chooses a lower price for his product in terms of the same good (berries), but that he chooses a price in terms of one good (berries from Jones) over a price in terms of an entirely different good (berries from Crusoe). Similarly, if, because of feelings of friendship or hostility, receiving berries from Crusoe takes on a different quality from that of receiving berries from Jones, the two packets of berries are no longer of equal serviceability to Jackson, and therefore they become for him two different goods. If these feelings cause him to sell to Jones for 4,000 berries rather than to Crusoe for 5,000 berries, this does not mean that he chooses a lower price for the same good; he chooses between two different goods—berries from Crusoe and berries from Jones. Thus, at all times, an actor will sell his product at the highest possible price in terms of the good received.

Clearly, the converse is true for the buyer. The buyer will always purchase his good at the lowest possible price. This truth can be traced in the example just discussed, since, at the point that Jackson was a seller of the cow, he was also a buyer of the berries. Where the good in question—berries—was comparable, he bought at the lowest possible price—say 1/5,000 cow per berry in preference to 1/4,000 cow per berry. In cases where Jackson chooses the latter price, the two berries are no longer the same, but different, goods. If, to buy berries, the purchaser has to range further afield or buy from someone he dislikes, then this good becomes a different one in kind from the good closer by or sold by a friend.

  • 21. Cf. Mises, Human Action, pp. 204–06; and Menger, Principles of Economics, pp. 192–94, 305–06.