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4. Prices and Consumption

1. Money Prices

WE HAVE SEEN THE ENORMOUS importance of the money prices of goods in an economy of indirect exchange. The money income of the producer or laborer and the psychic income of the consumer depend on the configuration of these prices. How are they determined? In this investigation, we may draw extensively from almost all of the discussion in chapter 2. There we saw how the prices of one good in terms of others are determined under conditions of direct exchange. The reason for devoting so much consideration to a state of affairs that can have only a very limited existence was that a similar analysis can be applied to conditions of indirect exchange.

In a society of barter, the markets that established prices (assuming that the system could operate) were innumerable markets of one good for every other good. With the establishment of a money economy, the number of markets needed is immeasurably reduced. A large variety of goods exchange against the money commodity, and the money commodity exchanges for a large variety of goods. Every single market, then (with the exception of isolated instances of barter) includes the money commodity as one of the two elements.

Aside from loans and claims (which will be considered below), the following types of exchange are made against money:

Old Consumer Goods ........................... against Money
New Consumer Goods and Services ...... against Money
Capital Goods ...................................... against Money
Labor Services ..................................... against Money
Land Factors ....................................... against Money

For durable goods, each unit may be sold in toto, or it may be hired out for its services over a certain period of time.

Now we remember from chapter 2 that 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 the exchange. If, in a certain exchange, 150 barrels of fish exchanged for three horses, then the price of horses in terms of fish, the “fish-price of horses,” was 50 barrels of fish per horse in that exchange. Now suppose that, in a money economy, three horses exchange for 15 ounces of gold (money). The money price of horses in this exchange is five ounces per horse. The money price of a good in an exchange, therefore, is the quantity of units of gold, divided by the quantity of units of the good, yielding a numerical ratio.

To illustrate how money prices may be computed for any exchange, suppose that the following exchanges are made:

15 ounces of gold for 3 horses
5 ounces of gold for 100 barrels of fish
1/8 ounce of gold for 2 dozen eggs
24 ounces of gold for 8 hours of X's labor

The money prices of these various exchanges were:

The last ratios on each line are the money prices of the units of each good for each exchange.

It is evident that, with money being used for all exchanges, money prices serve as a common denominator of all exchange ratios. Thus, with the above money prices, anyone can calculate that if one horse exchanges for five ounces and one barrel of fish exchanges for 1/20 ounces, then one horse can, indirectly, exchange for 100 barrels of fish, or for 80 dozen eggs, or 5/3 of an hour of X's labor, etc. Instead of a myriad of isolated markets for each good and every other good, each good exchanges for money, and the exchange ratios between every good and every other good can easily be estimated by observing their money prices. Here it must be emphasized that these exchange ratios are only hypothetical, and can be computed at all only because of the exchanges against money. It is only through the use of money that we can hypothetically estimate these “barter ratios,” and it is only by intermediate exchanges against money that one good can finally be exchanged for the other at the hypothetical ratio.1 Many writers have erred in believing that money can somehow be abstracted from the formation of money prices and that analysis can accurately describe affairs “as if “ exchanges really took place by way of barter. With money and money prices pervading all exchanges, there can be no abstraction from money in analyzing the formation of prices in an economy of indirect exchange.

Just as in the case of direct exchange, there will always be a tendency on the market for one money price to be established for each good. We have seen that the basic rule is that each seller tries to sell his good for the highest attainable money price, and each buyer tries to buy the good for the lowest attainable money price. The actions of the buyers and sellers will always and rapidly tend to establish one price on the market at any given time. If the “ruling” market price for 100 barrels of fish, for example, is five ounces—i.e., if sellers and buyers believe that they can sell and buy the fish they desire for five ounces per 100 barrels—then no buyer will pay six ounces, and no seller will accept four ounces for the fish. Such action will obtain for all goods on the market, establishing the rule that, for the entire market society, every homogeneous good will tend to be bought and sold at one particular money price at any given time.

What, then, are the forces that determine at what point this uniform money price for each good tends to be set? We shall soon see that, as demonstrated in chapter 2, the determinants are the individual value scales, expressed through demand and supply schedules.

We must remember that, in the course of determining the “fish-price of horses” in the direct exchange of fish as against horses, at the same time there was also determined the “horse-price of fish.” In the exchanges of a money economy, what is the “goods-price of money” and how is it determined?

Let us consider the foregoing list of typical exchanges against money. These exchanges established the money prices of four different goods on the market. Now let us reverse the process and divide the quantities of goods by the quantity of money in the exchange. This gives us:

This sort of list, or “array,” goes on and on for each of the myriad exchanges of goods against money. The inverse of the money price of any good gives us the “goods-price” of money in terms of that particular good. Money, in a sense, is the only good that remains, as far as its prices are concerned, in the same state that every good was in a regime of barter. In barter, every good had only its ruling market price in terms of every other good: fish-price of eggs, horse-price of movies, etc. In a money economy, every good except money now has one market price in terms of money. Money, on the other hand, still has an almost infinite array of “goods-prices” that establish the “goods-price of money.” The entire array, considered together, yields us the general “goods-price of money.” For if we consider the whole array of goods-prices, we know what one ounce of money will buy in terms of any desired combination of goods, i.e., we know what that “ounce's worth” of money (which figures so largely in consumers’ decisions) will be.

Alternatively, we may say that the money price of any good discloses what its “purchasing power” on the market will be. Suppose a man possesses 200 barrels of fish. He estimates that the ruling market price for fish is six ounces per 100 barrels, and that therefore he can sell the 200 barrels for 12 ounces. The “purchasing power” of 100 barrels on the market is six ounces of money. Similarly, the purchasing power of a horse may be five ounces, etc. The purchasing power of a stock of any good is equal to the amount of money it can “buy” on the market and is therefore directly determined by the money price that it can obtain. As a matter of fact, the purchasing power of a unit of any quantity of a good is equal to its money price. If the market money price of a dozen eggs (the unit) is 1/8 ounce of gold, then the purchasing power of the dozen eggs is also 1/8 of an ounce. Similarly, the purchasing power of a horse, above, was five ounces; of an hour of X's labor, three ounces; etc.

For every good except money, then, the purchasing power of its unit is identical to the money price that it can obtain on the market. What is the purchasing power of the monetary unit? Obviously, the purchasing power of, e.g., an ounce of gold can be considered only in relation to all the goods that the ounce could purchase or help to purchase. The purchasing power of the monetary unit consists of an array of all the particular goods-prices in the society in terms of the unit.2 It consists of a huge array of the type above: 1/5 horse per ounce; 20 barrels of fish per ounce; 16 dozen eggs per ounce; etc.

It is evident that the money commodity and the determinants of its purchasing power introduce a complication in the demand and supply schedules of chapter 2 that must be worked out; there cannot be a mere duplication of the demand and supply schedules of barter conditions, since the demand and supply situation for money is a unique one. Before investigating the “price” of money and its determinants, we must first take a long detour and investigate the determination of the money prices of all the other goods in the economy.

  • 1. [PUBLISHER'S NOTE: Page numbers cited in parentheses within the text refer to the present edition.] The exceptions are direct exchanges that might be made between two goods on the basis of their hypothetical exchange ratios on the market. These exchanges, however, are relatively isolated and unimportant and depend on the money prices of the two goods.
  • 2. Many writers interpret the “purchasing power of the monetary unit” as being some sort of “price level,” a measurable entity consisting of some sort of average of “all goods combined.” The major classical economists did not take this fallacious position:
    When they speak of the value of money or of the level of prices without explicit qualification, they mean the array of prices, of both commodities and services, in all its particularity and without conscious implication of any kind of statistical average. (Jacob Viner, Studies in the Theory of International Trade [New York: Harper & Bros., 1937], p. 314)
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