The Positive Theory of Capital
Book IV, Chapter I
The Fundamental Law
Exchanges are not made simply for amusement. People who take the—not always trifling—trouble to exchange the goods which they possess for other goods, do so for a rational and material end, and, in nine hundred and ninety-nine cases out of a thousand, this end is to better their economical condition by the exchange.*1 Whether this end be attained, and in what degree it be attained, depends naturally on the current conditions of exchange, particularly on the prices which the parties get as equivalent for their goods. It is, therefore, a perfectly natural thing that the motive which gives rise to exchange in general, namely, the striving after economical advantage, should maintain a commanding influence in the fixing of the exchange prices.
In what follows I mean to inquire how prices are determined under the assumption that all who take part in the exchange act exclusively from the motive of pursuing their immediate economical advantage in it. The law which we shall arrive at in this way I have already,*2 for very good reasons, called the fundamental law of the formation of price. I am perfectly aware that, in practical life, this law does not exactly obtain. For, although the motive of self-advantage is almost never absent, and is almost always the most prominent motive, still, in price transactions, other motives do very often get mixed up; such motives as humanity, custom, friendship, vanity, or the influence of outside institutions, such as government taxation, union regulations, boards for fixing wages, and the like, give them another direction than that they would have taken if exclusively dominated by self-advantage. Such motives, indeed, scarcely ever get the upper hand of the other to the extent of making us conclude an exchange which would cause us positive economic loss; but they often make us decide to be content with a less amount of advantage than we should have got in steadily pursuing our interests.
I have on the same occasion*3 expressed myself with all clearness on the theoretical and practical importance of the admixture of these other influences, and I shall only now briefly sum up what I then said. In actual life this admixture of motives causes certain modifications of the fundamental law of the formation of price, and the statement of these modifications cannot be neglected in any accurate and complete theory of it. But if all that is wanted is to grasp the characteristic features of the formation of price, it is enough to put forward the "fundamental law" above mentioned. For just as, among the motives that determine price, that of striving after self-advantage in exchange has the lions share, so does the lion's share in the theoretic explanation of the phenomena of price fall to the "fundamental law " here stated. And it is sufficient for us in our present task, as we have not to pursue the theory of price as an end in itself, but only so far as is necessary to establish the theoretical connection between the elementary phenomena of subjective value and the complicated phenomena of interest. In this law we obtain a principle which is not minutely accurate, but is amply sufficient for the further development of the theory of capital.
Before going on to state the peculiar laws of price, it may be desirable to preface them by some considerations that may, more accurately, unfold the content of the fundamental motive which forms the assumption and basis of the whole of the following inquiry.
In exchange transactions the decisions made always turn on two points; these are—(1) whether, in a given state of things, a man should exchange or not; and (2) if he decide to exchange, what form he should try to give to the terms of the exchange. Now in making these decisions it is obvious that the man who looks to his own immediate advantage and nothing else, will act according to the following rules. First, he will exchange only if the exchange brings him an advantage. Second, he will rather exchange for a greater advantage than for a less. Third, he will rather exchange for a small advantage than not exchange at all.
It scarcely need be shown that these three rules are dictated by our fundamental motive, and constitute the practical substance of it; what does require elucidation is an expression that recurs in them all, "to exchange with advantage."
The meaning of the expression obviously is—to exchange in such a way that the exchanger gains more in wellbeing from the goods he gets than he loses in the goods he gives; or, since the importance that goods have for life and wellbeing is expressed in their subjective value, to exchange in such a way that the goods received possess a greater subjective value than the goods parted with. If A owns a horse and is willing to exchange it for ten casks of wine, it can only be because the ten casks of wine have a greater value for him than his horse has. But, naturally, the other party to the contract thinks exactly in the same way. He, on his part, will not give up the ten casks of wine if he does not get for them a good that has a greater value for him. He will exchange his ten casks for A's horse only if the wine is worth less to him than the horse is.
From this we get an important rule. An exchange is economically possible only between persons who put a different value, even an opposite value, upon the commodity and upon the price equivalent.*4 The buyer must put a higher, the seller a lower, estimate on the commodity than he does on the equivalent. Indeed the interest which the two parties have in the exchange, and the gain they get from it, increases as the difference between their estimates increases; if the difference decreases their gain decreases; and if the difference disappears, and their estimates coincide, no exchange is, economically, possible between them.*5
It is easy to see that, under the regime of the division of labour, there must be innumerable chances of opposing estimates, and therefore innumerable opportunities of exchange. That is to say, as each producer makes only one or two kinds of articles, and these far in excess of his own personal requirements, he has at once a superfluity of his own products and an absence of all others. He will, therefore, ascribe to his own product a low subjective value, and to other products a relatively high subjective value. But, conversely, the other producers will ascribe a high value to all products which they have not, and a low value to their own products of which they have too many, and here we have in the fullest degree that relation of opposite valuations which is most favourable to the effecting of exchange.
Another idea that comes out in what has been said we may follow to its logical consequences. To one consulting his own advantage an exchange, as we saw, is economically possible only when he estimates the good to be acquired more highly than the good possessed. Now, obviously, this will more readily occur the less value he puts on his own commodity, and the more value he puts on the equivalent. A man who values his horse, subjectively, at £50, and values a cask of wine at £10, has, economically, a much greater possibility of exchange—or, as we shall say in future for brevity's sake, is much more "capable of exchange"—than another who values his horse at £100 and a cask of wine at £5. The former, obviously, can proceed with the exchange if six casks are offered him for his horse, while the latter must hold back unless something over twenty casks is offered him. If a third party again values his horse at £40 only, and a cask of wine at £15, obviously he would be economically capable of concluding an exchange if even three casks were offered him. Generally speaking, then, that exchanger is the "most capable" who puts the least value on his own commodity in comparison with that offered him in exchange, or, what is the same thing, puts the highest value on the other commodity in comparison with the commodity which he offers in exchange for it.
Now that we are sufficiently acquainted with the meaning and content of our "fundamental motive," we may proceed with our proper work, and consider what are the normal effects which this fundamental motive exerts on the formation of price. In this part of our work the method already pursued by several distinguished economists seems to me by far the most convenient: first, by typical illustrations to show how, under certain definite assumptions, price is and must be determined, and then to separate the accidental surroundings of the illustration from what is universal and typical, and formulate the latter into laws. I shall begin with the simplest typical case, the determination of price in isolated exchange between a single pair of exchangers.
Notes for this chapter
Menger, Grundsätze, p. 153. Of course now and then exchanges may be made simply to show some person a kindness; perhaps to conceal a present, or a charity in the guise of an exchange. But such cases form only a quite insignificant minority.
Grundzüge, part ii., in Conrad's Jahrbücher, vol. xiii. p. 486.
Grundzüge, p. 480.
It will be observed that our author does not confine the word Price to Money price, but applies it to the equivalent good or goods obtained in exchange for what is, pre-eminently, the good—the object of demand from buyers, and of supply from sellers. The convenient word Preisgut I render by "price equivalent," or simply "equivalent."—W. S.
Say, e.g., that A values his horse at five casks of wine, while B values it at fifteen, then, if the horse goes for ten casks, each gains an amount of value represented by five casks of wine. If A values the horse at eight and B values it at twelve, each gains only a value of two casks. Finally, if both agree in valuing the horse at twelve casks of wine, B, of course, would be glad to get the horse for ten casks, or for any price under twelve casks, but A, naturally, would not give it him at that price. See Menger, Grundsätze der Volkswirthschaftslehre, p. 155.
End of Notes
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