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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.27
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.28 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.29 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.
- 27. Wicksteed, Common Sense of Political Economy, I, 21–22.
- 28. 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.
- 29. 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.