THE ANALYSIS IN CHAPTER 1 WAS based on the logical implications of the assumption of action, and its results hold true for all human action. The application of these principles was confined, however, to “Crusoe economics,” where the actions of isolated individuals are considered by themselves. In these situations, there are no interactions between persons. Thus, the analysis could easily and directly be applied to n number of isolated Crusoes on n islands or other isolated areas. The next task is to apply and extend the analysis to consider interactions between individual human beings.

Let us suppose that Crusoe eventually finds that another individual, say Jackson, has also been living an isolated existence at the other end of the island. What types of interaction may now take place between them? One type of action is violence. Thus, Crusoe may entertain a vigorous hatred toward Jackson and decide to murder or otherwise injure him. In that case, Crusoe would gain his end—murder of Jackson—by committing violence. Or Crusoe may decide that he would like to expropriate Jackson’s house and collection of furs and murder Jackson as a means to that end. In either case, the result is that Crusoe gains in satisfaction at the expense of Jackson, who, to say the least, suffers great psychic loss. Fundamentally similar is action based on a threat of violence, or intimidation. Thus, Crusoe may hold up Jackson at the point of a knife and rob him of his accumulated furs and provisions. Both examples are cases of violent action and involve gain for one at the expense of another.

The following factors, singly or in combination, might work to induce Crusoe (or Jackson) to refrain from any violent action against the other:

(1) He may feel that the use of violence against any other human being is immoral, i.e., that refraining from violence against another person is an end in itself, whose rank in his value scale is higher than that of any advantages in the form of capital or consumers’ goods that he might gain from such action.

(2) He may decide that instituting violent action might well establish an unwelcome precedent, causing the other person to take up arms against him, so that he may end by being the victim instead of the victor. If he begins a type of action where one must gain at the expense of another, then he must face the fact that he might turn out to be the loser as a result of the action.

(3) Even if he feels that his violent action eventually will result in victory over the other, he may conclude that the “costs of the war” would exceed his net gain from the victory. Thus, the disutility of time and labor-energy spent in fighting the war (war may be defined as violent action used by two or more opponents), in accumulating weapons for the war (capital goods for war uses), etc., might, in prospect, outweigh the spoils of conquest.

(4) Even if Crusoe feels reasonably certain of victory and believes that the costs of fighting will be far less than the utility of his spoils of victory, this short-run gain may well be outweighed in his decision by long-run losses. Thus, his conquest of Jackson’s furs and house may add to his satisfaction for a while after the “period of production” (= preparing for the war + the length of time of the war itself), but, after a time, his house will decay and his furs will become worthless. He may then conclude that, by his murder of Jackson, he has lost permanently many services which Jackson’s continued existence might have furnished. This might be companionship or other types of consumers’ or capital goods. How Jackson might have served Crusoe without resort to violence will be indicated below, but, at any rate, Crusoe may be detained from using violence by estimating the disutility of the long-run consequences more highly than the utility of the expected short-run gains. On the other hand, his time preference may be so high as to cause his short-run gains to override the long-run losses in his decision.

It is possible that Crusoe may institute violent action without taking into consideration the costs of the war or the long-run consequences, in which case his actions will turn out to be erroneous, i.e., the means he used were not the appropriate ones to maximize his psychic revenue.

Instead of murdering his opponent, Crusoe might find it more useful to enslave him, and, under continual threat of violence, to force Jackson to agree to expend his labor for the satisfaction of Crusoe’s wants rather than his own.1 Under slavery, the master treats the slaves as he does his livestock, horses, and other animals, using them as factors of production to gratify his wants, and feeding, housing them, etc., just enough to enable them to continue in the master’s service. It is true that the slave agrees to this arrangement, but this agreement is the result of a choice between working for the master and injury through violence. Labor under these conditions is qualitatively different from labor not under the threat of violence, and may be called compulsory labor as compared to free labor or voluntary labor. If Jackson agrees to continue working as a slave under Crusoe’s dictates, it does not mean that Jackson is an enthusiastic advocate of his own slavery. It simply means that Jackson does not believe that revolt against his master will better his condition, because of the costs of the revolt in terms of possible violence inflicted on him, the labor of preparing and fighting, etc.

The argument that the slave might be an enthusiastic supporter of the system because of the food, etc., provided by his master ignores the fact that, in that case, violence and the threat of violence by the master would not be necessary. Jackson would simply voluntarily place himself in Crusoe’s service, and this arrangement would not be slavery, but another type considered in the next section.2 ,3 It is clear that the slave is always worse off than he would be without the threat of violence by the master, and therefore, that the master always gains at the expense of the slave.

The interpersonal relation under slavery is known as hegemonic.4 The relationship is one of command and obedience, the commands being enforced by threats of violence. The master uses the slaves as instruments, as factors of production, for gratifying his wants. Thus, slavery, or hegemony, is defined as a system in which one must labor under the orders of another under the threat of violence. Under hegemony, the man who does the obeying—the “slave,” “serf,” “ward,” or “subject”— makes only one choice among two alternatives: (1) to subject himself to the master or “dictator”; or (2) to revolt against the regime of violence by use of his own violence or by refusing to obey orders. If he chooses the first course, he submits himself to the hegemonic ruler, and all the other decisions and actions are made by that ruler. The subject chooses once in choosing to obey the ruler; the other choices are made by the ruler. The subject acts as a passive factor of production for use by the master. After that one act of (continual) choice made by the slave, he engages in coerced or compulsory labor, and the dictator alone is free to choose and act.

Violent action may result in the following developments: (a) inconclusive fighting, with neither opponent the victor, in which case the war may continue intermittently for a long period of time, or violent action may cease and peace be established (the absence of war); (b) the victor may kill the victim, in which case there is no further interpersonal action between the two; (c) the victor may simply rob the victim and leave, to return to isolation, or perhaps with intermittent violent forays; or (d) the victor may establish a continuing hegemonic tyranny over the victim by threats of violence.

In course (a), the violent action has proved abortive and erroneous; in (b), there is no further interpersonal interaction; in (c), there is an alternation between robbery and isolation; and in (d), a continuing hegemonic bond is established.

Of these results, only in (d) has a continuing pattern of interpersonal relationship been constituted. These relations are compulsory, involving the following coerced “exchanges”: the slaves are treated as factors of production in exchange for food and other provisions; the masters acquire factors of production in exchange for supplying the provisions. Any continuing pattern of interpersonal exchanges is called a society, and it is clear that a society has been established only in case (d).5 In the case of Crusoe’s enslavement of Jackson, the society established is a totally hegemonic one.

The term “society,” then, denotes a pattern of interpersonal exchanges among human beings. It is obviously absurd to treat “society” as “real,” with some independent force of its own. There is no reality to society apart from the individuals who compose it and whose actions determine the type of social pattern that will be established.

We have seen in chapter 1 that all action is an exchange, and we may now divide exchanges into two categories. One is autistic exchange. Autistic exchange consists of any exchange that does not involve some form of interpersonal exchange of services. Thus, all of isolated Crusoe’s exchanges were autistic. On the other hand, the case of slavery did involve interpersonal exchange, in which each gives up some goods in order to acquire other goods from the other. In this form of compulsory exchange, however, only the ruler benefits from the exchange, since he is the only one who makes it of his own free choice. Since he must impose the threat of violence in order to induce the subject to make the exchange, it is clear that the latter loses by the exchange. The master uses the subject as a factor of production for his own profit at the latter’s expense, and this hegemonic relationship may be called exploitation. Under hegemonic exchange, the ruler exploits the subject for the ruler’s benefit.6

• 1For a discussion of the transformation from murder to slavery, cf. Franz Oppenheimer, The State (New York: Vanguard Press, 1914, reprinted 1928), pp. 55–70 and passim.
• 2It is true that man, being what he is, cannot absolutely guarantee lifelong service to another under a voluntary arrangement. Thus, Jackson, at present, might agree to labor under Crusoe’s direction for life, in return for food, clothing, etc., but he cannot guarantee that he will not change his mind at some point in the future and decide to leave. In this sense, a man’s own person and will is “inalienable,” i.e., cannot be given up to someone else for any future period.
• 3Such an arrangement is not a guarantee of “security” of provisions, since no one can guarantee a steady supply of such goods. It simply means that A believes that B is better able to furnish a supply of these goods than he is himself.
• 4Cf. Mises, Human Action, pp. 196–99, and, for a comparison of slaves and animals, ibid., pp. 624–30.
• 5There is, of course, no judgment at this point concerning whether the establishment of a society or such a society is a good, bad, or indifferent development.
• 6This system has sometimes been called “compulsory co-operation,” but we prefer to limit the term “co-operation” to the result of voluntary choices.

From this point on, we shall develop an analysis of the workings of a society based purely on voluntary action, entirely unhampered by violence or threats of violence. We shall examine interpersonal actions that are purely voluntary, and have no trace of hegemonic relations. Then, after working out the laws of the unhampered market, we shall trace the nature and results of hegemonic relations—of actions based on violence or the threat of violence. We shall note the various effects of violent interference with voluntary actions and shall consider the consequences of approaches to a regime of total hegemony, of pure slavery or subjection. At present, we shall confine our discussion to an analysis of actions unhampered by the existence of violence of man against man.

The major form of voluntary interaction is voluntary interpersonal exchange. A gives up a good to B in exchange for a good that B gives up to A. The essence of the exchange is that both people make it because they expect that it will benefit them; otherwise they would not have agreed to the exchange. A necessary condition for an exchange to take place is that the two goods have reverse valuations on the respective value scales of the two parties to the exchange. Thus, suppose A and B are the two exchangers, and A gives B good X in exchange for good Y. In order for this exchange to take place, the following must have been their value scales before making the exchange:

(Parentheses around the good indicate that the party does not have it in his stock; absence of parentheses indicates that he has.) A possesses good X, and B possesses good Y, and each evaluates the good of the other more highly than his own. After the exchange is made, both A and B have shifted to a higher position on their respective value scales.

Thus, the conditions for an exchange to take place are that the goods are valued in reverse order by the two parties and that each of the parties knows of the existence of the other and the goods that he possesses. Without knowledge of the other person’s assets, no exchange of these assets could take place.

It is clear that the things that must be exchanged are goods, which will be useful to the receiving party. The goods may be present or future goods (or claims to future goods, which may be considered as equivalent to future goods), they may be capital goods or consumers’ goods, labor or nature-given factors. At any rate, the objects of an exchange must be scarce means to human ends, since, if they were available in abundance for all, they would be general conditions of human welfare and not objects of human action. If something were a general condition of human welfare, there would be no need to give something up to acquire it, and it would not become the object of exchange.

If the goods in question are unique goods with a supply of one unit, then the problem of when exchanges will or will not be made is a simple one. If A has a vase and B a typewriter, if each knows of the other’s asset, and if A values the typewriter more highly, and B values the vase more highly, there will be an exchange. If, on the other hand, either A or B values whatever he has more highly than what the other has, then an exchange will not take place. Similarly, an exchange will not take place if either party has no knowledge that the other party has a vase or a typewriter.

On the other hand, if the goods are available in supplies of homogeneous units, the problem becomes more complex. Here, in determining how far exchanges of the two goods will go, the law of marginal utility becomes the decisive factor.8 If Jones and Smith have certain quantities of units of goods X and Y in their possession, then in order for Jones to trade one unit of X for one unit of Y, the following conditions have to be met: To Jones, the marginal utility of the added unit of Y must be greater than the marginal utility of the unit of X given up; and to Smith, the marginal utility of the added unit of X must be greater than the marginal utility of the unit of Y given up. Thus:

(The marginal utilities of the goods to Jones and to Smith are, of course, not comparable, since they cannot be measured, and the two value scales cannot be reduced to one measure or scale.)

However, as Jones continues to exchange with Smith units of X for units of Y, the marginal utility of X to Jones increases, because of the law of marginal utility. Furthermore, the marginal utility of the added unit of Y continues to decrease as Jones’ stock of Y increases, because of the operation of this law. Eventually, therefore, Jones will reach a point where, in any further exchange of X for Y, the marginal utility of X will be greater than the marginal utility of the added unit of Y, so that he will make no further exchange. Furthermore, Smith is in a similar position. As he continues to exchange Y for X, for him the marginal utility of Y increases, and the marginal utility of the added unit of X decreases, with the operation of the law of marginal utility. He too will eventually reach a point where a further exchange will lower rather than raise his position on his value scale, so that he will decline to make any further exchange. Since it takes two to make a bargain, Jones and Smith will exchange units of X for units of Y until one of them reaches a point beyond which further exchange will lead to loss rather than profit.

Thus, suppose that Jones begins with a position where his assets (stock of goods) consist of a supply of five horses and zero cows, while Smith begins with assets of five cows and zero horses. How much, if any, exchanges of one cow for one horse will be effected is reflected in the value scales of the two people. Thus, suppose that Jones’ value diagram is as shown in Figure 5. The dots represent the value of the marginal utility of each additional cow, as Jones makes exchanges of one horse for one cow. The crosses represent the increasing marginal utility of each horse given up as Jones makes exchanges. Jones will stop trading after the third exchange, when his assets consist of two horses and three cows, since a further such exchange will make him worse off.

On the other hand, suppose that Smith’s value diagram appears as in Figure 6. The dots represent the marginal utility to Smith of each additional horse, while the crosses represent the marginal utility of each cow given up. Smith will stop trading after two exchanges, and therefore Jones will have to stop after two exchanges also. They will end with Jones having a stock of three horses and two cows, and Smith with a stock of three cows and two horses.

It is almost impossible to overestimate the importance of exchange in a developed economic system. Interpersonal exchanges have an enormous influence on productive activities. Their existence means that goods and units of goods have not only direct use-value for the producer, but also exchange-value. In other words, goods may now be exchanged for other goods of greater usefulness to the actor. A man will exchange a unit of a good so long as the goods that it can command in exchange have greater value to him than the value it had in direct use, i.e., so long as its exchange-value is greater than its direct use-value. In the example above, the first two horses that Jones exchanged and the first two cows surrendered by Smith had a greater exchange value than direct use-value to their owners. On the other hand, from then on, their respective assets had greater use-value to their owners than exchange-value.9

The existence and possibilities of exchange open up for producers the avenue of producing for a “market” rather than for themselves. Instead of attempting to maximize his product in isolation by producing goods solely for his own use, each person can now produce goods in anticipation of their exchange-value, and exchange these goods for others that are more valuable to him. It is evident that since this opens a new avenue for the utility of goods, it becomes possible for each person to increase his productivity. Through praxeology, therefore, we know that only gains can come to every participant in exchange and that each must benefit by the transaction; otherwise he would not engage in it. Empirically we know that the exchange economy has made possible an enormous increase in productivity and satisfactions for all the participants.

Thus, any person can produce goods either for his own direct use or for purposes of exchange with others for goods that he desires. In the former case, he is the consumer of his own product; in the latter case, he produces in the service of other consumers, i.e., he “produces for a market.” In either case, it is clear that, on the unhampered “market,” it is the consumers who dictate the course of production.

At any time, a good or a unit of a good may have for its possessor either direct use-value or exchange-value or a mixture of both, and whichever is the greater is the determinant of his action. Examples of goods with only direct use-value to their owner are those in an isolated economy or such goods as eyeglasses ground to an individual prescription. On the other hand, producers of such eyeglasses or of surgical instruments find no direct use-value in these products, but only exchange-value. Many goods, as in the foregoing example of exchange, have both direct and exchange-value for their owners. For the latter goods, changing conditions may cause direct use-value to replace exchange-value in the actor’s hierarchy of values, or vice versa. Thus, if a person with a stock of wine happens to lose his taste for wine, the previous greater use-value that wine had for him will change, and the wine’s exchange-value will take precedence over its use-value, which has now become almost nil. Similarly, a grown person may exchange the toys that he had used as a child, now that their use-value has greatly declined.

On the other hand, the exchange-value of goods may decline, causing their possessors to use them directly rather than exchange them. Thus, a milliner might make a hat for purposes of exchange, but some minor defect might cause its expected exchange value to dwindle, so that the milliner decides to wear the hat herself.

One of the most important factors causing a change in the relationship between direct use-value and exchange-value is an increase in the number of units of a supply available. From the law of marginal utility we know that an increase in the supply of a good available decreases the marginal utility of the supply for direct use. Therefore, the more units of supply are available, the more likely will the exchange-value of the marginal unit be greater than its value in direct use, and the more likely will its owner be to exchange it. The more horses that Jones had in his stock, and the more cows Smith had, the more eager would they be to exchange them. Conversely, a decrease in supply will increase the likelihood that direct use-value will predominate.

The network of voluntary interpersonal exchanges forms a society; it also forms a pattern of interrelations known as the market. A society formed solely by the market has an unhampered market, or a free market, a market not burdened by the interference of violent action. A society based on voluntary exchanges is called a contractual society. In contrast to the hegemonic society based on the rule of violence, the contractual type of society is based on freely entered contractual relations between individuals. Agreements by individuals to make exchanges are called contracts, and a society based on voluntary contractual agreements is a contractual society. It is the society of the unhampered market.

In a contractual society, each individual benefits by the exchange-contract that he makes. Each individual is an actor free to make his own decisions at every step of the way. Thus, the relations among people in an unhampered market are “symmetrical”; there is equality in the sense that each person has equal power to make his own exchange-decisions. This is in contrast to a hegemonic relationship, where power is asymmetrical—where the dictator makes all the decisions for his subjects except the one decision to obey, as it were, at bayonet point.

Thus, the distinguishing features of the contractual society, of the unhampered market, are self-responsibility, freedom from violence, full power to make one’s own decisions (except the decision to institute violence against another), and benefits for all participating individuals. The distinguishing features of a hegemonic society are the rule of violence, the surrender of the power to make one’s own decisions to a dictator, and exploitation of subjects for the benefit of the masters. It will be seen below that existing societies may be totally hegemonic, totally contractual, or various mixtures of different degrees of the two, and the nature and consequences of these various “mixed economies” and totally hegemonic societies will be analyzed.

Before we examine the exchange process further, it must be considered that, in order for a person to exchange anything, he must first possess it, or own it. He gives up the ownership of good X in order to obtain the ownership of good Y. Ownership by one or more owners implies exclusive control and use of the goods owned, and the goods owned are known as property. Freedom from violence implies that no one may seize the property of another by means of violence or the threat of violence and that each person’s property is safe, or “secure,” from such aggression.

What goods become property? Obviously, only scarce means are property. General conditions of welfare, since they are abundant to all, are not the objects of any action, and therefore cannot be owned or become property. On the free market, it is nonsense to say that someone “owns” the air. Only if a good is scarce is it necessary for anyone to obtain it, or ownership of it, for his use. The only way that a man could assume ownership of the air is to use violence to enforce this claim. Such action could not occur on the unhampered market.

On the free, unhampered market, a man can acquire property in scarce goods as follows: (1) In the first place, each man has ownership over his own self, over his will and actions, and the manner in which he will exert his own labor. (2) He acquires scarce nature-given factors either by appropriating hitherto unused factors for his own use or by receiving them as a gift from someone else, who in the last analysis must have appropriated them as hitherto unused factors.10 (3) He acquires capital goods or consumers’ goods either by mixing his own labor with nature-given factors to produce them or by receiving them as a gift from someone else. As in the previous case, gifts must eventually resolve themselves into some actor’s production of the goods by the use of his own labor. Clearly, it will be nature-given factors, capital goods, and durable consumers’ goods that are likely to be handed down through gifts, since nondurable consumers’ goods will probably be quickly consumed. (4) He may exchange any type of factor (labor service, nature-given factor, capital good, consumers’ good) for any type of factor. It is clear that gifts and exchanges as a source of property must eventually be resolved into: self-ownership, appropriation of unused nature-given factors, and production of capital and consumers’ goods, as the ultimate sources of acquiring property in a free economic system. In order for the giving or exchanging of goods to take place, they must first be obtained by individual actors in one of these ways. The logical sequence of events is therefore: A man owns himself; he appropriates unused nature-given factors for his ownership; he uses these factors to produce capital goods and consumers’ goods which become his own; he uses up the consumers’ goods and/or gives them and the capital goods away to others; he exchanges some of these goods for other goods that had come to be owned in the same way by others.11 ,12 These are the methods of acquiring goods that obtain on the free market, and they include all but the method of violent or other invasive expropriation of the property of others.13

In contrast to general conditions of welfare, which on the free market cannot be subject to appropriation as property, scarce goods in use in production must always be under someone’s control, and therefore must always be property. On the free market, the goods will be owned by those who either produced them, first put them to use, or received them in gifts. Similarly, under a system of violence and hegemonic bonds, someone or some people must superintend and direct the operations of these goods. Whoever performs these functions in effect owns these goods as property, regardless of the legal definition of ownership. This applies to persons and their services as well as to material goods. On the free market, each person is a complete owner of himself, whereas under a system of full hegemonic bonds, he is subject to the ownership of others, with the exception of the one decision not to revolt against the authority of the owner. Thus, violent or hegemonic regimes do not and cannot abolish property, which derives from the fundamentals of human action, but can only transfer it from one person or set of people (the producers or natural self-owners) to another set.

We may now briefly sum up the various types of human action in the following table:

          HUMAN ACTION

I. Isolation (Autistic Exchange)
II. Interpersonal Action
     a. Invasive Action
          1. War
          2. Murder, Assault
          3. Robbery
          4. Slavery
     b. Noninvasive Action
          1. Gifts
          2. Voluntary Exchange

This and subsequent chapters are devoted to an analysis of a noninvasive society, particularly that constituted by voluntary interpersonal exchange.

• 8Strictly, the law of marginal utility is also applicable to the case where the supply is only one unit, and we can say that, in the example above, exchange will take place if, for A, the marginal utility of good Y is greater than the marginal utility of good X, and vice versa for B.
• 9On use-value and exchange-value, see Menger, Principles of Economics, pp. 226–35.
• 10Analytically, receiving a factor from someone as a gift simply pushes the problem back another stage. At some point, the actor must have appropriated it from the realm of unused factors, as Crusoe appropriated the unused land on the island.
• 11On self-ownership and the acquisition of property, cf. the classic discussion of John Locke, “An Essay Concerning the True Original Extent and End of Civil Government, Second Treatise” in Ernest Barker, ed., Social Contract (London: Oxford University Press, 1948), pp. 15–30.
• 12The problem of self-ownership is complicated by the question of children. Children cannot be considered self-owners, because they are not yet in possession of the powers of reason necessary to direct their actions. The fact that children are under the hegemonic authority of their parents until they are old enough to become self-owning beings is therefore not contrary to our assumption of a purely free market. Since children are not capable of self-ownership, authority over them will rest in some individuals; on an unhampered market, it would rest in their producers, the parents. On the other hand, the property of the parents in this unique case is not exclusive; the parents may not injure the children at will. Children, not long after birth, begin to acquire the powers of reasoning human beings and embody the potential development of full self-owners. Therefore the child will, on the free market, be defended from violent actions in the same way as an adult. On children, see ibid., pp. 30–38.
• 13For more on invasive and noninvasive acts in a free market, see section 13 below.

In describing the conditions that must obtain for interpersonal exchange to take place (such as reverse valuations), we implicitly assumed that it must be two different goods that are being exchanged. If Crusoe at his end of the island produced only berries, and Jackson at his end produced only the same kind of berries, then no basis for exchange between them would occur. If Jackson produced 200 berries and Crusoe 150 berries, it would be nonsensical to assume that any exchange of berries would be made between them.14 The only voluntary interpersonal action in relation to berries that could occur would be a gift from one to another.

If exchangers must exchange two different goods, this implies that each party must have a different proportion of assets of goods in relation to his wants. He must have relatively specialized in the acquisition of different goods from those the other party produced. This specialization by each individual may have occurred for any one of three different reasons or any combination of the three: (a) differences in suitability and yield of the nature-given factors; (b) differences in given capital and durable consumers’ goods; and (c) differences in skill and in the desirability of different types of labor.15 These factors, in addition to the potential exchange-value and use-value of the goods, will determine the line of production that the actor will pursue. If the production is directed toward exchange, then the exchange-value will play a major role in his decision. Thus, Crusoe may have found abundant crops on his side of the island. These resources, added to his greater skill in farming and the lower disutility of this occupation for him because of a liking for agriculture, might cause him to take up farming, while Jackson’s greater skill in hunting and more abundant game supply induce him to specialize in hunting and trapping. Exchange, a productive process for both participants, implies specialization of production, or division of labor.

The extent to which division of labor is carried on in a society depends on the extent of the market for the products. The latter determines the exchange-value that the producer will be able to obtain for his goods. Thus, if Jackson knows that he will be able to exchange part of his catch of game for the grains and fruits of Crusoe, he may well expend all his labor on hunting. Then he will be able to devote all his labor-time to hunting, while Crusoe devotes his to farming, and their “surplus” stocks will be exchanged up to the limits analyzed in the previous section. On the other hand, if, for example, Crusoe has little use for meat, Jackson will not be able to exchange much meat, and he will be forced to be far more directly self-sufficient, producing his own grains and fruits as well as meat.

It is clear that, praxeologically, the very fact of exchange and the division of labor implies that it must be more productive for all concerned than isolated, autistic labor. Economic analysis alone, however, does not convey to us knowledge of the enormous increase in productivity that the division of labor brings to society. This is based on a further empirical insight, viz., the enormous variety in human beings and in the world around them. It is a fact that, superimposed on the basic unity of species and objects in nature, there is a great diversity. Particularly is there variety in the aforementioned factors that would give rise to specialization: in the locations and types of natural resources and in the ability, skills, and tastes of human beings. In the words of Professor von Mises:

One may as well consider these two facts as one and the same fact, namely, the manifoldness of nature which makes the universe a complex of infinite varieties. If the earth’s surface were such that the physical conditions of production were the same at every point and if one man were ... equal to all other men ... division of labor would not offer any advantages for acting man.16

It is clear that conditions for exchange, and therefore increased productivity for the participants, will occur where each party has a superiority in productivity in regard to one of the goods exchanged—a superiority that may be due either to better nature-given factors or to the ability of the producer. If individuals abandon attempts to satisfy their wants in isolation, and if each devotes his working time to that specialty in which he excels, it is clear that total productivity for each of the products is increased. If Crusoe can produce more berries per unit of time, and Jackson can kill more game, it is clear that productivity in both lines is increased if Crusoe devotes himself wholly to the production of berries and Jackson to hunting game, after which they can exchange some of the berries for some of the game. In addition to this, full-time specialization in a line of production is likely to improve each person’s productivity in that line and intensify the relative superiority of each.

More puzzling is the case in which one individual is superior to another in all lines of production. Suppose, for example, that Crusoe is superior to Jackson both in the production of berries and in the production of game. Are there any possibilities for exchange in this situation? Superficially, it might be answered that there are none, and that both will continue in isolation. Actually, it pays for Crusoe to specialize in that line of production in which he has the greatest relative superiority in production, and to exchange this product for the product in which Jackson specializes. It is clear that the inferior producer benefits by receiving some of the products of the superior one. The latter benefits also, however, by being free to devote himself to that product in which his productive superiority is the greatest. Thus, if Crusoe has a great superiority in berry production and a small one in game production, it will still benefit him to devote his full working time to berry production and then exchange some berries for Jackson’s game products. In an example mentioned by Professor Boulding:

A doctor who is an excellent gardener may very well prefer to employ a hired man who as a gardener is inferior to himself, because thereby he can devote more time to his medical practice.17

This important principle—that exchange may beneficially take place even when one party is superior in both lines of production—is known as the law of association, the law of comparative costs, or the law of comparative advantage.

With all-pervasive variation offering possibilities for specialization, and favorable conditions of exchange occurring even when one party is superior in both pursuits, great opportunities abound for widespread division of labor and extension of the market. As more and more people are linked together in the exchange network, the more “extended” is the market for each of the products, and the more will exchange-value predominate, as compared to direct use-value, in the decisions of the producer. Thus, suppose that there are five people on the desert island, and each specializes in that line of product in which he has a comparative or absolute advantage. Suppose that each one concentrates on the following products:

A ..... berries
B ..... game
C ..... fish
D ..... eggs
E ..... milk

With more people participating in the market process, the opportunities for exchange for each actor are now greatly increased. This is true even though each particular act of exchange takes place between just two people and involves two goods. Thus, as shown in Figure 7, the following network of exchange may take place: Exchange-value now takes a far more dominant place in the decisions of the producers. Crusoe (if A is Crusoe) now knows that if he specializes in berries, he does not now have to rely solely on Jackson to accept them, but can exchange them for the products of several other people. A sudden loss of taste for berries by Jackson will not impoverish Crusoe and deprive him of all other necessities as it would have before. Furthermore, berries will now bring to Crusoe a wider variety of products, each in far greater abundance than before, some being available now that would not have been earlier. The greater productivity and the wider market and emphasis on exchange-value obtain for all participants in the market.

It is evident, as will be explained further in later sections on indirect exchange, that the contractual society of the market is a genuinely co-operative society. Each person specializes in the task for which he is best fitted, and each serves his fellow men in order to serve himself in exchange. Each person, by producing for exchange, co-operates with his fellow men voluntarily and without coercion. In contrast to the hegemonic form of society, in which one person or one group of persons exploits the others, a contractual society leaves each person free to benefit himself in the market and as a consequence to benefit others as well. An interesting aspect of this praxeological truth is that this benefit to others occurs regardless of the motives of those involved in exchange. Thus, Jackson may specialize in hunting and exchange the game for other products even though he may be indifferent to, or even cordially detest, his fellow participants. Yet regardless of his motives, the other participants are benefitted by his actions as an indirect but necessary consequence of his own benefit. It is this almost marvelous process, whereby a man in pursuing his own benefit also benefits others, that caused Adam Smith to exclaim that it almost seemed that an “invisible hand” was directing the proceedings.18

Thus, in explaining the origins of society, there is no need to conjure up any mystic communion or “sense of belonging” among individuals. Individuals recognize, through the use of reason, the advantages of exchange resulting from the higher productivity of the division of labor, and they proceed to follow this advantageous course. In fact, it is far more likely that feelings of friendship and communion are the effects of a regime of (contractual) social co-operation rather than the cause. Suppose, for example, that the division of labor were not productive, or that men had failed to recognize its productivity. In that case, there would be little or no opportunity for exchange, and each man would try to obtain his goods in autistic independence. The result would undoubtedly be a fierce struggle to gain possession of the scarce goods, since, in such a world, each man’s gain of useful goods would be some other man’s loss. It would be almost inevitable for such an autistic world to be strongly marked by violence and perpetual war. Since each man could gain from his fellows only at their expense, violence would be prevalent, and it seems highly likely that feelings of mutual hostility would be dominant. As in the case of animals quarreling over bones, such a warring world could cause only hatred and hostility between man and man. Life would be a bitter “struggle for survival.” On the other hand, in a world of voluntary social co-operation through mutually beneficial exchanges, where one man’s gain is another man’s gain, it is obvious that great scope is provided for the development of social sympathy and human friendships. It is the peaceful, co-operative society that creates favorable conditions for feelings of friendship among men.

The mutual benefits yielded by exchange provide a major incentive (as in the case of Crusoe above) to would-be aggressors (initiators of violent action against others) to restrain their aggression and co-operate peacefully with their fellows. Individuals then decide that the advantages of engaging in specialization and exchange outweigh the advantages that war might bring.

Another feature of the market society formed by the division of labor is its permanence. The wants of men are renewed for each period of time, and so they must try to obtain for themselves anew a supply of goods for each period. Crusoe wants to have a steady rate of supply of game, and Jackson would like to have a continuing supply of berries, etc. Therefore, the social relations formed by the division of labor tend to be permanent as individuals specialize in different tasks and continue to produce in those fields.

There is one, less important, type of exchange that does not involve the division of labor. This is an exchange of the same types of labor for certain tasks. Thus, suppose that Crusoe, Jackson, and Smith are trying to clear their fields of logs. If each one engaged solely in the work of clearing his own field, it would take a long period of time. However, if each put in some time in a joint effort to roll the other fellow’s logs, the productivity of the log-rolling operations would be greatly increased. Each man could finish the task in a shorter period of time. This is particularly true for operations such as rolling heavy logs, which each man alone could not possibly accomplish at all and which they could perform only by agreed-upon joint action. In these cases, each man gives up his own labor in someone else’s field in exchange for receiving the labor of the others in his field, the latter being worth more to him. Such an exchange involves a combination of the same type of labor, rather than a division of labor into different types, to perform tasks beyond the ready capacity of an isolated individual. This type of co-operative “log-rolling,” however, would entail merely temporary alliances based on specific tasks, and, would not, as do specialization and division of labor, establish permanent exchange-ties and social relations.19

The great scope of the division of labor is not restricted to situations in which each individual makes all of one particular product, as was the case above. Division of labor may entail the specializing by individuals in the different stages of production necessary to produce a particular consumers’ good. Thus, with a wider market permitting, different individuals specialize in the different stages, for example, involved in the production of the ham sandwich discussed in the previous chapter. General productivity is greatly increased as some people and some areas specialize in producing iron ore, some in producing different types of machines, some in baking bread, some in packaging meat, some in retailing, etc. The essence of developed market economies consists in the framework of co-operative exchange emerging with such specialization.20

• 14It is possible that Crusoe and Jackson, for the mutual fun of it, might pass 50 berries back and forth between them. This, however, would not be genuine exchange, but joint participation in an enjoyable consumers’ good—a game or play.
• 15Basically, class (b) is resolvable into differences in classes (a) and (c), which account for their production.
• 16Mises, Human Action, pp. 157 ff. On the pervasiveness of variation, also cf. F.A. Harper, Liberty, A Path to Its Recovery (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1949), pp. 65–77, 139–41.
• 17Kenneth E. Boulding, Economic Analysis (1st ed.; New York: Harper & Bros., 1941), p. 30; also ibid., pp. 22–32.
• 18Those critics of Adam Smith and other economists who accuse the latter of “assuming” that God or Nature directs the market process by an “invisible hand” for the benefit of all participants completely miss the mark. The fact that the market provides for the welfare of each individual participating in it is a conclusion based on scientific analysis, not an assumption upon which the analysis is based. The “invisible hand” was simply a metaphor used in commenting on this process and its results. Cf. William D. Grampp, “Adam Smith and the Economic Man,” Journal of Political Economy, August, 1948, pp. 315–36, especially pp. 319–20.
• 19See Mises, Human Action, pp. 157–58.
• 20Such specialization of stages requires the adoption of indirect exchange, discussed in the following chapters.

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.

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

One22 of the most important problems in economic analysis is the question: What principles determine the formation of prices on the free market? What can be said by logical derivation from the fundamental assumption of human action in order to explain the determination of all prices in interpersonal exchanges, past, present, and future?

It is most convenient to begin with a case of isolated exchange, a case where only two isolated parties are involved in the exchange of two goods. For example, Johnson and Smith are considering a possible exchange of a horse of the former for some barrels of fish possessed by the latter. The question is: What can economic analysis say about the determinants of the exchange rate established between the two goods in the exchange?

An individual will decide whether or not to make an exchange on the basis of the relative positions of the two goods on his value scale. Thus, suppose the value scale of Smith, the possessor of the fish, is as follows:

(Any desired numbers of rank could be assigned to the various quantities, but these are not necessary here.)

It is clear that Smith would be willing to acquire a horse from Johnson if he could give up 100 barrels of fish or less. One hundred barrels or less are less valuable to Smith than the horse. On the other hand, 101 or more barrels of fish are more valuable to him than the horse. Thus, if the price of the horse in terms of the fish offered by Smith is 100 barrels or less, then Smith will make the exchange. If the price is 101 barrels or more, then the exchange will not be made.

Suppose Johnson’s value scale looks like this:

Then, Johnson will not give up his horse for less than 102 barrels of fish. If the price offered for his horse is less than 102 barrels of fish, he will not make the exchange. Here, it is clear that no exchange will be made; for at Johnson’s minimum selling price of 102 barrels of fish, it is more beneficial for Smith to keep the fish than to acquire the horse.

In order for an exchange to be made, then, the minimum selling price of the seller must be lower than the maximum buying price of the buyer for that good. In this case, it must be lower than the price of 100 barrels of fish per horse. Suppose that this condition is met, and Johnson’s value scale is as follows:

Johnson will sell the horse for any amount of fish at or above 81 barrels. This, then, is his minimum selling price for the horse. With this as Johnson’s value scale, and Smith’s as pictured in Figure 8, what price will they agree upon for the horse (and, conversely, for the fish)? All analysis can say about this problem is that, since the exchange must be for the mutual benefit of both parties, the price of the good in isolated exchange will be established somewhere between the maximum buying price and the minimum selling price, i.e., the price of the horse will be somewhere between 100 barrels and 81 barrels of fish. (Similarly, the price of the fish will be set somewhere between 1/81 and 1/100 of a horse per barrel.) We cannot say at which point the price will be set. That depends on the data of each particular case, on the specific conditions prevailing. In particular, it will depend upon the bargaining skill of the two individuals. Clearly, Johnson will try to set the price of the horse as high as possible, while Smith will try to set the price as low as possible. This is based on the principle that the seller of the product tries to obtain the highest price, while the buyer tries to secure the lowest price. We cannot predict the point that the two will agree on, except that it will be somewhere in this range set by the two points.23

Now, let us gradually remove our assumption of isolated exchange. Let us first assume that Smith has a competitor, Brown, a rival in offering fish for the desired horse of Johnson’s. We assume that the fish offered by Brown is of identical serviceability to Johnson as the fish offered by Smith. Suppose that Smith’s value scale is the same as before, but that Brown’s value scale is such that the horse is worth more than 90 barrels of fish to him, but less than 91 barrels. The value scales of the three individuals will then appear as is shown in Figure 11.

Brown and Smith are competing for the purchase of Johnson’s horse. Clearly, only one of them can make the exchange for the horse, and since their goods are identical to Johnson, the latter’s decision to exchange will be decided by the price offered for the horse. Obviously, Johnson will make the exchange with that potential buyer who will offer the highest price. Their value scales are such that Smith and Brown can continue to overbid each other as long as the price range is between 81 and 90 barrels of fish per horse. Thus, if Smith offers Johnson an exchange at 82 barrels per horse, Brown can compete by raising the bid to 84 barrels of fish per horse, etc. This can continue, however, only until Brown’s maximum buying price has been exceeded. If Smith offers 91 barrels for the horse, it no longer pays for Brown to make the exchange, and he drops out of the competition. Thus, the price in the exchange will be high enough to exclude the “less capable” or “less urgent” buyer—the one whose value scale does not permit him to offer as high a price as the other, “more capable,” buyer. We do not know exactly what the price will be, but we do know that it will be set by bargaining somewhere at or below the maximum buying price of the most capable buyer and above the maximum buying price of the next most capable buyer. It will be somewhere between 100 barrels and 91 barrels, and the exchange will be made with Smith. We see that the addition of another competing buyer for the product considerably narrows the zone of bargaining in determining the price that will be set.

This analysis can easily be extended to a case of one seller and n number of buyers (each offering the same commodity in exchange). Thus, suppose that there are five potential buyers for the horse, all offering fish, whose value scales are as follows:

With only one horse to be disposed of to one buyer, the buyers overbid each other until each must drop out of the competition. Finally, Smith can outbid A, his next most capable competitor, only with a price of 100. We see that in this case, the price in the exchange is uniquely determined—once the various value scales are given—at 100, since at a lower price A is still in the bidding, and, at a higher price, no buyer will be willing to conclude the exchange. At any rate, even if the value scales are not such as to determine the price uniquely, the addition of more competitors greatly narrows the bargaining zone. The general rule still holds: The price will be between the maximum buying price of the most capable and that of the next most capable competitor, including the former and excluding the latter.24

It is also evident that the narrowing of the bargaining zone has taken place in an upward direction, and to the advantage of the seller of the product.

The case of one-sided competition of many sellers with just one buyer is the direct converse of the above and may be considered by merely reversing the example and considering the price of the fish instead of the price of the horse. As more sellers of the fish competed to conclude the exchange with the one buyer, the zone of determination of the price of fish narrowed, although this time in a downward direction and to the further advantage of the buyer. As more sellers were added, each tried to underbid his rival—to offer a lower price for the product than his competitors. The sellers continued to underbid each other until all but the one seller were excluded from the market. In a case of many sellers and one buyer, the price will be set at a point between the minimum selling price of the second most capable and that of the most capable competitor—strictly, at a point below the former and down to or including the latter. In the final example above, the point was pushed down to be uniquely determined at the latter point—1/100 horse per barrel.

We have so far considered the cases of one buyer and more than one seller, and of one seller and more than one buyer. We now come to the only case with great importance in a modern, complex economy based on an intricate network of exchanges: two-sided competition of buyers and sellers. Let us therefore consider a market with any number of competing buyers and sellers. Any product could be considered, but our hypothetical example will continue to be the sale of horses in exchange for fish (with the horses as well as the fish considered by all parties as homogeneous units of the same good). The following is a list of the maximum buying prices of the various buyers, based on the valuations on their respective value scales:

The following is a list of the minimum selling prices of the various sellers on the market:

The “most capable buyer” of horses we recognize as Smith, with a buying price of 100 barrels. Johnson is the “most capable seller”— the seller with the lowest minimum selling price—at 81 barrels. The problem is to find the principle by which the price, or prices, of the exchanges of horses will be determined.

Now, let us first take the case of X1—Smith. It is clear that it is to the advantage of Smith to make the exchange at a price of 100 barrels for the horse. Yet it is to Smith’s greater advantage to buy the good at the lowest possible price. He is not engaged in overbidding his competitors merely for the sake of overbidding. He will try to obtain the good for the lowest price that he can. Therefore, Smith will prefer to begin bidding for a horse at the lowest prices offered by his competitors, and only raise the offered price if it becomes necessary to do so in order to avoid being shut out of the market. Similarly, Johnson would make an advantageous sale at a price of 81 barrels. However, he is interested in selling his product at the highest possible price. He will underbid his competitor only if it becomes necessary to do so in order to avoid being shut out of the market without making a sale.

It is evident that buyers will tend to start negotiations by offering as low prices as possible, while sellers will tend to start by asking for as high a price as they think they can obtain. Clearly, this preliminary “testing of the market” will tend to be more prolonged in a “new” market, where conditions are unfamiliar, while it will tend to be less prolonged in an “old” market, where the participants are relatively familiar with the results of the price-formation process in the past and can estimate more closely what the results will be.

Let us suppose that buyers begin by offering the low price of 82 barrels for a horse. Here is a price at which each of the buyers would be glad to make a purchase, but only one seller, Z1, would be willing to sell at 82. It is possible that Z1, through ignorance, might conclude the exchange with some one of the buyers at 82, without realizing that he could have obtained a higher price. It is also possible that the other buyers will, through ignorance, permit the buyer to get away with this windfall without overbidding him for this cheap horse. But such a result is not very likely. It seems most likely that Z1 will not sell at such a low price, and that the buyers would immediately overbid any attempt by one of their number to conclude an exchange at that price. Even if, by some chance, one exchange was concluded at 82, it is obvious that such a price could not last. Since no other seller would make an exchange at that price, the price of further exchanges would have to rise further, as a result of upbidding by buyers.

Let us assume at this point that no exchange will be made at this price because of the further upbidding of the buyers and the knowledge of this by the sellers. As the offering price rises, the least capable buyers, as in the previous case, begin to be excluded from the market. A price of 84 will bring two sellers into the market, but will exclude X9 from the buyer’s side. As the offering price rises, the disproportion between the amount offered for sale and the amount demanded for purchase at the given price diminishes, but as long as the latter is greater than the former, mutual overbidding of buyers will continue to raise the price. The amount offered for sale at each price is called the supply; the amount demanded for purchase at each price is called the demand. Evidently, at the first price of 82, the supply of horses on the market is one; the demand for horses on the market is nine. Only one seller would be willing to sell at this price, while all nine buyers would be willing to make their purchase. On the basis of the above tabulations of maximum buying prices and minimum selling prices, we are able to present a list of the quantities of the good that will be demanded and supplied at each hypothetical price.

This table reflects the progressive entry into the market of the sellers as the price increases and the dropping out of the buyers as the price increases. As was seen above, as long as the demand exceeds the supply at any price, buyers will continue to overbid and the price will continue to rise.

The converse occurs if the price begins near its highest point. Thus, if sellers first demand a price of 101 barrels for the horse, there will be eight eager sellers and no buyers. At a price of 99 the sellers may find one eager buyer, but chances are that a sale will not be made. The buyer will realize that there is no point in paying such a high price, and the other sellers will eagerly underbid the one who tries to make the sale at the price of 99. Thus, when the price is so high that the supply exceeds the demand at that price, underbidding of suppliers will drive the price downward. As the tentative price falls, more sellers are excluded from the market, and more buyers enter it.

If the overbidding of buyers will drive the price up whenever the quantity demanded is greater than the quantity supplied, and the underbidding of sellers drives the price down whenever supply is greater than demand, it is evident that the price of the good will find a resting point where the quantity demanded is equal to the quantity supplied, i.e., where supply equals demand. At this price and at this price only, the market is cleared, i.e., there is no incentive for buyers to bid prices up further or for sellers to bid prices down. In our example, this final, or equilibrium price, is 89, and at this price, five horses will be sold to five buyers. This equilibrium price is the price at which the good will tend to be set and sales to be made.25

Specifically, the sales will be made to the five most capable buyers at that price: X1, X2, X3, X4, and X5. The other less-capable (or less urgent) buyers are excluded from the market, because their value scales do not permit them to buy horses at that price. Similarly, sellers Z1–Z5 are the ones that make the sale at 89; the other sellers are excluded from the market, because their value scales do not permit them to be in the market at that price.

In this horse-and-fish market, Z5 is the least capable of the sellers who have been able to stay in the market. Z5, whose minimum selling price is 89, is just able to make his sale at 89. He is the marginal seller—the seller at the margin, the one who would be excluded with a slight fall in price. On the other hand, X5 is the least capable of the buyers who have been able to stay in the market. He is the marginal buyer—the one who would be excluded by a slight rise in price. Since it would be foolish for the other buyers to pay more than they must to obtain their supply, they will also pay the same price as the marginal buyer, i.e., 89. Similarly, the other sellers will not sell for less than they could obtain; they will sell at the price permitting the marginal seller to stay in the market.

Evidently, the more capable or “more urgent,” buyers (and sellers)—the supramarginal (which includes the marginal)— obtain a psychic surplus in this exchange, for they are better off than they would have been if the price had been higher (or lower). However, since goods can be ranked only on each individual’s value scale, and no measurement of psychic gain can be made either for one individual or between different individuals, little of value can be said about this psychic gain except that it exists. (We cannot even make the statement, for example, that the psychic gain in exchange obtained by X1 is greater than that of X5.) The excluded buyers and sellers are termed submarginal.

The specific feature of the “clearing of the market” performed by the equilibrium price is that, at this price alone, all those buyers and sellers who are willing to make exchanges can do so. At this price five sellers with horses find five buyers for the horses; all who wish to buy and sell at this price can do so. At any other price, there are either frustrated buyers or frustrated sellers. Thus, at a price of 84, eight people would like to buy at this price, but only two horses are available. At this price, there is a great amount of “unsatisfied demand” or excess demand. Conversely, at a price of, say, 95, there are seven sellers eager to supply horses, but only three people willing to demand horses. Thus, at this price, there is “unsatisfied supply,” or excess supply. Other terms for excess demand and excess supply are “shortage” and “surplus” of the good. Aside from the universal fact of the scarcity of all goods, a price that is below the equilibrium price creates an additional shortage of supply for demanders, while a price above equilibrium creates a surplus of goods for sale as compared to demands for purchase. We see that the market process always tends to eliminate such shortages and surpluses and establish a price where demanders can find a supply, and suppliers a demand.

It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply “quoted” by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to “move” their accumulation of unwanted stocks and to clear the market.

The case where buyers quote prices and therefore appear to set them is similar. If the buyers quote prices below the equilibrium price, they will find that they cannot satisfy all their demands at that price. As a result, they will have to raise their quoted prices. On the other hand, if the buyers set the prices too high, they will find a stampede of sellers with unsalable stocks and will take advantage of the opportunity to lower the price and clear the market. Thus, regardless of the form of the market, the result of the market process is always to tend toward the establishment of the equilibrium price via the mutual bidding of buyers and sellers.

It is evident that, if we eliminate the assumption that no preliminary sales were made before the equilibrium price was established, this does not change the results of the analysis. Even if, through ignorance and error, a sale was made at a price of 81 or 99, these prices still will be ephemeral and temporary, and the final price for the good will tend to be the equilibrium price.

Once the market price is established, it is clear that one price must rule over the entire market. This has already been implied by the fact that all buyers and sellers will tend to exchange at the same price as their marginal competitors. There will always be a tendency on the market to establish one and only one price at any time for a good. Thus, suppose that the market price has been established at 89, and that one crafty seller tries to induce a buyer to buy at 92. It is evident that no buyer will buy at 92 when he knows that he can buy on the regular market at 89. Similarly, no seller will be willing to sell at a price below the market if he knows that he can readily make his sale at 89. If for example, an ignorant seller sells a horse at 87, the buyer is likely to enter the market as a seller to sell the horse at 89. Such drives for arbitrage gains (buying and selling to take advantage of discrepancies in the price of a good) act quickly to establish one price for one good over the entire market. Such market prices will tend to change only when changing supply and demand conditions alter the equilibrium price and establish a condition of excess supply or excess demand where before the market had been cleared.

A clearer picture of equilibrium prices as determined by supply and demand conditions will be derived from the graphical representation in Figure 13.

It is evident that, as the price increases, new suppliers with higher minimum selling prices are brought into the market, while demanders with low maximum buying prices will begin to drop out. Therefore, as the price decreases, the quantity demanded must always either remain the same or increase, never decrease. Similarly, as the price decreases, the amount offered in supply must always decrease or remain the same, never increase. Therefore, the demand curve must always be vertical or rightward-sloping as the price decreases, while the supply curve must always be vertical or leftward-sloping as the price decreases. The curves will intersect at the equilibrium price, where supply and demand are equal.

Clearly, once the zone of intersection of the supply and demand curves has been determined, it is the buyers and sellers at the margin—in the area of the equilibrium point—that determine what the equilibrium price and the quantity exchanged will be.

The tabulation of supply offered at any given price is known as the supply schedule, while its graphical presentation, with the points connected here for the sake of clarity, is known as the supply curve. Similarly, the tabulation of demand is the demand schedule, and its graphical representation the demand curve, for each product and market. Given the point of intersection, the demand and supply curves above and below that point could take many conceivable shapes without affecting the equilibrium price. The direct determinants of the price are therefore the marginal buyers and sellers, while the valuations of the supra-marginal people are important in determining which buyers and sellers will be at the margin. The valuations of the excluded buyers and sellers far beyond the margin have no direct influence on the price and will become important only if a change in the market demand and supply schedules brings them near the intersection point.

Thus, given the intersection point, the pattern of supply and demand curves (represented by the solid and dotted lines) could be at least any one of the variants shown in Figure 14.

Up to this point we have assumed, for the sake of simplicity and clarity, that each demander, as well as each supplier, was limited to one unit of the good the price of which we have been concentrating on—the horse. Now we can remove this restriction and complete our analysis of the real world of exchange by permitting suppliers and demanders to exchange any number of horses that they may desire. It will be seen immediately that the removal of our implicit restriction makes no substantial change in the analysis. Thus, let us revert to the case of Johnson, whose minimum selling price for a horse was 81 barrels of fish. Let us now assume that Johnson has a stock of several horses. He is willing to sell one horse—the first—for a minimum price of 81 barrels, since on his value scale, he places the horse between 81 and 80 barrels of fish. What will be Johnson’s minimum selling price to part with his second horse? We have seen earlier in this chapter that, according to the law of marginal utility, as a man’s stock of goods declines, the value placed on each unit remaining increases; conversely, as a man’s stock of goods increases, the marginal utility of each unit declines. Therefore, the marginal utility of the second horse (or, strictly, of each horse after the first horse is gone), will be greater than the marginal utility of the first horse. This will be true even though each horse is capable of the same service as every other. Similarly, the value of parting with a third horse will be still greater. On the other hand, while the marginal utility placed on each horse given up increases, the marginal utility of the additional fish acquired in exchange will decline. The result of these two factors is inevitably to raise the minimum selling price for each successive horse sold. Thus, suppose the minimum selling price for the first horse is 81 barrels of fish. When it comes to the second exchange, the value forgone of the second horse will be greater, and the value of the same barrels in exchange will decline. As a result, the minimum selling price below which Johnson will not sell the horse will increase, say, to 88. Thus, as the seller’s stock dwindles, his minimum selling price increases. Johnson’s value scale may appear as in Figure 15.

On the basis of this value scale, Johnson’s own individual supply schedule can be constructed. He will supply zero horses up to a price of 80, one horse at a price between 81 and 87, two horses with the price between 88 and 94, three horses at a price of 95 to 98, and four horses at a price of 99 and above. The same can be done for each seller in the market. (Where the seller has only one horse to sell, the supply schedule is constructed as before.) It is clear that a market-supply schedule can be constructed simply by adding the supplies that will be offered by the various individual sellers in the market at any given price.

The essentials of the foregoing analysis of market supply remain unchanged. Thus, the effect of constructing the market-supply schedule in this case is the same as if there were four sellers, each supplying one horse, and each with minimum selling prices of 81, 88, 95, and 99. The fact that it is one man that is supplying the new units rather than different men does not change the results of the analysis. What it does is to reinforce the rule that the supply curve must always be vertical or rightward-sloping as the price increases, i.e., that the supply must always remain unchanged or increase with an increase in price. For, in addition to the fact that new suppliers will be brought into the market with an increase in price, the same supplier will offer more units of the good. Thus, the operation of the law of marginal utility serves to reinforce the rule that the supply cannot decrease at higher prices, but must increase or remain the same.

The exact converse occurs in the case of demand. Suppose that we allow buyers to purchase any desired number of horses. We remember that Smith’s maximum buying price for the first horse was 100 barrels of fish. If he considers buying a second horse, the marginal utility of the additional horse will be less than the utility of the first one, and the marginal utility of the same amount of fish that he would have to give up will increase. If the marginal utility of the purchases declines as more are made, and the marginal utility of the good given up increases, these factors result in lower maximum buying prices for each successive horse bought. Thus, Smith’s value scale might appear as in Figure 16.

Such individual demand schedules can be made for each buyer on the market, and they can be added to form a resultant demand curve for all buyers on the market.

It is evident that, here again, there is no change in the essence of the market-demand curve. Smith’s individual demand curve, with maximum buying prices as above, is analytically equivalent to four buyers with maximum buying prices of 83, 89, 94, and 100, respectively. The effect of allowing more than one unit to be demanded by each buyer brings in the law of marginal utility to reinforce the aforementioned rule that the demand curve is rightward-sloping as the price decreases, i.e., that the demand must either increase or remain unchanged as the price decreases.

For, added to the fact that lower prices bring in previously excluded buyers, each individual will tend to demand more as the price declines, since the maximum buying prices will be lower with the purchase of more units, in accordance with the law of marginal utility.

Let us now sum up the factors determining prices in interpersonal exchange. One price will tend to be established for each good on the market, and that price will tend to be the equilibrium price, determined by the intersection of the market supply and demand schedules. Those making the exchanges at this price will be the supramarginal and marginal buyers and sellers, while the less capable, or submarginal, will be excluded from the sale, because their value scales do not permit them to make an exchange. Their maximum buying prices are too low, or their minimum selling prices too high. The market supply and demand schedules are themselves determined by the minimum selling prices and maximum buying prices of all the individuals in the market. The latter, in turn, are determined by the placing of the units to be bought and sold on the individuals’ value scales, these rankings being influenced by the law of marginal utility.

In addition to the law of marginal utility, there is another factor influencing the rankings on each individual’s value scale. It is obvious that the amount that Johnson will supply at any price is limited by the stock of goods that he has available. Thus, Johnson may be willing to supply a fourth horse at a price of 99, but if this exhausts his available stock of horses, no higher price will be able to call forth a larger supply from Johnson. At least this is true as long as Johnson has no further stock available to sell. Thus, at any given time, the total stock of the good available puts a maximum limit on the amount of the good that can be supplied in the market. Conversely, the total stock of the purchasing good will put a maximum limit on the total of the sale good that any one individual, or the market, can demand.

At the same time that the market supply and demand schedules are setting the equilibrium price, they are also clearly setting the equilibrium quantity of both goods that will be exchanged. In our previous example, the equilibrium quantities exchanged are five horses, and 5 × 89, or 445 barrels of fish, for the aggregate of the market.

• 22Cf. Böhm-Bawerk, Positive Theory of Capital, pp. 195–222. Also cf. Fetter, Economic Principles, pp. 42–72; and Menger, Principles of Economics, pp. 191–97.
• 23Of course, given other value scales, the final prices might be determinate at our point, or within a narrow range. Thus, if Smith’s maximum buying price is 87, and Johnson’s minimum selling price is 87, the price will be uniquely determined at 87.
• 24Auction sales are examples of markets for one unit of a good with one seller and many buyers. Cf. Boulding, Economic Analysis, pp. 41–43.
• 25It is possible that the equilibrium point will not be uniquely determined at one definite price. Thus, the pattern of supply and demand schedules might be as follows:
  P     S     D
  89    5     6
  90    6     5The inequality is the narrowest possible, but there is no one point of equality. In that case, if the units are further divisible, then the price will be set to clear the market at a point in between, say 89.5 barrels of fish per horse. If both goods being exchanged are indivisible further, however, such as cows against horses, then the equilibrium price will be either 89 or 90, and this will be the closest approach to equilibrium rather than equilibrium itself.

The demand schedule tells us how many units of the purchase good will be bought at each hypothetical price.26 From this schedule we may easily find the total number of units of the sale good that will be expended at each price. Thus, from Table 2, we find that at a price of 95, three horses will be demanded. If three horses are demanded at a price of 95 barrels of fish, then the total number of units of the sale good that will be offered in exchange will be 3 × 95, or 285 barrels of fish. This, then, is the total outlay of the sale good that will be offered on the market at that price.

The total outlay of the sale good at each hypothetical price is shown in Table 3.

Figure 17 is a graphic presentation of the total outlay curve. It is evident that this is a logical derivation from the demand curve and that therefore it too is a curve of outlay by buyers at each hypothetical price.

A striking feature of the total outlay curve is that, in contrast to the other curves (such as the demand curve), it can slope in either direction as the price increases or decreases. The possibility of a slope in either direction stems from the operation of the two factors determining the position of the curve. Outlay = Price × Quantity Demanded (of purchase good). But we know that as the price decreases, the demand must either increase or remain the same. Therefore, a decrease in price tends to be counteracted by an increase in quantity, and, as a result, the total outlay of the sale good may either increase or decrease as the price changes.

For any two prices, we may compare the total outlay of the sale good that will be expended by buyers. If the lower price yields a greater total outlay than the higher price, the total outlay curve is defined as being elastic over that range. If the lower price yields a lower total outlay than the higher price, then the curve is inelastic over that range.

 Alternatively, we may say that the former case is that of an elasticity greater than unity, the latter of an elasticity less than unity, and the case where the total outlay is the same for the two prices is one of unit elasticity, or elasticity equal to one. Since numerical precision in the concept of elasticity is not important, we may simply use the terms “inelastic,” “elastic,” and (for the last case) “neutral.”

Some examples will clarify these concepts. Thus, suppose that we examine the total outlay schedule at prices of 96 and 95. At 96, the total outlay is 192 barrels; at 95, it is 285 barrels. The outlay is greater at the lower price, and hence the outlay schedule is elastic in this range. On the other hand, let us take the prices 95 and 94. At 94, the outlay is 282. Consequently, the schedule here is inelastic. It is evident that there is a simple geometrical device for deciding whether or not the demand curve is elastic or inelastic between two hypothetical prices: if the outlay curve is further to the right at the lower price, the demand curve is elastic; if further to the left, the latter is inelastic.

There is no reason why the concept of elasticity must be confined to two prices next to each other. Any two prices on the schedule may be compared. It is evident that an examination of the entire outlay curve demonstrates that the foregoing demand curve is basically elastic. It is elastic over most of its range, with the exception of a few small gaps. If we compare any two rather widely spaced prices, it is evident that the outlay is less at the higher price. If the price is high enough, the demand for any good will dwindle to zero, and therefore the outlay will dwindle to zero.

Of particular interest is the elasticity of the demand curve at the equilibrium price. Going up a step to the price of 90, the curve is clearly elastic—total outlay is less at the higher price. Going down a step to 88, the curve is also elastic. This particular demand curve is elastic in the neighborhood of the equilibrium price. Other demand curves, of course, could possibly be inelastic at their equilibrium price.

Contrary to what might be thought at first, the concept of “elasticity of supply” is not a meaningful one, as is “elasticity of demand.” If we multiply the quantity supplied at each price by the price, we obtain the number of barrels of fish (the sale good) which the sellers will demand in exchange. It will easily be seen, however, that this quantity always increases as the price increases, and vice versa. At 82 it is 82, at 84 it is 168, at 88 it is 352, etc. The reason is that its other determinant, quantity supplied, changes in the same direction as the price, not in the inverse direction as does quantity demanded. As a result, supply is always “elastic,” and the concept is an uninteresting one.27

• 26Cf. Benham, Economics, pp. 60–63.
• 27The attention of some writers to the elasticity of supply stems from an erroneous approach to the entire analysis of utility, supply, and demand. They assume that it is possible to treat human action in terms of “infinitely small” differences, and therefore to apply the mathematically elegant concepts of the calculus, etc., to economic problems. Such a treatment is fallacious and misleading, however, since human action must treat all matters only in terms of discrete steps. If, for example, the utility of X is so little smaller than the utility of Y that it can be regarded as identical or negligibly different, then human action will treat them as such, i.e., as the same good. Because it is conceptually impossible to measure utility, even the drawing of continuous utility curves is pernicious. In the supply and demand schedules, it is not harmful to draw continuous curves for the sake of clarity, but the mathematical concepts of continuity and the calculus are not applicable. As a result, the seemingly precise concept of “elasticity at a point” (percentage increase in demand divided by a “negligibly small” percentage decrease in price) is completely out of order. It is this mistaken substitution of mathematical elegance for the realities of human action that lends a seeming importance to the concept of “elasticity of supply,” comparable to the concept of elasticity of demand.

We have seen that market price is, in the final analysis, determined by the intersection of the supply and demand schedules. It is now in order to consider further the determinants of these particular schedules. Can we establish any other conclusions concerning the causes of the shape and position of the supply and demand schedules themselves?

We remember that, at any given price, the amount of a good that an individual will buy or sell is determined by the position of the sale good and the purchase good on his value scale. He will demand a good if the marginal utility of adding a unit of the purchase good is greater than the marginal utility of the sale good that he must give up. On the other hand, another individual will be a seller if his valuations of the units are in a reverse order. We have seen that, on this basis, and reinforced by the law of marginal utility, the market demand curve will never decrease when the price is lowered, and the supply curve will never increase when the price decreases.

Let us further analyze the value scales of the buyers and sellers. We have seen above that the two sources of value that a good may have are direct use-value and exchange-value, and that the higher value is the determinant for the actor. An individual, therefore, can demand a horse in exchange for one of two reasons: its direct use-value to him or the value that he believes it will be able to command in exchange. If the former, then he will be a consumer of the horse’s services; if the latter, then he purchases in order to make a more advantageous exchange later. Thus, suppose in the foregoing example, that the existing market price has not reached equilibrium—that it is now at 85 barrels per horse. Many demanders may realize that this price is below the equilibrium and that therefore they can attain an arbitrage profit by buying at 85 and reselling at the final, higher price.

We are now in a position to refine the analysis in the foregoing section, which did not probe the question whether or not sales took place before the equilibrium price was reached. We now assume explicitly that the demand schedule shown in Table 2 referred to demand for direct use by consumers. Smoothing out the steps in the demand curve represented in Figure 13, we may, for purposes of simplicity and exposition, portray it as in Figure 18. This, we may say, is the demand curve for direct use. For this demand curve, then, the approach to equilibrium takes place through actual purchases at the various prices, and then the shortages or the surpluses reveal the overbidding or underbidding, until the equilibrium price is finally reached.

To the extent that buyers foresee the final equilibrium price, however, they will not buy at a higher price (even though they would have done so if that were the final price), but will wait for the price to fall. Similarly, if the price is below the equilibrium price, to the extent that the buyers foresee the final price, they will tend to buy some of the good (e.g., horses) in order to resell at a profit at the final price. Thus, if exchange-value enters the picture, and a good number of buyers act on their anticipations, the demand curve might change as shown in Figure 19. The old demand curve, based only on demand for use, is DD, and the new demand curve, including anticipatory forecasting of the equilibrium price, is D′D′. It is clear that such anticipations render the demand curve far more elastic, since more will be bought at the lower price and less at the higher.

Thus, the introduction of exchange-value can restrict demand above the anticipated equilibrium price and increase it below that price, although the final demand—to consume—at the equilibrium price will remain the same.

Now, let us consider the situation of the seller of the commodity. The supply curve in Figure 13 treats the amount supplied at any price without considering possible equilibrium price. Thus, we may say that, with such a supply curve, sales will be made en route to the equilibrium price, and shortages or surpluses will finally reveal the path to the final price. On the other hand, suppose that many sellers anticipate the final equilibrium price. Clearly, they will refuse to make sales at a lower price, even though they would have done so if that were the final price. On the other hand, they will sell more above the equilibrium price, since they will be able to make an arbitrage profit by selling their horses above the equilibrium price and buying them back at the equilibrium price. Thus, the supply curve, with such anticipations, may change as shown in Figure 20. The supply curve changes, as a result of anticipating the equilibrium price, from SS to S′S′.

Let us suppose the highly unlikely event that all demanders and suppliers are able to forecast exactly the final, equilibrium price. What would be the pattern of supply and demand curves on the market in such an extreme case? It would be as follows: At a price above equilibrium (say 89) no one would demand the good, and suppliers would supply their entire stock. At a price below equilibrium, no one would supply the good, and everyone would demand as much as he could purchase, as shown in Figure 21. Such unanimously correct forecasts are not likely to take place in human action, but this case points up the fact that, the more this anticipatory, or speculative, element enters into supply and demand, the more quickly will the market price tend toward equilibrium. Obviously, the more the actors anticipate the final price, the further apart will be supply and demand at any price differing from equilibrium, the more drastic the shortages and surpluses will be, and the more quickly will the final price be established.

Up to now we have assumed that this speculative supply and demand, this anticipating of the equilibrium price, has been correct, and we have seen that these correct anticipations have hastened the establishment of equilibrium. Suppose, however, that most of these expectations are erroneous. Suppose, for example, that the demanders tend to assume that the equilibrium price will be lower than it actually is. Does this change the equilibrium price or obstruct the passage to that price? Suppose that the demand and supply schedules are as shown in Figure 22. Suppose that the basic demand curve is DD, but that the demanders anticipate lower equilibrium prices, thus changing and lowering the demand curve to D′D′. With the supply curve given at SS, this means that the intersection of the supply and demand schedules will be at Y instead of X, say at 85 instead of 89. It is clear, however, that this will be only a provisional resting point for the price. As soon as the price settles at 85, the demanders see that shortages develop at this price, that they would like to buy more than is available, and the overbidding of the demanders raises the price again to the genuine equilibrium price.

The same process of revelation of error occurs in the case of errors of anticipation by suppliers, and thus the forces of the market tend inexorably toward the establishment of the genuine equilibrium price, undistorted by speculative errors, which tend to reveal themselves and be eliminated. As soon as suppliers or demanders find that the price that their speculative errors have set is not really an equilibrium and that shortages and/or surpluses develop, their actions tend once again to establish the equilibrium position.

The actions of both buyers and sellers on the market may be related to the concepts of psychic revenue, profit, and cost. We remember that the aim of every actor is the highest position of psychic revenue and thus the making of a psychic profit compared to his next best alternative—his cost. Whether or not an individual buys depends on whether it is his best alternative with his given resources—in this case, his fish. His expected revenue in any action will be balanced against his expected cost—his next best alternative. In this case, the revenue will be either (a) the satisfaction of ends from the direct use of the horse or (b) expected resale of the horse at a higher price—whichever has the highest utility to him. His cost will be either (a) the marginal utility of the fish given up in direct use or (b) (possibly) the exchange-value of the fish for some other good or (c) the expected future purchase of the horse at a lower price—whichever has the highest utility. He will buy the horse if the expected revenue is greater; he will fail to buy if the expected cost is greater. The expected revenue is the marginal utility of the added horse for the buyer; the expected cost is the marginal utility of the fish given up. For either revenue or cost, the higher value in direct use or in exchange will be chosen as the marginal utility of the good.

Now let us consider the seller. The seller, as well as the buyer, attempts to maximize his psychic revenue by trying to attain a revenue higher than his psychic cost—the utility of the next best alternative he will have to forgo in taking his action. The seller will weigh the marginal utility of the added sale-good (in this case, fish) against the marginal utility of the purchase-good given up (the horse), in deciding whether or not to make the sale at any particular price.

The psychic revenue for the seller will be the higher of the utilities stemming from one of the following sources: (a) the value in direct use of the sale-good (the fish) or (b) the speculative value of re-exchanging the fish for the horse at a lower price in the future. The cost of the seller’s action will be the highest utility forgone among the following alternatives: (a) the value in direct use of the horse given up or (b) the speculative value of selling at a higher price in the future or (c) the exchange-value of acquiring some other good for the horse. He will sell the horse if the expected revenue is greater; he will fail to sell if the expected cost is greater. We thus see that the situations of the sellers and the buyers are comparable. Both act or fail to act in accordance with their estimate of the alternative that will yield them the highest utility. It is the position of the utilities on the two sets of value scales—of the individual buyers and sellers—that determines the market price and the amount that will be exchanged at that price. In other words, it is, for every good, utility and utility alone that determines the price and the quantity exchanged. Utility and utility alone determines the nature of the supply and demand schedules.

It is therefore clearly fallacious to believe, as has been the popular assumption, that utility and “costs” are equally and independently potent in determining price. “Cost” is simply the utility of the next best alternative that must be forgone in any action, and it is therefore part and parcel of utility on the individual’s value scale. This cost is, of course, always a present consideration of a future event, even if this “future” is a very near one. Thus, the forgone utility in making the purchase might be the direct consumption of fish that the actor might have engaged in within a few hours. Or it might be the possibility of exchanging for a cow, whose utility would be enjoyed over a long period of time. It goes without saying, as has been indicated in the previous chapter, that the present consideration of revenue and of cost in any action is based on the present value of expected future revenues and costs. The point is that both the utilities derived and the utilities forgone in any action refer to some point in the future, even if a very near one, and that past costs play no role in human action, and hence in determining price. The importance of this fundamental truth will be made clear in later chapters.

There is another way of treating supply and demand schedules, which, for some problems of analysis, is more useful than the schedules presented above. At any point on the market, suppliers are engaged in offering some of their stock of the good and withholding their offer of the remainder. Thus, at a price of 86, suppliers supply three horses on the market and withhold the other five in their stock. This withholding is caused by one of the factors mentioned above as possible costs of the exchange: either the direct use of the good (say the horse) has greater utility than the receipt of the fish in direct use; or else the horse could be exchanged for some other good; or, finally, the seller expects the final price to be higher, so that he can profitably delay the sale. The amount that sellers will withhold on the market is termed their reservation demand. This is not, like the demand studied above, a demand for a good in exchange; this is a demand to hold stock. Thus, the concept of a “demand to hold a stock of goods” will always include both demand-factors; it will include the demand for the good in exchange by nonpossessors, plus the demand to hold the stock by the possessors. The demand for the good in exchange is also a demand to hold, since, regardless of what the buyer intends to do with the good in the future, he must hold the good from the time it comes into his ownership and possession by means of exchange. We therefore arrive at the concept of a “total demand to hold” for a good, differing from the previous concept of exchange-demand, although including the latter in addition to the reservation demand by the sellers.

If we know the total stock of the good in existence (here, eight horses), we may, by inspecting the supply and demand schedules, arrive at a “total demand to hold”—or total demand schedule for the market. For example, at a price of 82, nine horses are demanded by the buyers, in exchange, and 8 - 1 = 7 horses are withheld by the sellers, i.e., demanded to be held by the sellers. Therefore, the total demand to hold horses on the market is 9 + 7 = 16 horses. On the other hand, at the price of 97, no horses are withheld by sellers, whose reservation demand is therefore zero, while the demand by buyers is two. Total demand to hold at this price is 0 + 2 = 2 horses.

Table 4 shows the total demand to hold derived from the supply and demand schedule in Table 2, along with the total stock, which is, for the moment, considered as fixed. Figure 23 represents the total demand to hold and the stock.

It is clear that the rightward-sloping nature of the total demand curve is even more accentuated than that of the demand curve. For the demand schedule increases or remains the same as the price falls, while the reservation demand schedule of the sellers also tends to increase as the price falls. The total demand schedule is the result of adding the two schedules. Clearly, the reservation demand of the sellers increases as the price falls for the same reason as does the demand curve for buyers. With a lower price, the value of the purchase-good in direct use or in other and future exchanges relatively increases, and therefore the seller tends to withhold more of the good from exchange. In other words, the reservation demand curve is the obverse of the supply curve.

Another point of interest is that, at the equilibrium price of 89, the total demand to hold is eight, equal to the total stock in existence. Thus, the equilibrium price not only equates the supply and demand on the market; it also equates the stock of a good to be held with the desire of people to hold it, buyers and sellers included. The total stock is included in the foregoing diagram at a fixed figure of eight.

It is clear that the market always tends to set the price of a good so as to equate the stock with the total demand to hold the stock. Suppose that the price of a good is higher than this equilibrium price. Say that the price is 92, at which the stock is eight and the total demand to hold is four. This means four horses exist which their possessors do not want to possess. It is clear that someone must possess this stock, since all goods must be property; otherwise they would not be objects of human action. Since all the stock must at all times be possessed by someone, the fact that the stock is greater than total demand means that there is an imbalance in the economy, that some of the possessors are unhappy with their possession of the stock. They tend to lower the price in order to sell the stock, and the price falls until finally the stock is equated with the demand to hold. Conversely, suppose that the price is below equilibrium, say at 85, where 13 horses are demanded compared to a stock of eight. The bids of the eager nonpossessors for the scarce stock push up the price until it reaches equilibrium.

In cases where individuals correctly anticipate the equilibrium price, the speculative element will tend to render the total demand curve even more “elastic” and flatter. At a higher-than-equilibrium price few will want to keep the stock—the buyers will demand very little, and the sellers will be eager to dispose of the good. On the other hand, at a lower price, the demand to hold will be far greater than the stock; buyers will demand heavily, and sellers will be reluctant to sell their stock. The discrepancies between total demand and stock will be far greater, and the underbidding and overbidding will more quickly bring about the equilibrium price.

We saw above that, at the equilibrium price, the most capable (or “most urgent”) buyers made the exchanges with the most capable sellers. Here we see that the result of the exchange process is that the stock finally goes into the hands of the most capable possessors. We remember that in the sale of the eight horses, the most capable buyers, X1–X5, purchased from the most capable sellers of the good, Z1–Z5. At the conclusion of the exchange, then, the possessors are X1–X5, and the excluded sellers Z6–Z8. It is these individuals who finish by possessing the eight horses, and these are the most capable possessors. At a price of 89 barrels of fish per horse, these were the ones who preferred the horse on their value scales to 89 barrels of fish, and they acted on the basis of this preference. For five of the individuals, this meant exchanging their fish for a horse; for three it meant refusing to part with their horses for the fish. The other nine individuals on the market were the less capable possessors, and they concluded by possessing the fish instead of the horse (even if they started by possessing horses). These were the ones who ranked 89 barrels of fish above one horse on their value scale. Five of these were original possessors of horses who exchanged them for fish; four simply retained the fish without purchasing a horse.

The total demand-stock analysis is a useful twin companion to the supply-demand analysis. Each has advantages for use in different spheres. One relative defect of the total demand-stock analysis is that it does not reveal the differences between the buyers and the sellers. In considering total demand, it abstracts from actual exchanges, and therefore does not, in contrast to the supply-demand curves, determine the quantity of exchanges. It reveals only the equilibrium price, without demonstrating the equilibrium quantity exchanged. However, it focuses more sharply on the fundamental truth that price is determined solely by utility. The supply curve is reducible to a reservation demand curve and to a quantity of physical stock. The demand-stock analysis therefore shows that the supply curve is not based on some sort of “cost” that is independent of utility on individual value scales. We see that the fundamental determinants of price are the value scales of all individuals (buyers and sellers) in the market and that the physical stock simply assumes its place on these scales.28

It is clear, in these cases of direct exchange of useful goods, that even if the utility of goods for buyers or sellers is at present determined by its subjective exchange-value for the individual, the sole ultimate source of utility of each good is its direct use-value. If the major utility of a horse to its possessor is the fish or the cow that he can procure in exchange, and the major value of the latter to their possessors is the horse obtainable in exchange, etc., the ultimate determinant of the utility of each good is its direct use-value to its individual consumer.

• 28On the total demand-stock analysis, see Philip H. Wicksteed, The Common Sense of Political Economy and Selected Papers (London: Routledge and Kegan Paul, 1933), I, 213–38; II, 493–526, and 784–88. Also see Boulding, Economic Analysis, pp. 51–80.

How, then, may we sum up the analysis of our hypothetical horse-and-fish market? We began with a stock of eight horses in existence (and a certain stock of fish as well), and a situation where the relative positions of horses and fish on different people’s value scales were such as to establish conditions for the exchange of the two goods. Of the original possessors, the “most capable sellers” sold their stock of horses, while among the original nonpossessors, the “most capable buyers” purchased units of the stock with their fish. The final price of their sale was the equilibrium price determined ultimately by their various value scales, which also determined the quantity of exchanges that took place at that price. The net result was a shift of the stock of each good into the hands of its most capable possessors in accordance with the relative rank of the good on their value scales. The exchanges having been completed, the relatively most capable possessors own the stock, and the market for this good has come to a close.

With arrival at equilibrium, the exchanges have shifted the goods to the most capable possessors, and there is no further motive for exchange. The market has ended, and there is no longer an active “ruling market price” for either good because there is no longer any motive for exchange. Yet in our experience the markets for almost all goods are being continually renewed.

The market can be renewed again only if there is a change in the relative position of the two goods under consideration on the value scales of at least two individuals, one of them a possessor of one good and the other a possessor of the second good. Exchanges will then take place in a quantity and at a final price determined by the intersection of the new combination of supply and demand schedules. This may set a different quantity of exchanges at the old equilibrium price or at a new price, depending on their specific content. Or it may happen that the new combination of schedules—in the new period of time—will be identical with the old and therefore set the same quantity of exchanges and the same price as on the old market.

The market is always tending quickly toward its equilibrium position, and the wider the market is, and the better the communication among its participants, the more quickly will this position be established for any set of schedules. Furthermore, a growth of specialized speculation will tend to improve the forecasts of the equilibrium point and hasten the arrival at equilibrium. However, in those cases where the market does not arrive at equilibrium before the supply or demand schedules themselves change, the market does not reach the equilibrium point. It becomes continuous, moving toward a new equilibrium position before the old one has been reached.29

The types of change introduced by a shift in the supply and/or the demand schedule may be depicted by the diagrams in Figure 24.

These four diagrams depict eight types of situations that may develop from changes in the supply and demand schedules. It must be noted that these diagrams may apply either to a market that has already reached equilibrium and is then renewed at some later date or to one continuous market that experiences a change in supply and/or demand conditions before reaching the old equilibrium point. Solid lines depict the old schedules, while broken lines depict the new ones.

In all these diagrams straight lines are assumed purely for convenience, since the lines may be of any shape, provided the aforementioned restrictions on the slope of the schedules are met (rightward-sloping demand schedules, etc.).

In diagram (a), the demand schedule of the individuals on the market increases. At each hypothetical price, people will wish to add more than before to their stock of the good—and it does not matter whether these individuals already possess some units of the good or not.

 The supply schedule remains the same. As a result, the new equilibrium price is higher than the old, and the quantity of exchanges made at the new equilibrium position is greater than at the old position.

In diagram (b), the supply schedule increases, while the demand schedule remains the same. At each hypothetical price, people will wish to dispose of more of their stock. The result is that the new equilibrium price is lower than the old, and the equilibrium quantity exchanged is greater.

Diagrams (a) and (b) also depict what will occur when the demand curve decreases and the supply curve decreases, the other schedule remaining the same. All we need do is think of the broken lines as the old schedules, and the solid lines as the new ones. On diagram (a) we see that a decrease in the demand schedule leads to a fall in price and a fall in the quantity exchanged. On diagram (b), we see that a decrease in the supply schedule leads to a rise in price and a fall in the quantity exchanged.

For diagrams (c) and (d), the restriction that one schedule must remain the same while the other one changes is removed. In diagram (c), the demand curve decreases and the supply curve increases. This will definitely lead to a fall in equilibrium price, although what will happen to the quantity exchanged depends on the relative proportion of change in the two schedules, and therefore this result cannot be predicted from the fact of an increase in the supply schedule and a decrease in the demand schedule. On the other hand, a decrease in the supply schedule plus an increase in the demand schedule will definitely lead to a rise in the equilibrium price.

Diagram (d) discloses that an increase in both demand and supply schedules will definitely lead to an increase in the quantity exchanged, although whether or not the price falls depends on the relative proportion of change. Also, a decrease in both supply and demand schedules will lead to a decline in the quantity exchanged. In diagram (c) what happens to the quantity, and in diagram (d) what happens to the price, depends on the specific shape and change of the curves in question.

The conclusions from these diagrams may be summarized in Table 5.

If these are the effects of changes in the demand and supply schedules from one period of time to another, the next problem is to explain the causes of these changes themselves. A change in the demand schedule is due purely to a change in the relative utility-rankings of the two goods (the purchase-good and the sale-good) on the value scales of the individual buyers on the market. An increase in the demand schedule, for example, signifies a general rise in the purchase-good on the value scales of the buyers. This may be due to either (a) a rise in the direct use-value of the good; (b) poorer opportunities to exchange the sale-good for some other good—as a result, say, of a higher price of cows in terms of fish; or (c) a decline in speculative waiting for the price of the good to fall further. The last case has been discussed in detail and has been shown to be self-correcting, impelling the market more quickly towards the true equilibrium. We can therefore omit this case now and conclude that an increase in the demand schedule is due either to an increase in the direct use-value of the good or to a higher price of other potential purchase-goods in terms of the sale-good that buyers offer in exchange.

A decrease in demand schedules is due precisely to the converse cases—a fall in the value in direct use or greater opportunities to buy other purchase-goods for this sale-good. The latter would mean a greater exchange-value—of fish, for example—in other fields of exchange. Changes in opportunities for other types of exchange may be a result of higher or lower prices for the other purchase-goods, or they may be the result of the fact that new types of goods are being offered for fish on the market. The sudden appearance of cows being offered for fish where none had been offered before is a widening of exchange opportunities for fish and will result in a general decline of the demand curve for horses in terms of fish.

A change in the market supply curve is, of course, also the result of a change in the relative rankings of utility on the sellers’ value scales. This curve, however, may be broken down into the amount of physical stock and the reservation-demand schedule of the sellers. If we assume that the amount of physical stock is constant in the two periods under comparison, then a shift in supply curves is purely the result of a change in reservation-demand curves. A decrease in the supply curve caused by an increase in reservation demand for the stock may be due to either (a) an increase in the direct use-value of the good for the sellers; (b) greater opportunities for making exchanges for other purchase-goods; or (c) a greater speculative anticipation of a higher price in the future. We may here omit the last case for the same reason we omitted it from our discussion of the demand curve. Conversely, a fall in the reservation-demand schedule may be due to either (a) a decrease in the direct use-value of the good to the sellers, or (b) a dwindling of exchange opportunities for other purchase-goods.

Thus, with the total stock constant, changes in both supply and demand curves are due solely to changes in the demand to hold the good by either sellers or buyers, which in turn are due to shifts in the relative utility of the two goods. Thus, in both diagrams A and B above, the increase in the demand schedule and a decrease in the supply schedule from S′S′to SS are a result of increased total demand to hold.

In one case the increased total demand to hold is on the part of the buyers, in the other case of the sellers. The relevant diagram is shown in Figure 25. In both cases of an increase in the total demand-to-hold schedule, say from TD to T′D′, the equilibrium price increases. On the contrary, when the demand schedule declines, and/or when the supply schedule increases, these signify a general decrease in the total demand-to-hold schedule and consequently a fall in equilibrium price.

A total demand-stock diagram can convey no information about the quantity exchanged, but only about the equilibrium price. Thus, in diagram (c), the broken lines both represent a fall in demand to hold, and we could consequently be sure that the total demand to hold declined, and that therefore price declined. (The opposite would be the case for a shift from the broken to the solid lines.) In diagram (d), however, since an increase in the supply schedule represented a fall in demand to hold, and an increase in demand was a rise in the demand to hold, we could not always be sure of the net effect on the total demand to hold and hence on the equilibrium price.

From the beginning of the supply-demand analysis up to this point we have been assuming the existence of a constant physical stock. Thus, we have been assuming the existence of eight horses and have been considering the principles on which this stock will go into the hands of different possessors. The analysis above applies to all goods—to all cases where an existing stock is being exchanged for the stock of another good. For some goods this point is as far as analysis can be pursued. This applies to those goods of which the stock is fixed and cannot be increased through production. They are either once produced by man or given by nature, but the stock cannot be increased by human action. Such a good, for example, is a Rembrandt painting after the death of Rembrandt. Such a painting would rank high enough on individual value scales to command a high price in exchange for other goods. The stock can never be increased, however, and its exchange and pricing is solely in terms of the previously analyzed exchange of existing stock, determined by the relative rankings of these and other goods on numerous value scales. Or assume that a certain quantity of diamonds has been produced, and no more diamonds are available anywhere. Again, the problem would be solely one of exchanging the existing stock. In these cases, there is no further problem of production—of deciding how much of a stock should be produced in a certain period of time. For most goods, however, the problem of deciding how much to produce is a crucial one. Much of the remainder of this volume, in fact, is devoted to an analysis of the problem of production.

We shall now proceed to cases in which the existing stock of a good changes from one period to another. A stock may increase from one period to the next because an amount of the good has been newly produced in the meantime. This amount of new production constitutes an addition to the stock. Thus, three days after the beginning of the horse market referred to above, two new horses might be produced and added to the existing stock. If the demand schedule of buyers and the reservation demand schedule of sellers remain the same, what will occur can be represented as in Figure 26.

The increased stock will lower the price of the good. At the old equilibrium price, individuals find that their stock is in excess of the total demand to hold, and the consequence is an underbidding to sell that lowers the price to the new equilibrium.

In terms of supply and demand curves, an increase in stock, with demand and reservation-demand schedules remaining the same, is equivalent to a uniform increase in the supply schedule by the amount of the increased stock—in this case by two horses. The amount supplied would be the former total plus the added two. Possessors with an excess of stock at the old equilibrium price must underbid each other in order to sell the increased stock. If we refer back to Table 2, we find that an increase in the supply schedule by two lowers the equilibrium price to 88, where the demand is six and the new supply is six.

Diagrammatically, the situation may be depicted as in Figure 27.

The increased stock is reflected in a uniform increase in the supply curve, and a consequent fall in price and an increase in the quantity exchanged.

Of course, there is no reason to assume that, in reality, an increased stock will necessarily be accompanied by an unchanged reservation-demand curve. But in order to study the various causal factors that interact to form the actual historical result, it is necessary to isolate each one and consider what would be its effect if the others remained unchanged. Thus, if an increased stock were at the same time absorbed by an equivalent increase in the reservation-demand schedule, the supply curve would not increase at all, and the price and quantity exchanged would remain unchanged. (On the total demand-stock schedule, this situation would be reflected in an increase in stock, accompanied by an offsetting rise in the total-demand curve, leaving the price at the original level.)

A decrease in stock from one period to another may result from the using up of the stock. Thus, if we consider only consumers’ goods, a part of the stock may be consumed. Since goods are generally used up in the process of consumption, if there is not sufficient production during the time considered, the total stock in existence may decline. Thus, one new horse may be produced, but two may die, from one point of time to the next, and the result may be a market with one less horse in existence. A decline in stock, with demand remaining the same, has the exactly reverse effect, as we may see on the diagrams by moving from the broken to the solid lines. At the old equilibrium price, there is an excess demand to hold compared to the stock available, and the result is an upbidding of prices to the new equilibrium. The supply schedule uniformly decreases by the decrease in stock, and the result is a higher price and a smaller quantity of goods exchanged.

We may summarize the relation between stock, production, and time, by stating that the stock at one period (assuming that a period of time is defined as one during which the stock remains unchanged) is related to the stock at a previous period as follows:

If:

St equals stock at a certain period (t)

St– n equals stock at an earlier period (t – n) which is n units of time before period (t) Pn equals production of the good over the period n

Un equals amount of the good used up over the period n

Then:

St = St – n + Pn – Un

Thus, in the case just mentioned, if the original stock is eight horses, and one new horse is produced while two die, the new stock of the good is 8 + 1 – 2 = 7 horses.

It is important to be on one’s guard here against a common confusion over such a term as “an increase in demand.” Whenever this phrase is used by itself in this work, it always signifies an increase in the demand schedule, i.e., an increase in the amounts that will be demanded at each hypothetical price. This “shift of the demand schedule to the right” always tends to cause an increase in price. It must never be confused with the “increase in quantity demanded” that takes place, for example, in response to an increased supply. An increased supply schedule, by lowering price, induces the market to demand the larger quantity offered. This, however, is not an increase in the demand schedule, but an extension along the same demand schedule. It is a larger quantity demanded in response to a more attractive price offer. This simple movement along the same schedule must not be confused with an increase in the demand schedule at each possible price. The diagrams in Figure 28 highlight the difference.

Diagram I depicts an increase in the demand schedule, while diagram II depicts an extension of quantity demanded along the same schedule as a result of an increase in the supply offered. In both cases, the value scales of the various individuals determine the final result, but great confusion can ensue if the concepts are not clearly distinguished when such terms as “increase” or “decrease” in demand are being used.

• 29This situation is not likely to arise in the case of the market equilibria described above. Generally, a market tends to “clear itself” quickly by establishing its equilibrium price, after which a certain number of exchanges take place, leading toward what has been termed the plain state of rest—the condition after the various exchanges have taken place. These equilibrium market prices, however (as will be seen in later chapters), in turn tend to move toward certain long-run equilibria, in accordance with the demand schedule and the effect on the size of stock produced. The supply curve involved in this final state of rest involves the ultimate decisions in producing a commodity and differs from the market supply curve. In the movements toward this “final state,” conditions, such as the demand curve, always change in the interim, thus setting a new final state as the goal of market prices. The final state is never reached. See Mises, Human Action, pp. 245 ff.

We have analyzed the exchanges that take place in existing stock and the effect of changes in the stock of a good. The question still remains: On what principles is the size of the stock itself determined? Aside from the consumers’ or producers’ goods given directly by nature, all goods must be produced by man. (And even seemingly nature-given products must be searched for and then used by man, and hence are ultimately products of human effort.) The size of the stock of any good depends on the rate at which the good has been and is being produced. And since human wants for most goods are continuous, the goods that are worn out through use must constantly be replaced by new production. An analysis of the rate of production and its determinants is thus of central importance in an analysis of human action.

A complete answer to this problem cannot be given at this point, but certain general conclusions on production can be made. In the first place, while any one individual can at different times be both a buyer and a seller of existing stock, in the production of that stock there must be specialization. This omnipresence of specialization has been treated above, and the further an exchange economy develops, the further advanced will be the specialization process. The basis for specialization has been shown to be the varying abilities of men and the varying location of natural resources. The result is that a good comes first into existence by production, and then is sold by its producer in exchange for some other good, which has been produced in the same way. The initial sales of any new stock will all be made by original producers of the good. Purchases will be made by buyers who will use the good either for their direct use or for holding the good in speculative anticipation of later reselling it at a higher price. At any given time, therefore, new stock will be sold by its original producers. The old stock will be sold by: (a) original producers who through past reservation demand had accumulated old stock; (b) previous buyers who had bought in speculative anticipation of reselling at a higher price; and (c) previous buyers on whose value scales the relative utility of the good for their direct use has fallen.

At any time, then, the market supply schedule is formed by the addition of the supply schedules of the following groups of sellers:30

(a) The supply offered by producers of the good.

1. The initial supply of new stock.
2. The supply of old stock previously reserved by the producers.

(b) The supply of old stock offered by previous buyers.

1. Sales by speculative buyers who had anticipated reselling at a higher price.
2. Sales by buyers who had purchased for direct use, but on whose value scales the relative utility of the good has fallen.

The market demand schedule at any time consists of the sum of the demand schedules of:

(c) Buyers for direct use.
(d) Speculative buyers for resale at a higher price.

Since the good consists of equally serviceable units, the buyers are necessarily indifferent as to whether it is old or new stock that they are purchasing. If they are not, then the “stock” refers to two different goods, and not the same good.

The supply curve of the class (b) type of sellers has already been fully analyzed above, e.g., the relationship between stock and reservation demand for speculative resellers and for those whose utility position has changed. What more can be said, however, of the supply schedule of the class (a) sellers—the original producers of the good?

In the first place, the stock of newly produced goods in the hands of the producers is also fixed for any given point in time Say that for the month of December the producers of copper decide to produce 5,000 tons of copper. At the end of that month their stock of newly produced copper is 5,000 tons. They might regret their decision and believe that if they could have made it again, they would have produced, say, 1,000 tons. But they have their stock, and they must use it as best they can. The distinguishing feature of the original producers is that, as a result of specialization, the direct use-value of their product to them is likely to be almost nonexistent. The further specialization proceeds, the less possible use-value the product can have for its producer. Picture, for example, how much copper a copper manufacturer could consume in his personal use, or the direct use-value of the huge number of produced automobiles to the Ford family. Therefore, in the supply schedule of the producers, the direct-use element in their reservation demand disappears. The only reason for a producer to reserve, to hold on to, any of his stock is speculative—in anticipation of a higher price for the good in the future. (In direct exchange, there is also the possibility of exchange for a third good—say cows instead of fish, in our example.)

If, for the moment, we make the restrictive assumptions that there are no class (b) sellers on the market and that the producers have no present or accumulated past reservation demand, then the market supply-demand schedules can be represented as SS, DD in Figure 29. Thus, with no reservation demand, the supply curve will be a vertical straight line (SS) at the level of the new stock.

It seems more likely, however, that a price below equilibrium will tend to call forth a reservation demand to hold by the producers in anticipation of a higher price (called “building up inventory”), and that a price above equilibrium will result in the unloading of old stock that had been accumulated as a result of past reservation demand (called “drawing down inventory”). In that case, the supply curve assumes a more familiar shape (the broken line above—S′S′).

The removal of direct use-value from the calculation of the sellers signifies that all the stock must eventually be sold, so that ultimately none of the stock can be reserved from sale by the producers. The producers will make their sales at that point at which they expect the market price to be the greatest that they can attain—i.e., at the time when the market demand for the given stock is expected to be the greatest.31 The length of time that producers can reserve supply is, of course, dependent on the durability of the good; a highly perishable good like strawberries, for example, could not be reserved for long, and its market supply curve is likely to be a vertical line.

Suppose that an equilibrium price for a good has been reached on the market. In this case, the speculative element of reservation demand drops out. However, in contrast to the market in re-exchange of existing stock, the market for new production does not end. Since wants are always being renewed in each successive period of time, new stock will also be produced in each period, and if the amount of stock is the same and the demand schedule given, the same amount will continue to be sold at the same equilibrium price. Thus, suppose that the copper producers produce 5,000 tons in a month; these are sold (no reservation demand) at the equilibrium price of 0X on the foregoing diagram. The equilibrium quantity is 0S. The following month, if 5,000 tons are produced, the equilibrium price will be the same. If more is produced, then, as we saw above, the equilibrium price is lower; if less, the equilibrium price will be higher.

If the speculative elements are also excluded from the demand schedule, it is clear that this schedule will be determined solely by the utility of the good in direct use (as compared with the utility of the sale-good). The only two elements in the value of a good are its direct use-value and its exchange-value, and the demand schedule consists of demand for direct use plus the speculative demand in anticipation of reselling at a higher price. If we exclude the latter element (e.g., at the equilibrium price), the only ultimate source of demand is the direct use-value of the good to the purchaser. If we abstract from the speculative elements in a market, therefore, the sole determinant of the market price of the stock of a good is its relative direct use-value to its purchasers.

It is clear, as has been shown in previous sections, that production must take place over a period of time. To obtain a certain amount of new stock at some future date, the producer must first put into effect a series of acts, using labor, nature, and capital goods, and the process must take time from the initial and intermediary acts until the final stock is produced. Therefore, the essence of specialized production is anticipation of the future state of the market by the producers. In deciding whether or not to produce a certain quantity of stock by a future date, the producer must use his judgment in estimating the market price at which he will be able to sell his stock. This market price is likely to be at some equilibrium, but an equilibrium is not likely to last for more than a short time. This is especially true when (as a result of ever-changing value scales), the demand curve for the good continually shifts. Each producer tries to use his resources—his labor and useful goods—in such a way as to obtain, in the production of stock, the maximum psychic revenue and hence a psychic profit. He is ever liable to error, and errors in anticipating the market will bring him a psychic loss. The essence of production for the market, therefore, is entrepreneurship. The key consideration is that the demand schedules, and consequently the future prices, are not and can never be definitely and automatically known to the producers. They must estimate the future state of demand as best they can.

Entrepreneurship is also the dominant characteristic of buyers and sellers who act speculatively, who specialize in anticipating higher or lower prices in the future. Their entire action consists in attempts to anticipate future market prices, and their success depends on how accurate or erroneous their forecasts are. Since, as was seen above, correct speculation quickens the movement toward equilibrium, and erroneous speculation tends to correct itself, the activity of these speculators tends to hasten the arrival of an equilibrium position.

The direct users of a good must also anticipate their desires for a good when they purchase it. At the time of purchase, their actual use of a good will be at some date in the future, even if in the very near future. The position of the good on their value scales is an estimate of its expected future value in these periods, discounted by time preferences. It is very possible for the buyer to make an erroneous forecast of the value of the good to him in the future, and the more durable the good, the greater the likelihood of error. Thus, it is more likely that the buyer of a house will be in error in forecasting his own future valuation than the buyer of strawberries. Hence, entrepreneurship is also a feature of the buyer’s activity—even in direct use. However, in the case of specialized producers, entrepreneurship takes the form of estimating other people’s future wants, and this is obviously a far more difficult and challenging task than forecasting one’s own valuations.

Human action occurs in stages, and at each stage an actor must make the best possible use of his resources in the light of expected future developments. The past is forever bygone. The role of errors in different stages of human action may be considered in the comparatively simple case of the man who buys a good for direct use. Say that his estimate of his future uses is such that he purchases a good—e.g., 10 quarts of milk—in exchange for 100 barrels of fish, which also happens to be his maximum buying price for 10 quarts of milk. Suppose that after the purchase is completed he finds, for some reason, that his valuations have changed and that the milk is now far lower on his value scale. He is now confronted with the question of the best use to make of the 10 quarts of milk. The fact that he has made an error in using his resources of 100 barrels of fish does not remove the problem of making the best use of the 10 quarts of milk. If the price is still 100 barrels of fish, his best course at present would be to resell the milk and reobtain the 100 barrels of fish. If the price is now above 100, he has made a speculative gain, and he can resell the milk for more fish. And if the price of milk has fallen, but the fish is still higher on his value scale than the 10 quarts of milk, it would maximize his psychic revenue to sell the milk for less than 100 barrels of fish.

It is important to recognize that it is absurd to criticize such an action by saying that he suffered a clear loss of X barrels of fish from the two exchanges. To be sure, if he had correctly forecast later developments, the man would not have made the original exchange. His original exchange can therefore be termed erroneous in retrospect. But once the first exchange has been made, he must make the best possible present and future use of the milk, regardless of past errors, and therefore his second exchange was his best possible choice under the circumstances.

If, on the other hand, the price of milk has fallen below his new minimum buying price, then his best alternative is to use the milk in its most valuable direct use.

Similarly, a producer might decide to produce a certain amount of stock, and, after the stock has been made, the state of the market turns out to be such as to make him regret his decision. However, he must do the best he can with the stock, once it has been produced, and obtain the maximum psychic revenue from it. In other words, if we consider his action from the beginning—when he invested his resources in production—his act in retrospect was a psychic loss because it did not yield the best available alternative from these resources. But once the stock is produced, this is his available resource, and its sale at the best possible price now nets him a psychic gain.

At this point, we may summarize the expected (psychic) revenue and the expected (psychic) cost, factors that enter into the decision of buyers and sellers in any direct exchange of two goods.

If we eliminate the temporary speculative element, we are left with factors: revenue A, cost A, cost C for buyers; and revenue A, cost A, cost B for sellers. Similarly, if we consider the sellers as the specialized original producers—and this will be more true the greater the proportion of the rate of production to accumulated stock—cost A drops out for the sellers. If we also remember that, since the exchange involves two goods, the set of buyers for one good is the set of sellers for the other good, cost A is eliminated as a factor for buyers as well. Only the factors asterisked above ultimately remain. The revenue for both the buyers and the sellers is the expected direct use of the goods acquired; the costs are the exchange for a third good that is forgone because of this exchange.

The revenue and costs that are involved in making the original decision regarding the production of stock are, as we have indicated, of a different order, and these will be explored in subsequent chapters.

• 30The addition of supply schedules is a simple process to conceive: if at a price X, the class (a) sellers will supply T tons of a good and the class (b) sellers will supply T′ the total market supply for that price is T + T′ tons. The same process applies to each hypothetical price.
• 31Strictly, of course, costs of storage will have to be considered in their calculations.

For the sake of clarity, the examples of exchangeable goods in this chapter have mainly been taken from tangible commodities, such as horses, fish, eggs, etc. Such commodities are not the only type of goods subject to exchange, however. A may exchange his personal services for the commodity of B. Thus, for example, A may give his labor services to farmer B in exchange for farm produce. Furthermore, A may give personal services that function directly as consumers’ goods in exchange for another good. An individual may thus exchange his medical advice or his musical performance for food or clothing. These services are as legitimately consumers’ goods as those goods that are embodied in tangible, physical commodities. Similarly, individual labor services are as much producers’ goods as are tangible capital goods. As a matter of fact, tangible goods are valued not so much for their physical content as for their services to the user, whether he is a consumer or a producer. The actor values the bread for its services in providing nourishment, the house for its services in providing shelter, the machine for its service in producing a lower-order good. In the last analysis, tangible commodities are also valued for their services, and are thus on the same plane as intangible personal “services.”

Economics, therefore, is not a science that deals particularly with “material goods” or “material welfare.” It deals in general with the action of men to satisfy their desires, and, specifically, with the process of exchange of goods as a means for each individual to “produce” satisfactions for his desires. These goods may be tangible commodities or they may be intangible personal services. The principles of supply and demand, of price determination, are exactly the same for any good, whether it is in one category or the other. The foregoing analysis is applicable to all goods.

Thus, the following types of possible exchanges have been covered by our analysis:

(a)  A commodity for a commodity; such as horses for fish.
(b)  A commodity for a personal service; such as medical advice for butter, or farm labor for food.
(c)  A personal service for a personal service; such as mutual log-rolling by two settlers, or medical advice for gardening labor, or teaching for a musical performance.32

In cases where there are several competing homogeneous units, supply and demand schedules can be added; in cases where one or both parties are isolated or are the only ones exchanging, the zone of price determination will be established as indicated above. Thus, if one arithmetic teacher is bargaining with one violinist for an exchange of services, their respective utility rankings will set the zone of price determination. If several arithmetic teachers and several violinists who provide homogeneous services form a market for their two goods, the market price will be formed with the addition and intersection of supply and demand schedules. If the services of the different individuals are not considered as of equal quality by the demanders, they will be evaluated separately, and each service will be priced separately.33 The supply curve will then be a supply of units of a commodity possessed by only one individual. This individual supply curve is, of course, sloped upward in a rightward direction. Where only one individual is the supplier of a good on the market, his supply curve is identical with the market supply curve.

One evident reason for the confusion of exchange with a mere trade of material objects is the fact that much intangible property cannot, by its very nature, be exchanged. A violinist may own his musicianly ability and exchange units of it, in the form of service, for the services of a physician. But other personal attributes, which cannot be exchanged, may be desired as goods. Thus, Brown might have a desired end: to gain the genuine approval of Smith. This is a particular consumers’ good which he cannot purchase with any other good, for what he wants is the genuine approval rather than a show of approval that might be purchased. In this case, the consumers’ good is a property of Smith’s that cannot be exchanged; it might be acquired in some way, but not by exchange. In relation to exchange, this intangible good is an inalienable property of Smith’s, i.e., it cannot be given up. Another example is that a man cannot permanently transfer his will, even though he may transfer much of his services and his property. As mentioned above, a man may not agree to permanent bondage by contracting to work for another man for the rest of his life. He might change his mind at a later date, and then he cannot, in a free market, be compelled to continue working thereafter. Because a man’s self-ownership over his will is inalienable, he cannot, on the unhampered market, be compelled to continue an arrangement whereby he submits his will to the orders of another, even though he might have agreed to this arrangement previously.34 ,35 On the other hand, when property that can be alienated is transferred, it, of course, becomes the property—under the sole and exclusive jurisdiction—of the person who has received it in exchange, and no later regret by the original owner can establish any claim to the property.

Thus, exchange may occur with alienable goods; they may be consumers’ goods, of varying degrees of durability; or they may be producers’ goods. They may be tangible commodities or intangible personal services. There are other types of exchangeable items, which are based on these alienable goods. For example, suppose that Jones deposits a good—say 1,000 bushels of wheat—in a warehouse for safekeeping. He retains ownership of the good, but transfers its physical possession to the warehouse owner, Green, for safekeeping. Green gives Jones a warehouse receipt for the wheat, certifying that the wheat is there for safekeeping and giving the owner of the receipt a claim to receive the wheat whenever he presents the receipt to the warehouse. In exchange for this service as a guardian of the wheat, Jones pays him a certain agreed amount of some other good, say emeralds. Thus, the claim originates from an exchange of a commodity for a service—emeralds for storage—and the price of this exchange is determined according to the principles of the foregoing analysis. Now, however, the warehouse receipt has come into existence as a claim to the wheat. On an unhampered market, the claim would be regarded as absolutely secure and certain to be honored, and therefore Jones would be able to exchange the claim as a substitute for actual physical exchange of the wheat. He might find another party, Robinson, who wishes to purchase the wheat in exchange for horses. They agree on a price, and then Robinson accepts the claim on the warehouse as a perfectly good substitute for actual transfer of the wheat. He knows that when he wants to use the wheat, he will be able to redeem the claim at the warehouse; the claim therefore functions here as a goods-substitute. In this case, the claim is to a present good, since the good can be redeemed at any time that the owner desires.

Here, the nature and function of the claim is simple. The claim is a secure evidence of ownership of the good. Even simpler is a case where ownership of property, say a farm, is transferred from A to B by transferring written title, or evidence of ownership, which may be considered a claim. The situation becomes more complicated, however, when ownership is divided into pieces, and these pieces are transferred from person to person. Thus, suppose that Harrison is the owner of an iron mine. He decides to divide up the ownership, and sell the various divided pieces, or shares, of the good to other individuals. Assume that he creates 100 tickets, with the total constituting the full ownership of the mine, and then sells all but 10 tickets to numerous other individuals. The owner of two shares then becomes a 2/100 owner of the mine. Since there is very little practical scope for such activity in a regime of direct exchange, analysis of this situation will be reserved for later chapters. It is clear, however, that the 2/100 owner is entitled to his proportionate share of direction and control of, and revenue from, the jointly owned property. In other words, the share is evidence of part-ownership, or a claim to part-ownership, of a good. This property right in a proportionate share of the use of a good can also be sold or bought in exchange.

A third type of claim arises from a credit exchange (or credit transaction). Up to this point we have been discussing exchanges of one present good for another—i.e., the good can be used at present—or at any desired time—by each receiver in the exchange. In a credit transaction, a present good is exchanged for a future good, or rather, a claim on a future good. Suppose, for example, that Jackson desires to acquire 100 pounds of cotton at once. He makes the following exchange with Peters: Peters to give Jackson 100 pounds of cotton now (a present good); and, in return, Jackson gives Peters a claim on 110 pounds of cotton one year from now. This is a claim on a future good—110 pounds of cotton one year from now. The price of the present good in terms of the future good is 1.1 pounds of future cotton (one year from now) per pound of present cotton. Prices in such exchanges are determined by value scales and the meeting of supply and demand schedules, just as in the case of exchanges of present goods. Further analysis of the pricing of credit transactions must be left for later chapters; here it may be pointed out that, as explained in the previous chapter, every man will evaluate a homogeneous good more highly the earlier in time is his prospect of attaining it. A present good (a good consisting of units capable of rendering equivalent satisfaction) will always be valued more highly than the same good in the future, in accordance with the individual’s rate of time preference. It is evident that the various rates of time preference—ultimately determined by relative positions on individual value scales—will act to set the price of credit exchanges. Moreover, the receiver of the present good—the debtor—will always have to repay a greater amount of the good in the future to the creditor—the man who receives the claim, since the same number of units is worth more as a present good than as a future good. The creditor is rendering the debtor the service of using a good in the present, while the debtor pays for this service by repaying a greater amount of the good in the future.

At the date when the claim finally falls due, the creditor redeems the claim and acquires the good itself, thus ending the existence of the claim. In the meanwhile, however, the claim is in existence, and it can be bought and sold in exchange for other goods. Thus, Peters, the creditor, might decide to sell the claim—or promissory note—to Williams in exchange for a wagon. The price of this exchange will again be determined by supply and demand schedules. Demand for the note will be based on its security as a claim to the cotton. Thus, Williams’ demand for the note (or Peters’ demand to hold) in terms of wagons will be based on (a) the direct utility and exchange-value of the wagon, and (b) the marginal utility of the added units of cotton, discounted by him on two possible grounds: (l) the length of time the claim has left until the date of “maturity,” and (2) the estimate of the security of the note. Thus, the less time there remains to elapse for a claim to any given good, the higher will it tend to be valued in the market. Also, if the eventual payment is considered less than absolutely secure, because of possible failure to redeem, the claim will be valued less highly in accordance with people’s estimates of the likelihood of its failure. After a note has been transferred, it becomes the property of the new owner, who becomes the creditor and will be entitled to redeem the claim when due.

When a claim is thus transferred in exchange for some other good (or claim), this in itself is not a credit transaction. A credit exchange sets up an unfinished payment on the part of the debtor; in this case, Peters pays Williams the claim in return for the other good, and the transaction is finished. Jackson, on the other hand, remains the debtor as a result of the original transaction, which remains unfinished until he makes his agreed-upon payment to the creditor on the date of maturity.36

The several types of claims, therefore, are: on present goods, by such means as warehouse receipts or shares of joint ownership in a good; and on future goods, arising from credit transactions. These are evidences of ownership, or, as in the latter case, objects that will become evidence of ownership at a later date.

Thus, in addition to the three types of exchanges mentioned above, there are three other types whose terms and principles are included in the preceding analysis of this chapter:

(d) A commodity for a claim; examples of this are: (1) the deposit of a commodity for a warehouse receipt—the claim to a present good; (2) a credit transaction, with a commodity exchanged for a claim to a future commodity; (3) the purchase of shares of stock in a commodity by exchanging another type of commodity for them; (4) the purchase of promissory notes on a debtor by exchanging a commodity. All four of these cases have been described above.

(e) A claim for a service; an example is personal service being exchanged for a promissory note or warehouse receipt or stock.

(f ) A claim for a claim; examples would be: exchange of a promissory note for another one; of stock shares for a note; of one type of stock share for another; of a warehouse receipt for any of the other types of claims.

With all goods analyzable into categories of tangible commodities, services, or claims to goods (goods-substitutes), all six possible types of exchanges are covered by the utility and supply-demand analysis of this chapter. In each case, different concrete considerations enter into the formation of the value scales–such as time preference in the case of credit exchanges; and this permits more to be said about the various specific types of exchanges. The level of analysis presented in this chapter, however, encompasses all possible exchanges of goods. In later chapters, when indirect exchange has been introduced, the present analysis will apply also, but further analysis will be made of production and exchange problems involved in credit exchanges (time preference); in exchanges for capital goods and consumer goods; and in exchanges for labor services (wages).

• 32On the importance of services, see Arthur Latham Perry, Political Economy (21st ed.; New York: Charles Scribner’s Sons, 1892), pp. 124–39.
• 33This is not to deny, of course, that the existence of several violinists of different quality will affect the consumer’s evaluations of each one.
• 34If he has taken the property of another by means of such an agreement, he will, on the free market, have to return the property. Thus, if A has agreed to work for life for B in exchange for 10,000 grams of gold, he will have to return the proportionate amount of property if he terminates the arrangement and ceases the work.
• 35In other words, he cannot make enforceable contracts binding his future personal actions. (On contract enforcement in an unhampered market, see section 13 below. This applies also to marriage contracts. Since human self-ownership cannot be alienated, a man or a woman, on a free market, could not be compelled to continue in marriage if he or she no longer desired to do so. This is regardless of any previous agreement. Thus, a marriage contract, like an individual labor contract, is, on an unhampered market, terminable at the will of either one of the parties.
• 36In a credit transaction, it is not necessary for the present and the future goods exchanged to be the same commodity. Thus, a man can sell wheat now in exchange for a certain amount of corn at a future date. The example in the text, however, highlights the importance of time preference and is also more likely to occur in practice.

As we have stated above, the origin of all property is ultimately traceable to the appropriation of an unused nature-given factor by a man and his “mixing” his labor with this natural factor to produce a capital good or a consumers’ good. For when we trace back through gifts and through exchanges, we must reach a man and an unowned natural resource. In a free society, any piece of nature that has never been used is unowned and is subject to a man’s ownership through his first use or mixing of his labor with this resource.

How will an individual’s title to the nature-given factor be determined? If Columbus lands on a new continent, is it legitimate for him to proclaim all the new continent his own, or even that sector “as far as his eye can see”? Clearly, this would not be the case in the free society that we are postulating. Columbus or Crusoe would have to use the land, to “cultivate” it in some way, before he could be asserted to own it. This “cultivation” does not have to involve tilling the soil, although that is one possible form of cultivation. If the natural resource is land, he may clear it for a house or a pasture, or care for some plots of timber, etc. If there is more land than can be used by a limited labor supply, then the unused land must simply remain unowned until a first user arrives on the scene. Any attempt to claim a new resource that someone does not use would have to be considered invasive of the property right of whoever the first user will turn out to be.

There is no requirement, however, that land continue to be used in order for it to continue to be a man’s property. Suppose that Jones uses some new land, then finds it is unprofitable, and lets it fall into disuse. Or suppose that he clears new land and therefore obtains title to it, but then finds that it is no longer useful in production and allows it to remain idle. In a free society, would he lose title? No, for once his labor is mixed with the natural resource, it remains his owned land. His labor has been irretrievably mixed with the land, and the land is therefore his or his assigns’ in perpetuity. We shall see in later chapters that the question whether or not labor has been mixed with land is irrelevant to its market price or capital value; in catallactics, the past is of no interest. In establishing the ownership of property, however, the question is important, for once the mixture takes place, the man and his heirs have appropriated the nature-given factor, and for anyone else to seize it would be an invasive act.

As Wolowski and Levasseur state:

Nature has been appropriated by him (man) for his use; she has become his own; she is his property. This property is legitimate; it constitutes a right as sacred for man as is the free exercise of his faculties. It is his because it has come entirely from himself, and is in no way anything but an emanation from his being. Before him, there was scarcely anything but matter; since him, and by him, there is interchangeable wealth. The producer has left a fragment of his own person in the thing which has thus become valuable, and may hence be regarded as a prolongation of the faculties of man acting upon external nature. As a free being he belongs to himself; now, the cause, that is to say, the productive force, is himself; the effect, that is to say, the wealth produced, is still himself. Who shall dare contest his title of ownership so clearly marked by the seal of his personality?37

Some critics, especially the Henry Georgists, assert that, while a man or his assigns may be entitled to the produce of his own labor or anything exchanged for it, he is not entitled to an original, nature-given factor, a “gift of nature.” For one man to appropriate this gift is alleged to be an invasion of a common heritage that all men deserve to use equally. This is a self-contradictory position, however. A man cannot produce anything without the co-operation of original nature-given factors, if only as standing room. In order to produce and possess any capital good or consumers’ good, therefore, he must appropriate and use an original nature-given factor. He cannot form products purely out of his labor alone; he must mix his labor with original nature-given factors. Therefore, if property in land or other nature-given factors is to be denied man, he cannot obtain property in the fruits of his labor.

Furthermore, in the question of land, it is difficult to see what better title there is than the first bringing of this land from a simple unvaluable thing into the sphere of production. For that is what the first user does. He takes a factor that was previously unowned and unused, and therefore worthless to anyone, and converts it into a tool for production of capital and consumers’ goods. While such questions as communism of property will be discussed in later parts of this book, it is difficult indeed to see why the mere fact of being born should automatically confer upon one some aliquot part of the world’s land. For the first user has mixed his labor with the land, while neither the newborn child nor his ancestors have done anything with the land at all.

The problem will be clearer if we consider the case of animals. Animals are “economic land,” because they are equivalent to physical land in being original, nature-given factors of production. Yet will anyone deny title to a cow to the man that finds and domesticates her, putting her to use? For this is precisely what occurs in the case of land. Previously valueless “wild” land, like wild animals, is taken and transformed by a man into goods useful for man. The “mixing” of labor gives equivalent title in one case as in the other.

We must remember, also, what “production” entails. When man “produces,” he does not create matter. He uses given materials and transforms and rearranges them into goods that he desires. In short, he moves matter further toward consumption. His finding of land or animals and putting them to use is also such a transformation.

Even if the value accruing to a piece of land at present is substantial, therefore, it is only “economic land” because of the innumerable past efforts of men at work on the land. When we are considering legitimacy of title, the fact that land always embodies past labor becomes extremely important.38

If animals are also “land” in the sense of given original nature factors, so are water and air. We have seen that “air” is inappropriable, a condition of human welfare rather than a scarce good that can be owned. However, this is true only of air for breathing under usual conditions. For example, if some people want their air to be changed, or “conditioned,” then they will have to pay for this service, and the “conditioned air” becomes a scarce good that is owned by its producers.

Furthermore, if we understand by “air” the medium for the transmission of such things as radio waves and television images, there is only a limited quantity of wave lengths available for radio and for television purposes. This scarce factor is appropriable and ownable by man. In a free society, ownership of these channels would accrue to individuals just like that of land or animals: the first users obtain the property. The first user, Jones, of the wave length of 1,000 kilocycles, would be the absolute owner of this length for his wave area, and it will be his right to continue using it, to abandon it, to sell it, etc. Anyone else who set up a transmitter on the owner’s wave length would be as guilty of invasion of another’s property right as a trespasser on someone else’s land or a thief of someone else’s livestock.39 ,40

The same is true of water. Water, at least in rivers and oceans, has been considered by most people as also inappropriable and unownable, although it is conceded to be ownable in the cases of (small) lakes and wells. Now it is true that the high seas, in relation to shipping lanes, are probably inappropriable, because of their abundance in relation to shipping routes.41 This is not true, however, of fishing rights in oceans. Fish are definitely not available in unlimited quantities relatively to human wants. Therefore, they are appropriable—their stock and source just as the captured fish themselves. Indeed, nations are always quarreling about “fishing rights.” In a free society, fishing rights to the appropriate areas of oceans would be owned by the first users of those areas and then usable or salable to other individuals. Ownership of areas of water that contain fish is directly analogous to private ownership of areas of land or forests that contain animals to be hunted. Some people raise the difficulty that water flows and has no fixed position, as land does. This is a completely invalid objection, however. Land “moves” too, as when soil is uprooted in dust storms. Most important, water can definitely be marked off in terms of latitudes and longitudes. These boundaries, then, would circumscribe the area owned by individuals, in the full knowledge that fish and water can move from one person’s property to another. The value of the property would be gauged according to this knowledge.42

Another argument is that appropriation of ownership by a first user would result in an uneconomic allocation of the nature-given factors. Thus, suppose that one man can fence, cultivate, or otherwise use, only five acres of a certain land, while the most economic allocation would be units of 15 acres. However, the rule of first ownership by the first user, followed in a free society, would not mean that ownership must end with this allocation. On the contrary. In this case, either the owners would pool their assets in one corporate form, or the most efficient individual owners would buy out the others, and the final size of each unit of land in production would be 15 acres.

It must be added that the theory of land ownership in a free society set forth here, i.e., first ownership by the first user, has nothing in common with another superficially similar theory of land ownership—advanced by J.K. Ingalls and his disciples in the late nineteenth century. Ingalls advocated continuing ownership only for actual occupiers and personal users of the land. This is in contrast to original ownership by the first user.

The Ingalls system would, in the first place, bring about a highly uneconomic allocation of land factors. Land sites where small “homestead” holdings are uneconomic would be forced into use in spite of this, and land would be prevented from entering other lines of use greatly demanded by consumers. Some land would be artificially and coercively withdrawn from use, since land that could not be used by owners in person would have to lie idle. Furthermore, this theory is self-contradictory, since it would not really permit ownership at all. One of the prime conditions of ownership is the right to buy, sell, and dispose of property as the owner or owners see fit. Since small holders would not have the right to sell to nonoccupying large holders, the small holders would not really be owners of the land at all. The result is that on the ownership question, the Ingalls thesis reverts, in the final analysis, to the Georgist view that Society (in the alleged person of the State) should own the land.43

• 37Léon Wolowski and Émile Levasseur, “Property,” Lalor’s Cyclopedia of Political Science, etc. (Chicago: M.B. Cary & Co., 1884), III, 392.
• 38See the vivid discussion by Edmond About, Handbook of Social Economy (London: Strahan & Co., 1872), pp. 19–30. Even urban sites embody much past labor. Cf. Herbert B. Dorau and Albert G. Hinman, Urban Land Economics (New York: Macmillan & Co., 1928), pp. 205–13.
• 39If a channel has to be a certain number of wave lengths in width in order to permit clear transmission, then the property would accrue to the first user, in terms of such width.
• 40Professor Coase has demonstrated that Federal ownership of airwaves was arrogated, in the 1920’s, not so much to alleviate a preceding “chaos,” as to forestall this very acquisition of private property rights in air waves, which the courts were in the process of establishing according to common law principles. Ronald H. Coase, “The Federal Communications Commission,” Journal of Law and Economics, October, 1959, pp. 5, 30–32.
• 41It is rapidly becoming evident that air lanes for planes are becoming scarce and, in a free society, would be owned by first users—thus obviating a great many plane crashes.
• 42Flowing water should be owned in proportion to its rate of use by the first user—i.e., by the “appropriation” rather than the “riparian” method of ownership. However, the appropriator would then have absolute control over his property, might transfer his share, etc., something which cannot be done in those areas, e.g., states in the West, where an approach to appropriation ownership now predominates. See Murray N. Rothbard, “Concerning Water,” The Freeman, March, 1956, pp. 61–64. Also see the excellent article by Professor Jerome W. Milliman, “Water Law and Private Decision-Making: A Critique,” The Journal of Law and Economics, October, 1959, pp. 41–63; Milliman, “Commonality, the Price System, and Use of Water Supplies,” Southern Economic Journal, April, 1956, pp. 426–37.
• 43On Ingalls and his doctrines, see James J. Martin, Men Against the State (DeKalb, Ill.: Adrian Allen Associates, 1953), pp. 142–52, 220 ff., 246 ff. Also cf. Benjamin R. Tucker, Instead of a Book (2nd ed.; New York: B.R. Tucker, 1897), pp. 299–357, for the views of Ingalls’ most able disciple. Despite the underlying similarity and their many economic errors, the Ingalls-Tucker group launched some interesting and effective critiques of the Georgist position. These take on value in the light of the excessive kindness often accorded to Georgist doctrines by economists.

This work is largely the analysis of a market society unhampered by the use of violence or theft against any man’s person or property. The question of the means by which this condition is best established is not at present under consideration. For the present purpose, it makes no difference whether this condition is established by every man’s deciding to refrain from invasive action against others or whether some agency is established to enforce the abandonment of such action by every individual. (Invasive action may be defined as any action—violence, theft, or fraud—taking away another’s personal freedom or property without his consent.) Whether the enforcement is undertaken by each person or by some sort of agency, we assume here that such a condition—the existence of an unhampered market—is maintained in some way.

One of the problems in maintaining the conditions of a free market is the role of the enforcing agency—whether individual or organizational—in exchange contracts. What type of contracts are to be enforced to maintain the conditions of an unhampered market? We have already seen that contracts assigning away the will of an individual cannot be enforced in such a market, because the will of each person is by its nature inalienable. On the other hand, if the individual made such a contract and received another’s property in exchange, he must forfeit part or all of the property when he decides to terminate the agreement. We shall see that fraud may be considered as theft, because one individual receives the other’s property but does not fulfill his part of the exchange bargain, thereby taking the other’s property without his consent. This case provides the clue to the role of contract and its enforcement in the free society. Contract must be considered as an agreed-upon exchange between two persons of two goods, present or future. Persons would be free to make any and all property contracts that they wished; and, for a free society to exist, all contracts, where the good is naturally alienable, must be enforced. Failure to fulfill contracts must be considered as theft of the other’s property. Thus, when a debtor purchases a good in exchange for a promise of future payment, the good cannot be considered his property until the agreed contract has been fulfilled and payment made. Until then, it remains the creditor’s property, and nonpayment would be equivalent to theft of the creditor’s property.

An important consideration here is that contract not be enforced because a promise has been made that is not kept. It is not the business of the enforcing agency or agencies in the free market to enforce promises merely because they are promises; its business is to enforce against theft of property, and contracts are enforced because of the implicit theft involved.

Evidence of a promise to pay property is an enforceable claim, because the possessor of this claim is, in effect, the owner of the property involved, and failure to redeem the claim is equivalent to theft of the property. On the other hand, take the case of a promise to contribute personal services without an advance exchange of property. Thus, suppose that a movie actor agrees to act in three pictures for a certain studio for a year. Before receiving any goods in exchange (salary), he breaks the contract and decides not to perform the work. Since his personal will is inalienable, he cannot, on the free market, be forced to perform the work there. Further, since he has received none of the movie company property in exchange, he has committed no theft, and thus the contract cannot be enforced on the free market. Any suit for “damages” could not be entertained on an unhampered market. The fact that the movie company may have made considerable plans and investments on the expectation that the actor would keep the agreement may be unfortunate for the company, but it could not expect the actor to pay for its lack of foresight and poor entrepreneurship. It pays the penalty for placing too much confidence in the man. The movie actor has not received and kept any of the company’s property and therefore cannot be held accountable in the form of payment of goods as “damages.”44 Any such enforced payment would be an invasion of his property rights on the free market rather than an attack upon invasion. It may be considered more moral to keep promises than to break them, but the condition of a free market is that each individual’s rights of person and property be maintained, and not that some further standard of morals be coercively imposed on all. Any coercive enforcement of such a moral code, going beyond the abolition of invasive acts, would in itself constitute an invasion of individual rights of person and property and be an interference in the free market.45

It certainly would be consonant with the free market, however, for the movie company to ask the actor to pay a certain sum in consideration of his breaking the contract, and, if he refuses, to refuse to hire him again, and to notify other prospective contracting parties (such as movie companies) of the person’s action. It seems likely that his prospect of making exchanges in the future will suffer because of his action. Thus, the “blacklist” is permissible on the free market. Another legitimate action on the free market is the boycott, by which A urges B not to make an exchange with C, for whatever reason. Since A’s and B’s actions are purely voluntary and noninvasive, there is no reason for a boycott not to be permitted on the unhampered market. On the contrary, any coercive action against a boycott is an invasion against the rights of free persons.

If default on contracted debts is to be considered as equivalent to theft, then on the unhampered market its treatment by the enforcing agency will be similar to that of theft. It is clear—for example, in the case of burglary—that the recovery of the stolen property to its owner would be the fundamental consideration for the enforcing agency. Punishment of the wrongdoer would be a consideration subsidiary to the former. Thus, suppose A has stolen 100 ounces of gold from B. By the time A has been apprehended by the enforcing agency, he has dissipated the 100 ounces and has no assets by which the 100 ounces can be obtained. The main goal of the enforcement agency should be to force A to return the 100 ounces. Thus, instead of simply idle imprisonment, the agency could force the thief to labor and to attach his earnings to make up the amount of the theft, plus a compensation for the delay in time. Whether this forced labor is done in or out of prison is immaterial here. The main point is that the invader of another’s rights on the free market gives up his rights to the same extent. The first consideration in the punishment of the aggressor against property in the free market is the forced return of the equivalent property.46 On the other hand, suppose that B voluntarily decides to forgive A and grant the latter a gift of the property; he refuses to “press charges” against the thief. In that case, the enforcement agency would take no action against the robber, since he is now in the position of the receiver of a gift of property.

This analysis provides the clue to the treatment of defaulting debtors on the free market. If a creditor decides to forget about the debt and not press charges, he in effect grants a gift of his property to the debtor, and there is no further room for enforcement of contract. What if the creditor insists on keeping his property? It is clear that if the debtor can pay the required amount but refuses to do so, he is guilty of pure fraud, and the enforcing agency would treat his act as such. Its prime move would be to make sure that the debtor’s assets are transferred to their rightful owner, the creditor. But suppose that the debtor has not got the property and would be willing to pay if he had it? Does this entitle him to special privilege or coerced elimination of the debt, as in the case of bankruptcy laws? Clearly not. The prime consideration in the treatment of the debtor would be his continuing and primary responsibility to redeem the property of the creditor. The only way by which this treatment could be eliminated would be for the debtor and the creditor to agree, as part of the original contract, that if the debtor makes certain investments and fails to have the property at the date due, the creditor will forgive the debt; in short, he grants the debtor the rights of a partial co-owner of the property.

There could be no room, in a free society such as we have outlined, for “negotiable instruments.” Where the government designates a good as “negotiable,” if A steals it from B and then sells it to C without the latter’s knowledge of the theft, B cannot take the good back from C. Despite the fact that A was a thief and had no proper title to the good, C is decreed to be the legitimate owner, and B has no way of regaining his property. The law of negotiability is evidently a clear infringement of property right. Where property rights are fully defended, theft cannot be compounded in this manner. The buyer would have to purchase at his own risk and make sure that the good is not stolen; if he nonetheless does buy stolen goods, he must try to obtain restitution from the thief, and not at the expense of the rightful owner.

What of a cartel agreement? Would that be enforceable in a free society? If there has been no exchange of property, and A, B, C ... firms agree among themselves to set quotas on their production of a good, this agreement would surely not be illegal, but neither would it be enforceable. It could be only a simple promise and not an enforceable case of implicit theft.47

One difficulty often raised against a free society of individual property rights is that it ignores the problem of “external diseconomies” or “external costs.” But cases of “external diseconomy” all turn out to be instances of failure of government— the enforcing agency—adequately to enforce individual property rights. The “blame,” therefore, rests not on the institution of private property, but on the failure of the government to enforce this property right against various subtle forms of invasion—the failure, e.g., to maintain a free society.

One instance of this failure is the case of smoke, as well as air pollution generally. In so far as the outpouring of smoke by factories pollutes the air and damages the persons and property of others, it is an invasive act. It is equivalent to an act of vandalism and in a truly free society would have been punished after court action brought by the victims. Air pollution, then, is not an example of a defect in a system of absolute property rights, but of failure on the part of the government to preserve property rights. Note that the remedy, in a free society, is not the creation of an administrative State bureau to prescribe regulations for smoke control. The remedy is judicial action to punish and proscribe pollution damage to the person and property of others.48

In a free society, as we have stated, every man is a self-owner. No man is allowed to own the body or mind of another, that being the essence of slavery. This condition completely overthrows the basis for a law of defamation, i.e., libel (written defamation) or slander (oral defamation). For the basis of outlawing defamation is that every man has a “property in his own reputation” and that therefore any malicious or untruthful attack on him or his character (or even more, a truthful attack!) injures his reputation and therefore should be punished. However, a man has no such objective property as “reputation.” His reputation is simply what others think of him, i.e., it is purely a function of the subjective thoughts of others. But a man cannot own the minds or thoughts of others. Therefore, I cannot invade a man’s property right by criticizing him publicly. Further, since I do not own others’ minds, either, I cannot force anyone else to think less of the man because of my criticism.49

The foregoing observations should firmly remind us that what the enforcing agency combats in a free society is invasion of the physical person and property, not injury to the values of property. For physical property is what the person owns; he does not have any ownership in monetary values, which are a function of what others will pay for his property. Thus, someone’s vandalism against, or robbery of, a factory is an invasion of physical property and is outlawed. On the other hand, someone’s shift from the purchase of this factory’s product to the purchase of a competing factory’s product may lower the monetary value of the former’s property, but this is certainly not a punishable act. It is precisely the condition of a free society that a property owner have no unearned claim on the property of anyone else; therefore, he has no vested right in the value of his property, only in its physical existence. As for the value, this must take its chance on the free market. This is the answer, for example, to those who believe that “undesirable” businesses or people must be legally prevented from moving into a certain neighborhood because this may or will “lower the existing property value.”

One method of acquiring property that we have not discussed yet is fraud. Fraud involves cases where one party to an agreed-upon exchange deliberately refuses to fulfill his part of the contract. He thus acquires the property of the other person, but he sacrifices either none of the agreed-upon goods or less than he had agreed. We have seen that a debtor’s deliberate failure to pay his creditor is equivalent to an outright theft of the creditor’s property.

Another example of fraudulent action is the following exchange: Smith agrees to give up 15 ounces of gold to Jones in exchange for a package of certain specified chinaware. When he receives the package, after having given up the gold, Smith finds that he has received an empty crate instead of the goods that the two had agreed to exchange. Jones has falsely represented the goods that he would exchange, and here again this is equivalent to outright theft of Smith’s property. Since the exchange has been made falsely, the actual form of which might not have been contracted had the other party not been deceived, this is not an example of voluntary exchange, but of one-sided theft. We therefore exclude both explicit violence and the implicit violence of fraud from our definition of the market—the pattern of voluntary interpersonal exchanges. At this point we are dealing only with an analysis of the market unhampered by fraud or violence.

We have not here been discussing what type of enforcing agency will be set up or the means it will use, but what type of actions the agency will combat and what type will be permissible. In a free market, all invasive acts by one person against another’s property, either against his person or his material goods, will be combatted by the enforcing agency or agencies. We are assuming here that there are no invasive acts in the society, either because no individuals commit them or because they are successfully combatted and prevented by some sort of enforcing agency. The problem then becomes one of defining invasive, as distinguished from noninvasive, acts, and this is what has been done here in various typical examples. Each man would be entitled to ownership over his own person and over any property that he has acquired by production, by appropriation of unowned factors, by receiving gifts, or by voluntary exchange. Never has the basis of the free, noninvasive, or “voluntaryist” society been described more clearly in a brief space than by the British political philosopher Auberon Herbert:

(1) The great natural fact of each person being born in possession of a separate mind and separate body implies the ownership of such mind and body by each person, and rights of direction over such mind and body; it will be found on examination that no other deduction is reasonable.

(2) Such self-ownership implies the restraint of violent or fraudulent aggressions made upon it.

(3) Individuals, therefore, have the right to protect themselves by force against such aggressions made forcibly or fraudulently, and they may delegate such acts of self-defense to a special body called a government ...

Condensed into a few words, our Voluntaryist formula would run: “The sovereignty of the individual must remain intact, except where the individual coerced has aggressed upon the sovereignty of another unaggressive individual.”

Elaborating on the first point, Herbert continued:

If there is one thing on which we can safely build, it is the great natural fact that each human being forms with his or her body and mind a separate entity—from which we must conclude that the entities belong to themselves and not to each other. As I have said, no other deduction is possible. If the entities do not belong to themselves, then we are reduced to the most absurd conclusion. A or B cannot own himself; but he can own, or part own, C or D.50

• 44This is true even if the actor had previously agreed in a contract that he would pay damages. For this is still merely a promise; he has not implicitly seized someone else’s property. The object of an enforcing agency in a free society is not to uphold promise-keeping by force, but to redress any invasions of person and property.
• 45Sir Frederick Pollock thus describes original English contract law:
  Money debts, it is true, were recoverable from an early time. But this was not because the debtor had promised to repay the loan; it was because the money was deemed still to belong to the creditor, as if the identical coins were merely in the debtor’s custody. The creditor sued to recover money ... in exactly the same form which he would have used to demand possession of land ... and down to Blackstone’s time the creditor was said to have a property in the debt — property which the debtor had granted him. Giving credit, in this way of thinking, is not reliance on the right to call thereafter for an act ... to be performed by the debtor, but merely suspension of the immediate right to possess one’s own particular money, as the owner of a house lot suspends his right to occupy it. ... The foundation of the plaintiff’s right was not bargain or promise, but the unjust detention by the defendant of the plaintiff’s money or goods. (Sir Frederick Pollock, “Contract,” Encyclopedia Britannica [14th ed.; London, 1929], VI, 339–40)
• 46Wordsworth Donisthorpe, Law in A Free State (London: Macmillan & Co., 1895), p. 135:
  In Rome one could recover stolen goods, or damages for their loss, by what we should call a civil process, without in the least affecting the relation between the thief and the public by reason of the theft. Restitution first and punishment afterwards was the rule.
• 47This reason for the unenforceability of a cartel agreement in a free society has no relation to any common-law hostility to agreements allegedly “in restraint of trade.” However, it is very similar to the English common-law doctrine finally worked out in the Mogul Steamship Case (1892). See William L. Letwin, “The English Common Law Concerning Monopolies,” University of Chicago Law Review, Spring, 1954, pp. 382ff.
• 48Noise is also an invasive act against another, a transmission of sound waves assaulting the eardrums of others. On “external diseconomies,” the only good discussion by an economist is the excellent one in Mises, Human Action, pp. 650–53. For an appreciation of the distinction between judicial and administrative action in a free society, as well as a fine grasp of property rights and governmental enforcement, see the classic discussion of adulteration in Donisthorpe, Law in A Free State, pp. 132–58.
• 49Similarly, blackmail would not be illegal in the free society. For blackmail is the receipt of money in exchange for the service of not publicizing certain information about the other person. No violence or threat of violence to person or property is involved.
• 50Auberon Herbert, in A. Herbert and J.H. Levy, Taxation and Anarchism (London: The Personal Rights Assn., 1912), pp. 24, 36–39; and Herbert, “A Cabinet Minister’s Vade Mecum” in Michael Goodwin, ed., Nineteenth-Century Opinion (London: Penguin Books, 1951), pp. 206–07.