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

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

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

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

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

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

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

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

The money prices of these various exchanges were:

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

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

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

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

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

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

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

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

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

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

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

Let us first take a typical good and analyze the determinants of its money price on the market. (Here the reader is referred back to the more detailed analysis of price in chapter 2.) Let us take a homogeneous good, Grade A butter, in exchange against money.

The money price is determined by actions decided according to individual value scales. For example, a typical buyer’s value scale may be ranked as follows:

The quantities in parentheses are those which the person does not possess but is considering adding to his ownership; the others are those which he has in his possession. In this case, the buyer’s maximum buying money price for his first pound of butter is six grains of gold. At any market price of six grains or under, he will exchange these grains for the butter; at a market price of seven grains or over, he will not make the purchase. His maximum buying price for a second pound of butter will be considerably lower. This result is always true, and stems from the law of utility; as he adds pounds of butter to his ownership, the marginal utility of each pound declines. On the other hand, as he dispenses with grains of gold, the marginal utility to him of each remaining grain increases. Both these forces impel the maximum buying price of an additional unit to decline with an increase in the quantity purchased.3 From this value scale, we can compile this buyer’s demand schedule, the amount of each good that he will consume at each hypothetical money price on the market. We may also draw his demand curve, if we wish to see the schedule in graphic form. The individual demand schedule of the buyer considered above is as shown in Table 6.

We note that, because of the law of utility, an individual demand curve must be either “vertical” as the hypothetical price declines, or else rightward-sloping (i.e., the quantity demanded, as the money price falls, must be either the same or greater), not leftward-sloping (not a lower quantity demanded).

If this is the necessary configuration of every buyer’s demand schedule, it is clear that the existence of more than one buyer will tend greatly to reinforce this behavior. There are two and only two possible classifications of different people’s value scales: either they are all identical, or else they differ. In the extremely unlikely case that everyone’s relevant value scales are identical with everyone else’s (extremely unlikely because of the immense variety of valuations by human beings), then, for example, buyers B, C, D, etc. will have the same value scale and therefore the same individual demand schedules as buyer A who has just been described. In that case, the shape of the aggregate market-demand curve (the sum of the demand curves of the individual buyers) will be identical with the curve of buyer A, although the aggregate quantities will, of course, be much greater. To be sure, the value scales of the buyers will almost always differ, which means that their maximum buying prices for any given pound of butter will differ. The result is that, as the market price is lowered, more and more buyers of different units are brought into the market. This effect greatly reinforces the rightward-sloping feature of the market-demand curve.

As an example of the formation of a market-demand schedule from individual value scales, let us take the buyer described above as buyer A and assume two other buyers on the market, B and C, with the following value scales:

From these value scales, we can construct their individual demand schedules (Table 7). We notice that, in each of the varied patterns of individual demand schedules, none can ever be leftward-sloping as the hypothetical price declines.

Now we may summate the individual demand schedules, A, B, and C, into the market-demand schedule. The market-demand schedule yields the total quantity of the good that will be bought by all the buyers on the market at any given money price for the good. The market-demand schedule for buyers A, B, and C is as shown in Table 8.

Figure 33 is a graphical representation of these schedules and of their addition to form the market-demand schedule.

The principles of the formation of the market-supply schedule are similar, although the causal forces behind the value scales will differ.4 Each supplier ranks each unit to be sold and the amount of money to be obtained in exchange on his value scale. Thus, one seller’s value scale might be as follows:

If the market price were two grains of gold, this seller would sell no butter, since even the first pound in his stock ranks above the acquisition of two grains on his value scale. At a price of three grains, he would sell two pounds, each of which ranks below three grains on his value scale. At a price of four grains, he would sell three pounds, etc. It is evident that, as the hypothetical price is lowered, the individual supply curve must be either vertical or leftward-sloping, i.e., a lower price must lead either to a lesser or to the same supply, never to more. This is, of course, equivalent to the statement that as the hypothetical price increases, the supply curve is either vertical or rightward-sloping. Again, the reason is the law of utility; as the seller disposes of his stock, its marginal utility to him tends to rise, while the marginal utility of the money acquired tends to fall. Of course, if the marginal utility of the stock to the supplier is nil, and if the marginal utility of money to him falls only slowly as he acquires it, the law may not change his quantity supplied during the range of action on the market, so that the supply curve may be vertical throughout almost all of its range. Thus, a supplier Y might have the following value scale:

This seller will be willing to sell, above the minimum price of one grain, every unit in his stock. His supply curve will be shaped as in Figure 34.

In seller X’s case, his minimum selling price was three grains for the first and second pounds of butter, four grains for the third pound, five grains for the fourth and fifth pounds, and six grains for the sixth pound. Seller Y ‘s minimum selling price for the first pound and for every subsequent pound was one grain. In no case, however, can the supply curve be rightward-sloping as the price declines; i.e., in no case can a lower price lead to more units supplied.

Let us assume, for purposes of exposition, that the suppliers of butter on the market consist of just these two, X and Y, with the foregoing value scales. Then their individual and aggregate market-supply schedules will be as shown in Table 9.

This market-supply curve is diagramed above in Figure 33.

We notice that the intersection of the market-supply and market-demand curves, i.e., the price at which the quantity supplied and the quantity demanded are equal, here is located at a point in between two prices. This is necessarily due to the lack of divisibility of the units; if a unit grain, for example, is indivisible, there is no way of introducing an intermediate price, and the market-equilibrium price will be at either 2 or 3 grains. This will be the best approximation that can be made to a price at which the market will be precisely cleared, i.e., one at which the would-be suppliers and the demanders at that price are satisfied. Let us, however, assume that the monetary unit can be further divided, and therefore that the equilibrium price is, say, two and a half grains. Not only will this simplify the exposition of price formation; it is also a realistic assumption, since one of the important characteristics of the money commodity is precisely its divisibility into minute units, which can be exchanged on the market. It is this divisibility of the monetary unit that permits us to draw continuous lines between the points on the supply and demand schedules.

The money price on the market will tend to be set at the equilibrium price—in this case, at two and a half grains. At a higher price, the quantity offered in supply will be greater than the quantity demanded; as a result, part of the supply could not be sold, and the sellers will underbid the price in order to sell their stock. Since only one price can persist on the market, and the buyers always seek their best advantage, the result will be a general lowering of the price toward the equilibrium point. On the other hand, if the price is below two and a half grains, there are would-be buyers at this price whose demands remain unsatisfied. These demanders bid up the price, and with sellers looking for the highest attainable price, the market price is raised toward the equilibrium point. Thus, the fact that men seek their greatest utility sets forces into motion that establish the money price at a certain equilibrium point, at which further exchanges tend to be made. The money price will remain at the equilibrium point for further exchanges of the good, until demand or supply schedules change. Changes in demand or supply conditions establish a new equilibrium price, toward which the market price again tends to move.

What the equilibrium price will be depends upon the configuration of the supply and demand schedules, and the causes of these schedules will be subjected to further examination below.

The stock of any good is the total quantity of that good in existence. Some will be supplied in exchange, and the remainder will be reserved. At any hypothetical price, it will be recalled, adding the demand to buy and the reserved demand of the supplier gives the total demand to hold on the part of both groups.5 The total demand to hold includes the demand in exchange by present nonowners and the reservation demand to hold by the present owners. Since the supply curve is either vertical or increasing with a rise in price, the sellers’ reservation demand will fall with a rise in price or will be nonexistent. In either case, the total demand to hold rises as the price falls.

Where there is a rise in reservation demand, the increase in the total demand to hold is greater—the curve far more elastic—than the regular demand curve, because of the addition of the reservation-demand component.6 Thus, the higher the market price of a stock, the less the willingness on the market to hold and own it and the greater the eagerness to sell it. Conversely, the lower the price of a good on the market, the greater the willingness to own it and the less the willingness to sell it.

It is characteristic of the total demand curve that it always intersects the physical stock available at the same equilibrium price as the one at which the demand and supply schedules intersect. The Total Demand and Stock lines will therefore yield the same market equilibrium price as the other, although the quantity exchanged is not revealed by these curves. They do disclose, however, that, since all units of an existing stock must be possessed by someone, the market price of any good tends to be such that the aggregate demand to keep the stock will equal the stock itself. Then the stock will be in the hands of the most eager, or most capable, possessors. These are the ones who are willing to demand the most for the stock. That owner who would just sell his stock if the price rose slightly is the marginal possessor: that nonowner who would buy if the price fell slightly is the marginal nonpossessor.7

Figure 35 is a diagram of the supply, demand, total demand, and stock curves of a good.

The total demand curve is composed of demand plus reserved supply; both slope rightward as prices fall. The equilibrium price is the same both for the intersection of the S and D curves, and for TD and Stock.

If there is no reservation demand, then the supply curve will be vertical, and equal to the stock. In that case, the diagram becomes as in Figure 36.

• 3The tabulations in the text are simplified for convenience and are not strictly correct. For suppose that the man had already paid six gold grains for one ounce of butter. When he decides on a purchase of another pound of butter, his ranking for all the units of money rise, since he now has a lower stock of money than he had before. Our tabulations, therefore, do not fully portray the rise in the marginal utility of money as money is spent. However, the correction reinforces, rather than modifies, our conclusion that the maximum demand-price falls as quantity increases, for we see that it will fall still further than we have depicted.
• 4On market-supply schedules, cf. Friedrich von Wieser, Social Economics (London: George Allen & Unwin, 1927), pp. 179–84.
• 5The reader is referred to the section on “Stock and the Total Demand to Hold” in chapter 2, pp. 137–42.
• 6If there is no reservation-demand schedule on the part of the sellers, then the total demand to hold is identical with the regular demand schedule.
• 7The proof that the two sets of curves always yield the same equilibrium price is as follows:
  
  Let, at any price, the quantity demanded = D, the quantity supplied = S, the quantity of existing stock = K, the quantity of reserved demand = R, and the total demand to hold = T. The following are always true, by definition:
  S = K - R
  T = D + RNow, at the equalibrium price, where S and D intersect, S is obviously equal to D. But if S = D, then T = K - R + R, or T = K.

Every money price of a good on the market, therefore, is determined by the supply and demand schedules of the individual buyers and sellers, and their action tends to establish a uniform equilibrium price on the market at the point of intersection, which changes only when the schedules do.8 Now the question arises: What are the determinants of the demand and supply schedules themselves? Can any conclusions be formed about the value scales and the resulting schedules?

In the first place, the analysis of speculation in chapter 2 can be applied directly to the case of the money price. There is no need to repeat that analysis here.9 Suffice it to say, in summary, that, in so far as the equilibrium price is anticipated correctly by speculators, the demand and supply schedules will reflect the fact: above the equilibrium price, demanders will buy less than they otherwise would because of their anticipation of a later drop in the money price; below that price, they will buy more because of an anticipation of a rise in the money price. Similarly, sellers will sell more at a price that they anticipate will soon be lowered; they will sell less at a price that they anticipate will soon be raised. The general effect of speculation is to make both the supply and demand curves more elastic, viz., to shift them from DD to D′D′ and from SS to S′S′ in Figure 37. The more people engage in such (correct) speculation, the more elastic will be the curves, and, by implication, the more rapidly will the equilibrium price be reached.

We also saw that preponderant errors in speculation tend inexorably to be self-correcting. If the speculative demand and supply schedules (D′D′– S′S′) preponderantly do not estimate the correct equilibrium price and consequently intersect at another price, then it soon becomes evident that that price does not really clear the market. Unless the equilibrium point set by the speculative schedules is identical to the point set by the schedules minus the speculative elements, the market again tends to bring the price (and quantity sold) to the true equilibrium point. For if the speculative schedules set the price of eggs at two grains, and the schedules without speculation would set it at three grains, there is an excess of quantity demanded over quantity supplied at two grains, and the bidding of buyers finally brings the price to three grains.10

Setting speculation aside, then, let us return to the buyer’s demand schedules. Suppose that he ranks the unit of a good above a certain number of ounces of gold on his value scale. What can be the possible sources of his demand for the good? In other words, what can be the sources of the utility of the good to him? There are only three sources of utility that any purchase good can have for any person.11 One of these is (a) the anticipated later sale of the same good for a higher money price. This is the speculative demand, basically ephemeral—a useful path to uncovering the more fundamental demand factors. This demand has just been analyzed. The second source of demand is (b) direct use as a consumers’ good; the third source is (c) direct use as a producers’ good. Source (b) can apply only to consumers’ goods; (c) to producers’ goods. The former are directly consumed; the latter are used in the production process and, along with other co-operating factors, are transformed into lower-order capital goods, which are then sold for money. Thus, the third source applies solely to the investing producers in their purchases of producers’ goods; the second source stems from consumers. If we set aside the temporary speculative source, (b) is the source of the individual demand schedules for all consumers’ goods, (c) the source of demands for all producers’ goods.

What of the seller of the consumers’ good or producers’ good—why is he demanding money in exchange? The seller demands money because of the marginal utility of money to him, and for this reason he ranks the money acquired above possession of the goods that he sells. The components and determinants of the utility of money will be analyzed in a later section.

Thus, the buyer of a good demands it because of its direct use-value either in consumption or in production; the seller demands money because of its marginal utility in exchange. This, however, does not exhaust the description of the components of the market supply and demand curves, for we have still not explained the rankings of the good on the seller’s value scale and the rankings of money on the buyer’s. When a seller keeps his stock instead of selling it, what is the source of his reservation demand for the good? We have seen that the quantity of a good reserved at any point is the quantity of stock that the seller refuses to sell at the given price. The sources of a reservation demand by the seller are two: (a) anticipation of later sale at a higher price; this is the speculative factor analyzed above; and (b) direct use of the good by the seller. This second factor is not often applicable to producers’ goods, since the seller produced the producers’ good for sale and is usually not immediately prepared to use it directly in further production. In some cases, however, this alternative of direct use for further production does exist. For example, a producer of crude oil may sell it or, if the money price falls below a certain minimum, may use it in his own plant to produce gasoline. In the case of consumers’ goods, which we are treating here, direct use may also be feasible, particularly in the case of a sale of an old consumers’ good previously used directly by the seller—such as an old house, painting, etc. However, with the great development of specialization in the money economy, these cases become infrequent.

If we set aside (a) as being a temporary factor and realize that (b) is frequently not present in the case of either consumers’ or producers’ goods, it becomes evident that many market-supply curves will tend to assume an almost vertical shape. In such a case, after the investment in production has been made and the stock of goods is on hand, the producer is often willing to sell it at any money price that he can obtain, regardless of how low the market price may be. This, of course, is by no means the same as saying that investment in further production will be made if the seller anticipates a very low money price from the sale of the product. In the latter case, the problem is to determine how much to invest at present in the production of a good to be produced and sold at a point in the future. In the case of the market-supply curve, which helps set the day-to-day equilibrium price, we are dealing with already given stock and with the reservation demand for this stock. In the case of production, on the other hand, we are dealing with investment decisions concerning how much stock to produce for some later period. What we have been discussing has been the market-supply curve. Here the seller’s problem is what to do with given stock, with already produced goods. The problem of production will be treated in chapter 5 and subsequent chapters.

Another condition that might obtain on the market is a previous buyer’s re-entering the market and reselling a good. For him to be able to do so, it is obvious that the good must be durable. (A violin-playing service, for example, is so nondurable that it is not resalable by the purchasing listeners.) The total stock of the good in existence will then equal the producers’ new supply plus the producers’ reserved demand plus the supply offered by old possessors plus the reserved demand of the old possessors (i.e., the amount the old buyers retain). The market-supply curve of the old possessors will increase or be vertical as the price rises; and the reserved-demand curve of the old possessors will increase or be constant as the price falls. In other words, their schedules behave similarly to their counterpart schedules among the producers. The aggregate market-supply curve will be formed simply by adding the producers’ and old possessors’ supply curves. The total-demand-to-hold schedule will equal the demand by buyers plus the reservation demand (if any) of the producers and of the old possessors.

If the good is Chippendale chairs, which cannot be further produced, then the market-supply curves are identical with the supply curves of the old possessors. There is no new production, and there are no additions to stock.

It is clear that the greater the proportion of old stock to new production, other things being equal, the greater will tend to be the importance of the supply of old possessors compared to that of new producers. The tendency will be for old stock to be more important the greater the durability of the good.

There is one type of consumers’ good the supply curve of which will have to be treated in a later section on labor and earnings. This is personal service, such as the services of a doctor, a lawyer, a concert violinist, a servant, etc. These services, as we have indicated above, are, of course, nondurable. In fact, they are consumed by the seller immediately upon their production. Not being material objects like “commodities,” they are the direct emanation of the effort of the supplier himself, who produces them instantaneously upon his decision. The supply curve depends on the decision of whether or not to produce—supply—personal effort, not on the sale of already produced stock. There is no “stock” in this sphere, since the goods disappear into consumption immediately on being produced. It is evident that the concept of “stock” is applicable only to tangible objects. The price of personal services, however, is determined by the intersection of supply and demand forces, as in the case of tangible goods.

For all goods, the establishment of the equilibrium price tends to establish a state of rest; a cessation of exchanges. After the price is established, sales will take place until the stock is in the hands of the most capable possessors, in accordance with the value scales. Where new production is continuing, the market will tend to be continuing, however, because of the inflow of new stock from producers coming into the market. This inflow alters the state of rest and sets the stage for new exchanges, with producers eager to sell their stock, and consumers to buy. When total stock is fixed and there is no new production, on the other hand, the state of rest is likely to become important. Any changes in price or new exchanges will occur as a result of changes of valuations, i.e., a change in the relative position of money and the good on the value scales of at least two individuals on the market, which will lead them to make further exchanges of the good against money. Of course, where valuations are changing, as they almost always are in a changing world, markets for old stock will again be continuing.12

An example of that rare type of good for which the market may be intermittent instead of continuous is Chippendale chairs, where the stock is very limited and the money price relatively high. The stock is always distributed into the hands of the most eager possessors, and the trading may be infrequent. Whenever one of the collectors comes to value his Chippendale below a certain sum of money, and another collector values that sum in his possession below the acquisition of the furniture, an exchange is likely to occur. Most goods, however, even nonreproducible ones, have a lively, continuing market, because of continual changes in valuations and a large number of participants in the market.

In sum, buyers decide to buy consumers’ goods at various ranges of price (setting aside previously analyzed speculative factors) because of their demand for the good for direct use. They decide to abstain from buying because of their reservation demand for money, which they prefer to retain rather than spend on that particular good. Sellers supply the goods, in all cases, because of their demand for money, and those cases where they reserve a stock for themselves are due (aside from speculation on price increases) to their demand for the good for direct use. Thus, the general factors that determine the supply and demand schedules of any and all consumers’ goods, by all persons on the market, are the balancing on their value scales of their demand for the good for direct use and their demand for money, either for reservation or for exchange. Although we shall further discuss investment-production decisions below, it is evident that decisions to invest are due to the demand for an expected money return in the future. A decision not to invest, as we have seen above, is due to a competing demand to use a stock of money in the present.

• 8Of course, this equilibrium price might be a zone rather than a single price in those cases where there is a zone between the valuations of the marginal buyer and those of the marginal seller. See the analysis of one buyer and one seller in chapter 2, above, pp. 107–10. In such rare cases, where there generally must be very few buyers and very few sellers, there is a zone within which the market is cleared at any point, and there is room for “bargaining skill” to maneuver. In the extensive markets of the money economy, however, even one buyer and one seller are likely to have one determinate price or a very narrow zone between their maximum buying- and minimum selling-prices.
• 9See chapter 2 above, pp. 130–37.
• 10This and the analysis of chapter 2 refute the charge made by some writers that speculation is “self-justifying,” that it distorts the effects of the underlying supply and demand factors, by tending to establish pseudoequilibrium prices on the market. The truth is the reverse; speculative errors in estimating underlying factors are self-correcting, and anticipation tends to establish the true equilibrium market-price more rapidly.
• 11Compare this analysis with the analysis of direct exchange, chapter 2 above, pp. 160–61.
• 12See chapter 2 above, pp. 142–44.

As in the case considered in chapter 2, the sellers who are included in the sale at the equilibrium price are those whose value scales make them the most capable, the most eager, sellers. Similarly, it will be the most capable, or most eager, buyers who will purchase the good at the equilibrium price. With a price of two and a half grains of gold per pound of butter, the sellers will be those for whom two and a half grains of gold is worth more than one pound of butter; the buyers will be those for whom the reverse valuation holds. Those who are excluded from sale or purchase by their own value scales are the “less capable,” or “less eager,” buyers and sellers, who may be referred to as “submarginal.” The “marginal” buyer and the “marginal” seller are the ones whose schedules just barely permit them to stay in the market. The marginal seller is the one whose minimum selling price is just two and a half; a slightly lower selling price would drive him out of the market. The marginal buyer is the one whose maximum buying price is just two and a half; a slightly higher selling price would drive him out of the market. Under the law of price uniformity, all the exchanges are made at the equilibrium price (once it is established), i.e., between the valuations of the marginal buyer and those of the marginal seller, with the demand and supply schedules and their intersection determining the point of the margin. It is clear from the nature of human action that all buyers will benefit (or decide they will benefit) from the exchange. Those who abstain from buying the good have decided that they would lose from the exchange. These propositions hold true for all goods.

Much importance has been attached by some writers to the “psychic surplus” gained through exchange by the most capable buyers and sellers, and attempts have been made to measure or compare these “surpluses.” The buyer who would have bought the same amount for four grains is obviously attaining a subjective benefit because he can buy it for two and a half grains. The same holds for the seller who might have been willing to sell the same amount for two grains. However, the psychic surplus of the “supramarginal” cannot be contrasted to, or measured against, that of the marginal buyer or seller. For it must be remembered that the marginal buyer or seller also receives a psychic surplus: he gains from the exchange, or else he would not make it. Value scales of each individual are purely ordinal, and there is no way whatever of measuring the distance between the rankings; indeed, any concept of such distance is a fallacious one. Consequently, there is no way of making interpersonal comparisons and measurements, and no basis for saying that one person subjectively benefits more than another.13

We may illustrate the impossibility of measuring utility or benefit in the following way. Suppose that the equilibrium market price for eggs has been established at three grains per dozen. The following are the value scales of some selected buyers and would-be buyers:

The money prices are divided into units of one-half grain; for purposes of simplification, each buyer is assumed to be considering the purchase of one unit—one dozen eggs. C is obviously a submarginal buyer; he is just excluded from the purchase because three grains is higher on his value scale than the dozen eggs. A and B, however, will make the purchase. Now A is a marginal buyer; he is just able to make the purchase. At a price of three and a half grains, he would be excluded from the market, because of the rankings on his value scale. B, on the other hand, is a supramarginal buyer: he would buy the dozen eggs even if the price were raised to four and a half grains. But can we say that B benefits from his purchase more than A? No, we cannot. Each value scale, as has been explained above, is purely ordinal, a matter of rank. Even though B prefers the eggs to four and a half grains, and A prefers three and a half grains to the eggs, we still have no standard for comparing the two surpluses. All we can say is that above the price of three grains, B has a psychic surplus from exchange, while A becomes submarginal, with no surplus. But, even if we assume for a moment that the concept of “distance” between ranks makes sense, for all we know, A’s surplus over three grains may give him a far greater subjective utility than B’s surplus over three grains, even though the latter is also a surplus over four and a half grains. There can be no interpersonal comparison of utilities, and the relative rankings of money and goods on different value scales cannot be used for such comparisons.

Those writers who have vainly attempted to measure psychic gains from exchange have concentrated on “consumer surpluses.” Most recent attempts try to base their measurements on the price a man would have paid for the good if confronted with the possibility of being deprived of it. These methods are completely fallacious. The fact that A would have bought a suit at 80 gold grains as well as at the 50 grains’ market price, while B would not have bought the suit if the price had been as high as 52 grains, does not, as we have seen, permit any measurement of the psychic surpluses, nor does it permit us to say that A’s gain was in any way “greater” than B’s. The fact that even if we could identify the marginal and supramarginal purchasers, we could never assert that one’s gain is greater than another’s is a conclusive reason for the rejection of all attempts to measure consumers’ or other psychic surpluses.

There are several other fundamental methodological errors in such a procedure. In the first place, individual value scales are here separated from concrete action. But economics deals with the universal aspects of real action, not with the actors’ inner psychological workings. We deduce the existence of a specific value scale on the basis of the real act; we have no knowledge of that part of a value scale that is not revealed in real action. The question how much one would pay if threatened with deprivation of the whole stock of a good is strictly an academic question with no relation to human action. Like all other such constructions, it has no place in economics. Furthermore, this particular concept is a reversion to the classical economic fallacy of dealing with the whole supply of a good as if it were relevant to individual action. It must be understood that only marginal units are relevant to action and that there is no determinate relation at all between the marginal utility of a unit and the utility of the supply as a whole.

It is true that the total utility of a supply increases with the size of the supply. This is deducible from the very nature of a good. Ten units of a good will be ranked higher on an individual’s value scale than four units will. But this ranking is completely unrelated to the utility ranking of each unit when the supply is 4, 9, 10, or any other amount. This is true regardless of the size of the unit. We can affirm only the trivial ordinal relationship, i.e., that five units will have a higher utility than one unit, and that the first unit will have a higher utility than the second unit, the third unit, etc. But there is no determinate way of lining up the single utility with the “package” utility.14 Total utility, indeed, makes sense as a real and relevant rather than as a hypothetical concept only when actual decisions must be made concerning the whole supply. In that case, it is still marginal utility, but with the size of the margin or unit now being the whole supply.

The absurdity of the attempt to measure consumers’ surplus would become clearer if we considered, as we logically may, all the consumers’ goods at once and attempted to measure in any way the undoubted “consumers’ surplus” arising from the fact that production for exchange exists at all. This has never been attempted.15

• 13We might, in some situations, make such comparisons as historians, using imprecise judgment. We cannot, however, do so as praxeologists or economists.
• 14For more on these matters, see Rothbard, “Toward a Reconstruction of Utility and Welfare Economics,” pp. 224–43. Also see Mises, Theory of Money and Credit, pp. 38–47.
• 15It is interesting that those who attempt to measure consumers’ surplus explicitly rule out consideration of all goods or of any good that looms “large” in the consumers’ budget. Such a course is convenient, but illogical, and glosses over fundamental difficulties in the analysis. It is, however, typical of the Marshallian tradition in economics. For an explicit statement by a leading present-day Marshallian, see D.H. Robertson, Utility and All That (London: George Allen & Unwin, 1952), p. 16.

Thus, at any given point in time, the consumer is confronted with the previously existing money prices of the various consumers’ goods on the market. On the basis of his utility scale, he determines his rankings of various units of the several goods and of money, and these rankings determine how much money he will spend on each of the various goods. Specifically, he will spend money on each particular good until the marginal utility of adding a unit of the good ceases to be greater than the marginal utility that its money price on the market has for him. This is the law of consumer action in a market economy. As he spends money on a good, the marginal utility of the new units declines, while the marginal utility of the money forgone rises, until he ceases spending on that good. In those cases where the marginal utility of even one unit of a good is lower than the marginal utility of its money price, the individual will not buy any of that good.

In this way are determined the individual demand schedules for each good and, consequently, the aggregate market-demand schedules for all buyers. The position of the market-demand schedule determines what the market price will be in the immediate future. Thus, if we consider action as divided into periods consisting of “days,” then the individual buyers set their rankings and demand schedules on the basis of the prices existing at the end of day 1, and these demand schedules determine what the prices will be by the end of day 2.

The reader is now referred back to the discussion in chapter 2 above, sections 9 and 10. The analysis, there applied to barter conditions, applies to money prices as well. At the end of each day, the demand schedules (or rather, the total demand schedules) and the stock in existence on that day set the market equilibrium price for that day. In the money economy, these factors determine the money prices of the various goods during that day. The analysis of changes in the prices of a good, set forth in chapter 2, is directly applicable here. In the money economy, the most important markets are naturally continuous, as goods continue to be produced in each day. Changes in supply and demand schedules or changes in total demand schedules and quantity of stock have exactly the same directional effect as in barter. An increase in the market’s total demand schedule over the previous day tends to increase the money price for the day; an increase in stock available tends to lower the price, etc. As in barter, the stock of each good, at the end of each day, has been transferred into the hands of the most eager possessors.

Up to this point we have concentrated on the determination of the money price of each consumers’ good, without devoting much attention to the relations among these prices. The interrelationships should be clear, however. The available goods are ranked, along with the possibility of holding the money commodity in one’s cash balance, on each individual’s value scale. Then, in accordance with the rankings and the law of utility, the individual allocates his units of money to the most highly valued uses: the various consumers’ goods, investment in various factors, and addition to his cash balance. Let us here set aside the question of the distribution chosen between consumption and investment, and the question of addition to the cash balance, until later chapters, and consider the interrelations among the prices of consumers’ goods alone.

The law of the interrelation of consumers’ goods is: The more substitutes there are available for any given good, the more elastic will tend to be the demand schedules (individual and market) for that good. By the definition of “good,” two goods cannot be “perfect substitutes” for each other, since if consumers regarded two goods as completely identical, they would, by definition, be one good. All consumers’ goods are, on the other hand, partial substitutes for one another. When a man ranks in his value scale the myriad of goods available and balances the diminishing utilities of each, he is treating them all as partial substitutes for one another. A change in ranking for one good by necessity changes the rankings of all the other goods, since all the rankings are ordinal and relative. A higher price for one good (owing, say, to a decrease in stock produced) will tend to shift the demand of consumers from that to other consumers’ goods, and therefore their demand schedules will tend to increase. Conversely, an increased supply and a consequent lowering of price for a good will tend to shift consumer demand from other goods to this one and lower the demand schedules for the other goods (for some, of course, more than for others).

It is a mistake to suppose that only technologically similar goods are substitutes for one another. The more money consumers spend on pork, the less they have to spend on beef, or the more money they spend on travel, the less they have to spend on TV sets. Suppose that a reduction in its supply raises the price of pork on the market; it is clear that the quantity demanded, and the price, of beef will be affected by this change. If the demand schedule for pork is more than unitarily elastic in this range, then the higher price will cause less money to be spent on pork, and more money will tend to be shifted to such a substitute as beef. The demand schedules for beef will increase, and the price of beef will tend to rise. On the other hand, if the demand schedule for pork is inelastic, more consumers’ money will be spent on pork, and the result will be a fall in the demand schedule for beef and consequently in its price. Such interrelations of substitute goods, however, hold true in some degree for all goods, since all goods are substitutes for one another; for every good is engaged in competing for the consumers’ stock of money. Of course, some goods are “closer” substitutes than others, and the interrelations among them will be stronger than among the others. The closeness of the substitution depends, however, on the particular circumstances of the consumer and his preferences rather than on technological similarity.

Thus, consumers’ goods, in so far as they are substitutes for one another, are related as follows: When the stock of A rises and the price of A therefore falls, (1) if the demand schedule for A is elastic, there will be a tendency for a decline in the demand schedules for B, C, D, etc., and consequent declines in their prices; (2) if the demand schedule for A is inelastic, there will be a rise in the demand schedules for B, C, D, etc., and a consequent rise in their prices; (3) if the demand schedule has exactly neutral (or unitary) elasticity, so that there is no change in the amount of money expended on A, there will be no effect on the demands for and the prices of the other goods.

As the money economy develops and civilization flowers, there is a great expansion in the types of goods available and therefore in the number of goods that can be substituted for one another. Consequently, there is a tendency for the demands for the various consumers’ goods to become more elastic, although they will continue to vary from highly elastic to highly inelastic. In so far as the multiplication of substitutes tends to render demand curves for individual goods elastic, the first type of interaction will tend to predominate. Furthermore, when new types of goods are established on the market, these will clearly draw monetary demand away from other, substitute products, and hence bring about the first type of reaction.

The substitutive interrelations of consumers’ goods were cogently set forth in this passage by Philip Wicksteed:

It is sufficiently obvious that when a woman goes into the market uncertain whether she will or will not buy new potatoes, or chickens, the price at which she finds that she can get them may determine her either way. ... For the price is the first and most obvious indication of the nature of the alternatives that she is foregoing, if she makes a contemplated purchase. But it is almost equally obvious that not only the price of these particular things, but the price of a number of other things also will affect the problem. If good, sound, old potatoes are to be had at a low price, the marketer will be less likely to pay a high price for new ones, because there is a good alternative to be had on good terms. ... If the housewife is thinking of doing honour to a small party of neighbours by providing a couple of chickens for their entertainment at supper, it is possible that she could treat them with adequate respect, though not with distinction, by substituting a few pounds of cod. And in that case not only the price of chickens but the price of cod will tend to affect her choice. ...

But on what does the significance ... [of the price difference between chicken and cod] depend? Probably upon the price of things that have no obvious connection with either chicken or cod. A father and mother may have ambitions with respect to the education or accomplishments of their children, and may be willing considerably to curtail their expenditure on other things in order to gratify them. Such parents may be willing to incur ... entertaining their guests less sumptuously than custom demands, and at the same time getting French or violin lessons for their children. In such cases the question whether to buy new or old potatoes, or whether to entertain friends with chicken or cod, or neither, may be affected by the terms on which French or music lessons of a satisfactory quality can be secured.27

While all consumers’ goods compete with one another for consumer purchases, some goods are also complementary to one another. These are goods whose uses are closely linked together by consumers, so that movements in demand for them are likely to be closely tied together. An example of complementary consumers’ goods is golf clubs and golf balls, two goods the demands for which tend to rise and fall together. In this case, for example, an increase in the supply of golf balls will tend to cause a fall in their prices, which will tend to raise the demand schedule for golf clubs as well as to increase the quantity of golf balls demanded. This will tend to increase the price of golf clubs. In so far, then, as two goods are complementary to each other, when the stock of A rises, and the price of A therefore falls, the demand schedule for B increases and its price will tend to rise. Since a fall in the price of a good will always increase the quantity of the good demanded (by the law of demand), this will always stimulate the demand schedule for a complementary good and thus tend to raise its price.28 For this effect the elasticity of demand for the original good has no relevance.

Summing up these interrelations among consumers’ goods:

All goods are substitutable for one another, while fewer are complementary. When they are also complementary, then the complementary effect will be mixed with the substitutive effect, and the nature of each particular case will determine which effect will be the stronger.

This discussion of the interrelation of consumers’ goods has treated the effect only of changes from the stock, or supply, side. The effects are different when the change occurs in the demand schedule instead of in the quantity of stock. Suppose that the market-demand schedule for good A increases—shifts to the right. This means that, for every hypothetical price, the quantity of A bought, and therefore the amount of money spent on A, increases. But, given the supply (stock) of money in the society, this means that there will be decreases in the demand schedules for one or more other goods.29 More money spent on good A, given the stock of money, signifies that less money is spent on goods B, C, D ... The demand curves for the latter goods “shift to the left,” and the prices of these goods fall. Therefore, the effect of the substitutability of all goods for one another is that an increased demand for A, resulting in a rise in the price of A, will lead to decreased demand schedules and falling prices for goods B, C, D ... We can see this relation more fully when we realize that the demand schedules are determined by individual value scales and that a rise in the marginal utility of a unit of A necessarily means a relative fall in the utility of the other consumers’ goods.

In so far as two goods are complementary, another effect tends to occur. If there is an increase in the demand schedule for golf clubs, it is likely to be accompanied by an increase in the demand schedule for golf balls, since both are determined by increased relative desires to play golf. When changes come from the demand side, the prices of complementary goods tend to rise and fall together. In this case, we should not say that the rise in demand for A led to a rise in demand for its complement B, since both increases were due to an increased demand for the consumption “package” in which the two goods are intimately related.

We may now sum up both sets of interrelations of consumers’ goods, for changes in stock and in demand (suppliers’ reservation demand can be omitted here, since this speculative element tends toward correct estimates of the basic determinant, consumer demand).

Table 10 indicates the reactions of other goods, B, C, D, to changes in the determinants for good A, in so far as these goods are substitutable for it or complementary to it. A + sign signifies that the prices of the other goods react in the same direction as the price of good A; a – sign signifies that the prices of the other goods react in the opposite direction.

In some cases, an old stock of a good may be evaluated differently from the new and therefore may become a separate good. Thus, while well-stored old nails might be considered the same good as newly produced nails, an old Ford will not be considered the same as a new one. There will, however, definitely be a close relation between the two goods. If the supply schedule for the new Fords decreases and the price rises, consumers will tend to shift to the purchase of old Fords, tending to raise the price of the latter.

Thus, old and new commodities, technologically similar, tend to be very close substitutes for each other, and their demands and prices tend to be closely related.

Much has been written in the economic literature of consumption theory on the “assumption” that each consumers’ good is desired quite independently of other goods. Actually, as we have seen, the desires for various goods are of necessity interdependent, since all are ranged on the consumers’ value scales. Utilities of each of the goods are relative to one another. These ranked values for goods and money permit the formation of individual, and then aggregate, demand schedules in money for each particular good.

• 27Wicksteed, Common Sense of Political Economy, I, 21–22.
• 28The exception is those cases in which the demand curve for the good is directly vertical, and there will then be no effect on the complementary good.
• 29We omit at this point analysis of the case in which the increase in demand results from decreases of cash balance and/or decreases in investment.

Why does a man purchase a consumers’ good? As we saw back in chapter 1, a consumers’ good is desired and sought because the actor believes that it will serve to satisfy his urgently valued desires, that it will enable him to attain his valued ends. In other words, the good is valuable because of the expected services that it will provide. Tangible commodities, then, such as food, clothing, houses, etc., and intangible personal services, such as medical attention and concert performances, are similar in the life of the consumer. Both are evaluated by the consumer in terms of their services in providing him with satisfactions.

Every type of consumers’ good will yield a certain amount of services per unit of time. These may be called unit services. When they are exchangeable, these services may be sold individually. On the other hand, when a good is a physical commodity and is durable, it may be sold to the consumer in one piece, thereby embodying an expected future accrual of many unit services. What are the interrelations among the markets for, and prices of, the unit services and the durable good as a whole?

Other things being equal, it is obvious that a more durable good is more valuable than a less durable good, since it embodies more future unit services. Thus, suppose that there are two television sets, each identical in service to the viewer, but that A has an expected life of five years, and B of 10. Though the service is identical, B has twice as many services as A to offer the consumer. On the market, then, the price of B will tend to be twice the price of A.30

For nondurable goods, the problem of the separate sale of the service of the good and of the good itself does not arise. Since they embody services over a relatively short span of time, they are almost always sold as a whole. Butter, eggs, Wheaties, etc., are sold as a whole, embodying all their services. Few would think of “renting” eggs. Personal services, on the other hand, are never sold as a whole, since, on the free market, slave contracts are not enforceable. Thus, no one can purchase a doctor or a lawyer or a pianist for life, to perform services at will with no further payment. Personal services, then, are always sold in their individual units.

The problem whether services should be sold separately or with the good as a whole arises in the case of durable commodities, such as houses, pianos, tuxedos, television sets, etc. We have seen that goods are sold, not as a total class, e.g., “bread” or “eggs,” but in separate homogeneous units of their supply, such as “loaves of bread,” or “dozens of eggs.” In the present discussion, a good can be sold either as a complete physical unit—a house, a television set, etc.—or in service units over a period of time. This sale of service units of a durable good is called renting or renting out or hiring out the good. The price of the service unit is called the rent.

Since the good itself is only a bundle of expected service units, it is proper to base our analysis on the service unit. It is clear that the demand for, and the price of, a service unit of a consumers’ good will be determined on exactly the same principles as those set forth in the preceding analysis of this chapter.

A durable consumers’ good embodies service units as they will accrue over a period of time. Thus, suppose that a house is expected to have a life of 20 years. Assume that a year’s rental of the house has a market price, as determined by the market supply and demand schedules, of 10 ounces of gold. Now, what will be the market price of the house itself should it be sold? Since the annual rental price is 10 ounces (and if this rental is expected to continue), the buyer of the house will obtain what amounts to 20 × 10, or 200 ounces, of prospective rental income. The price of the house as a whole will tend inexorably to equal the present value of the 200 ounces. Let us assume for convenience at this point that there is no phenomenon of time preference and that the present value of 200 ounces is therefore equal to 200 ounces. In that case, the price of the house as a whole will tend to equal 200 ounces.

Suppose that the market price of the house as a whole is 180 ounces. In that case, there will be a rush to buy the house, since there is an expected monetary profit to be gained by purchasing for 180 ounces and then renting out for a total income of 200 ounces. This action is similar to speculative purchasers’ buying a good and expecting to resell at a higher price. On the other hand, there will be a great reluctance by the present owners of such houses (or of the house, if there is no other house adjudged by the market as the same good), to sell at that price, since it is far more profitable to rent it out than to sell it. Thus, under these conditions, there will be a considerable excess of demand over supply of this type of house for sale, at a price of 180 ounces. The upbidding of the excess demand tends to raise the price toward 200. On the other hand, suppose that the market price is above 200. In that case, there will be a paucity of demand to purchase, since it would be cheaper to pay rental for it instead of paying the sum to purchase it. On the contrary, possessors will be eager to sell the house rather than rent it out, since the price for sale is better. The excess supply over demand at a price over 200 will drive the price down to the equilibrium point.

Thus, while every type of market price is determined as in the foregoing sections of this chapter, the market also determines price relations. We see that there is a definite relationship between the price of the unit services of a durable consumers’ good and the price of the good as a whole. If that relationship is disturbed or does not apply at any particular time, the actions of individuals on the market will tend to establish it, because prospects of monetary gain arise until it is established, and action to obtain such gain inevitably tends to eliminate the opportunity. This is a case of “arbitrage” in the same sense as the establishment of one price for a good on the market. If two prices for one good exist, people will tend to rush to purchase in the cheaper market and sell more of the good in the more expensive market, until the play of supply and demand on each market establishes an “equilibrium” price and eliminates the arbitrage opportunity. In the case of the durable good and its services, there is an equilibrium-price relation, which the market tends to establish. The market price of the good as a whole is equal to the present value of the sum of its expected (future) rental incomes or rental prices.

The expected future rental incomes are, of course, not necessarily a simple extrapolation of present rental prices. Indeed, since prices are always changing, it will almost always be the case that rental prices will change in the future. When a person buys a durable good, he is buying its services for a length of time extending into the future; hence, he is more concerned with future than with present rates; he merely takes the latter as a possible guide to the future.31 Now, suppose that the individuals on the market generally estimate that rents for this house over the next decade or so will be much lower than at present. The price of the house then will not be 20 × 10 ounces, but some correspondingly smaller amount.

At this point, we shall define the “price of the good as whole” as its capital value on the market, even though there is risk of confusion with the concept of “capital good.” The capital value of any good (be it consumers’ or capital good or nature-given factor) is the money price which, as a durable good, it presently sells for on the market. The concept applies to durable goods, embodying future services.32 The capital value of a consumers’ good will tend to equal the present value of the sum of expected unit rentals.

The capital value at any time is based on expectations of future rental prices. What happens when these expectations are erroneous? Suppose, for example, that the market expects the rental prices of this house to increase in the next few years and therefore sets the capital value higher than 200 ounces. Suppose, further, that the rental prices actually decline instead. This means that the original capital value on the market had overestimated the rental income from the house. Those who had sold the house at, say, 250, have gained, while those who bought the house in order to rent it out have lost on the transaction. Thus, those who have forecast better than their fellows gain, while the poorer forecasters lose, as a result of their speculative transactions.

It is obvious that such monetary profits come not simply from correct forecasting, but from forecasting more correctly than other individuals. If all the individuals had forecast correctly, then the original capital value would have been below 200, say, 150, to account for the eventually lower rental prices. In that case no such monetary profit would have appeared.33 It should be clear that the gains or losses are the consequences of the freely undertaken action of the gainers and losers themselves. The man who has bought a good to rent out at what proves to be an excessive capital value has only himself to blame for being overly-optimistic about the monetary return on his investment. The man who sells at a capital value higher than the eventual rental income is rewarded for his sagacity through decisions voluntarily taken by all parties. And since successful forecasters are, in effect, rewarded, and poor ones penalized, and in proportion to good and poor judgment respectively, the market tends to establish and maintain as high a quality of forecasting as is humanly possible to achieve.

The equilibrium relation between the capital value on the market and the sum of expected future rents is a day-to-day equilibrium that tends always to be set by the market. It is similar to the day-to-day market equilibrium price for a good set by supply and demand. On the other hand, the equilibrium relation between present capital value and actual future rents is only a long-range tendency fostered by the market’s encouragement of successful forecasters. This relation is a final equilibrium, similar to the final equilibrium prices that set the goal toward which the day-to-day prices tend.

Study of capital value and rental prices requires additional supply-demand analysis. The determination of the unit rental price presents no problem. Price determination of the capital value, however, needs to be modified to account for this dependence on, and relationship to, the rental price. The demand for the durable good will now be, not only for direct use, but also, on the part of others, demand for investment in future renting out. If a man feels that the market price of the capital value of a good is lower than the income he can obtain from future rentals, he will purchase the good and enter the renting-out market as a supplier. Similarly, the reserved demand for the good as a whole will be not only for direct use or for speculative price increases, but also for future renting out of the good. If the possessor of a durable good believes that the selling price (capital value) is lower than what he can get in rents, he will reserve the supply and rent out the good. The capital value of the good will be such as to clear the total stock, and the total of all these demands for the good will be in equilibrium. The reserved demand of the buyers will, as before, be due to their reserved demand for money, while the sellers of both the good as a whole and of its unit services will be demanding money in exchange.

In other words, for any consumers’ good, the possessors have the choice of either consuming it directly or selling it for money. In the case of durable consumers’ goods, the possessors can do any one of the following with the good: use it directly, sell it whole, or hire it out—selling its unit services over a period of time. We have already seen that if using it directly is highest on his value scale, then the man uses the good and reserves his stock from the market. If selling it whole is highest on his value scale, he enters the “capital” market for the good as a supplier. If renting it out is highest on his value scale, then he enters the “renting” market for the good as a supplier. Which of these latter alternatives will be higher on his value scale depends on his estimate of which course will yield him the higher money income. The shape of the supply curves in both the capital and rental markets will be either rightward- and upward-sloping or vertical, since the greater the expected income, the less will be the amount reserved for direct use. It is clear that the supply schedules on the two markets are interconnected. They will tend to come into equilibrium when the equilibrium-price relation is established between them.

Similarly, the nonpossessors of a good at any given time will choose between (a) not buying it and reserving their money, (b) buying it outright, and (c) renting it. They will choose the course highest on their value scales, which depends partially on their demand for money and on their estimate of which type of purchase will be cheaper. If they decide to buy, they will buy on what they estimate is the cheaper market; then they can either use the good directly or resell it on the more expensive market. Thus, if the capital value of the house is 200 and a buyer estimates that total rental prices will be 220, he buys outright at 200, after which he may either use it directly or enter the rental market as a supplier in order to earn the expected 220 ounces. The latter choice again depends on his value scale. This is another example of the arbitrage action already explained, and the effect is to link the demand curves for the two types of markets for durable goods.

Here it must be pointed out that in some cases the renting contract itself takes on the characteristics of a capital contract and the estimating of future return. Such is the case of a long-term renting contract. Suppose that A is planning to rent a house to B for 30 years, at a set annual price. Then, instead of continual changes in the rental price, the latter is fixed by the original contract. Here again, the demand and supply schedules are set according to the various individual estimates of the changing course of other varying rents for the same type of good. Thus, if there are two identical houses, and it is expected that the sum of the varying rents on house A for the next 30 years will be 300 ounces, then the long-term renting price for house B will tend to be set at 10 ounces per year. Here again, there is a similar connection between markets. The price of presently established long-term rents will tend to be equal to the present value of the sum of the expected fluctuating rents for identical goods. If the general expectation is that the sum of rents will be 360 ounces, then there will be a heavy demand for long-term rent purchases at 300 ounces and a diminished supply for rent at that price, until the long-term rental price is driven to 12 ounces per year, when the sum will be the same. And here again, the ever-present uncertainty of the future causes the more able forecasters to gain and the less able ones to lose.34

In actuality, time preference exists, and the present value of the future rentals is always less by a certain discount than the sum of these rentals. If this were not so, the capital value of very durable goods, goods which wear out only imperceptibly, would be almost infinite. An estate expected to last and be in demand for hundreds of years would have an almost infinitely high selling price. The reason this does not happen is that time preference discounts future goods in accordance with the length of time being considered. How the rate of time preference is arrived at will be treated in later chapters. However, the following is an illustration of the effect of time preference on the capital-value of a good. Assume a durable good, expected to last for 10 years, with an expected rental value of 10 ounces each year. If the rate of time preference is 10 percent per annum, then the future rents and their present value are as follows:

As the date of time recedes into the future, the compounded discount becomes greater, finally reducing the present value to a negligible amount.

It is important to recognize that the time-preference factor does not, as does relatively correct forecasting of an uncertain situation, confer monetary profits or losses. If the time-preference rate is 10 percent, purchasing the aforementioned good for 59.4 ounces, holding it, and renting it out for 10 years to acquire 100 ounces does not constitute a monetary profit. Present money was at this premium over future money, and what this man earned was simply the amount of future income that the market had evaluated as equal to 59.4 ounces of present money.

In general, we may sum up the action of entrepreneurs in the field of durable consumers’ goods by saying that they will tend to invest in the outright purchase of (already existing) durable consumers’ goods when they believe that the present capital value of the good on the market is less than the sum of future rentals (discounted by time preference) that they will receive. They will sell such goods outright when they believe that the present capital value is higher than the discounted sum of future rentals. Better forecasters will earn profits, and poorer ones will suffer losses. In so far as the forecasting is correct, these “arbitrage” opportunities will tend to disappear.

Although we have analyzed the arbitrage profits and losses of entrepreneurship in the case of selling outright as against renting, we have yet to unravel fully the laws that govern entrepreneurial incomes—the incomes that the producers strive to obtain in the process of production. This problem will be analyzed in later chapters.35

• 30Strictly, this is not correct, and the important qualification will be added below. Since, as a result of time preference, present services are worth more than the same ones in the future, and those in the near future more than those in the far future, the price of B will be less than twice the price of A.
• 31It needs to be kept in mind that, strictly, there is no such thing as a “present” price established by the market. When a man considers the price of a good, he is considering that price agreed upon in the last recorded transaction in the market. The “present” price is always, in reality the historically recorded price of the most immediate past (say, a half-hour ago). What always interests the actor is what various prices will be at various times in the future.
• 32On the different uses of the term “value,” see Appendix B, “On Value,” below.
• 33The concept of monetary profit and loss and their relation to capitalization will be explored below.
• 34Cf. Fetter, Economic Principles, pp. 158–60.
• 35For a discussion of the value of durable goods, see the brilliant treatment in Böhm-Bawerk, Positive Theory of Capital, pp. 339–57; Fetter, Economic Principles, pp. 111–21; and Wicksteed, Common Sense of Political Economy, I, 101–11.

In our preoccupation with analysis of the action of man in the monetary economy, it must not be thought that the general truths presented in chapter 1 remain no longer valid. On the contrary, in chapter 1 they were applied to isolated Crusoe-type situations because we logically begin with such situations in order to be able to analyze the more complex interrelations of the monetary economy. However, the truths formulated in the first chapter are applicable still, not only through logical inferences applied to the monetary nexus, but also directly to all situations in the monetary economy in which money is not involved.

There is another sense in which the analysis of the first chapter is directly applicable in a money economy. We may be primarily concerned in the analysis of exchange with the consumer’s allocation of money to the most highly valued of its uses—based on the individual’s value scales. We must not forget, however, the ultimate goal of the consumer’s expenditures of money. This goal is the actual use of the purchased goods in attaining his most highly valued ends. Thus, for the purposes of analysis of the market, once Jones has purchased three pounds of butter, we have lost interest in the butter (assuming there is no chance of Jones’ re-entering the market to sell the butter). We call the retail sale of the butter the sale of the consumers’ good, since this is its last sale for money along the path of the butter’s production. Now the good is in the hands of the ultimate consumer. The consumer has weighed the purchase on his value scale and has decided upon it.

Strictly, we must never lose sight of the fact that this purchase by the consumer is not the last stopping point of the butter, when we consider human action in its entirety. The butter must be carried to the man’s home. Then, Jones allocates the units of butter to their most highly valued uses: buttered toast, butter in a cake, butter on a bun, etc. To use the butter in a cake or sandwich, for example, Mrs. Jones bakes the cake and prepares the sandwich and then brings it to the table where Jones eats it. We can see that the analysis of chapter 1 holds true, in that useful goods—horses, butter, or anything else—in the hands of the consumer are allocated, in accordance with their utility, to the most highly valued uses. Also, we can see that actually the butter when last sold for money was not a consumers’ good, but a capital good—albeit one of lower order than at any other previous stage of its production. Capital goods are produced goods that must be combined still further with other factors in order to provide the consumers’ good—the good that finally yields the ultimate satisfaction to the consumer. From the full praxeological point of view, the butter becomes a consumers’ good only when it is actually being eaten or otherwise “consumed” by the ultimate consumer.

From the standpoint of praxeology proper—the complete formal analysis of human action in all its aspects—it is inadmissible to call the good at its last retail sale to the consumer a “consumers’ good.” From the point of view of that subdivision of praxeology that covers traditional economics—that of catallactics, the science of monetary exchanges—however, it becomes convenient to call the good at the last retail stage a “consumers’ good.” This is the last stage of the good in the monetary nexus—the last point, in most cases, at which it is open to producers to invest money in factors. To call the good at this final monetary stage a “consumers’ good” is permissible, provided we are always aware of the foregoing qualifications. We must always remember that without the final stages and the final allocation by consumers, there would be no raison d’être for the whole monetary exchange process. Economics cannot afford to dismiss the ultimate consumption stage simply because it has passed beyond the monetary nexus; it is the final goal and end of the monetary transactions by individuals in society.

Attention to this point will clear up many confusions. Thus, there is the question of consumers’ income. In chapter 3, we analyzed consumers’ money income and the universal goal of maximizing psychic income, and we indicated to some extent the relation between the two. Everyone attempts to maximize the latter, which includes on its value scale a vast range of all consumers’ goods, both exchangeable and nonexchangeable. Exchangeable goods are generally in the monetary nexus, and therefore can be purchased for money, whereas nonexchangeable goods are not. We have indicated some of the consequences of the fact that it is psychic and not monetary income that is being maximized, and how this introduces qualifications into the expenditure of effort or labor and in the investment in producers’ goods. It is also true that psychic income, being purely subjective, cannot be measured. Further, from the standpoint of praxeology, we cannot even ordinally compare the psychic income or utility of one person with that of another. We cannot say that A’s income or “utility” is greater than B’s.

We can—at least, theoretically—measure monetary incomes by adding the amount of money income each person obtains, but this is by no means a measure of psychic income. Furthermore, it does not, as we perhaps might think, give any exact indication of the amount of services that each individual obtains purely from exchangeable consumers’ goods. An income of 50 ounces of gold in one year may not, and most likely will not, mean the same to him in terms of services from exchangeable goods as an income of 50 ounces in some other year. The purchasing power of money in terms of all other commodities is continually changing, and there is no way to measure such changes.

Of course, as historians rather than economists, we can make imprecise judgments comparing the “real” income rather than the monetary income between periods. Thus, if Jones received 1,000 ounces of income in one year and 1,200 in the next, and prices generally rose during the year, Jones’ “real income” in terms of goods purchasable by the money has risen considerably less than the nominal monetary increase or perhaps fallen. However, as we shall see further below, there is no precise method of measuring or even identifying the purchasing power of money and its changes.

Even if we confine ourselves to the same period, monetary incomes are not an infallible guide. There are, for example, many consumers’ goods that are obtainable both through monetary exchange and outside the money nexus. Thus, Jones may be spending 18 ounces a month on food, rent, and household maintenance, while Smith spends only nine ounces a month. This does not necessarily mean that Jones obtains twice as much of these services as Smith. Jones may live in a hotel, which provides him with these services in exchange for money. Smith, on the other hand, may be married and may obtain household and cooking services outside the monetary nexus. Smith’s psychic income from these services may be equal to, or greater than, Jones’, despite the lower monetary expenditures.

Neither can we measure psychic incomes if we confine ourselves to goods in the monetary nexus. A and B might live in the same sort of house, but how can the economist-observer deduce from this that the two are deriving the same amount of enjoyment from the house? Obviously, the degree of enjoyment will most likely differ, but the mere fact of the income or property will provide no clue to the direction or extent of the difference.

It follows that the law of the diminishing marginal utility of money applies only to the valuations of each individual person. There can be no comparison of such utility between persons. Thus, we cannot, as some writers have done, assert that an extra dollar is enjoyed less by a Rockefeller than by a poor man. If Rockefeller were suddenly to become poor, each dollar would be worth more to him than it is now; similarly, if the poor man were to become rich, his value scales remaining the same, each dollar would be worth less than it is now. But this is a far cry from attempting to compare different individuals’ enjoyments or subjective valuations. It is certainly possible that a Rockefeller enjoys the services of each dollar more than a poor, but highly ascetic, individual does.

A doctrine commonly held by writers on utility is that the consumer acts so as to bring the marginal utility that any good has for him into equality with the price of that good. To understand this thesis, let us examine the preference scale of Mr. Jones in contemplating the purchase of one or more suits (and we shall assume that each suit is of the same quality—the same “good”). Suppose his value scale is as follows:

And suppose also that the market price is 2.9 grains per suit. Jones will buy not one or three, but two, suits. He will buy up to the last unit at which the diminishing marginal utility that the suit has for him exceeds the increasing marginal utility of money.36 This is obvious. Now, if a writer couches the exposition in terms of highly divisible goods, such as butter, and in terms of small units of money, such as pennies, it is easy to leap unthinkingly to the conclusion that the consumer for each good will act in such a way as to equalize, at the market price, the marginal utility of the sum of money and the marginal utility of the good. It should be clear, however, that there is never any such “equalization.” In the case of the suit, the rank of the second suit is still considerably above the rank of the 2.9 grains. So there is no equalization. Even in the case of the most divisible of goods, there will still be a difference in rank, not an equalization, between the two utilities. A man may buy 11 ounces of butter at 10 cents an ounce, until there is nothing ranking between the 11th ounce and the 10 cents on his utility scale; yet there is still no equality, but a difference in rank, with the last ounce bought ranking higher than the last sum of money spent. Of course, the consumer tries to spend his money so as to bring the two as close as possible, but they can never be equal.

Furthermore, the marginal utility of each particular good, after the purchases are made, differs in rank from that of every other. Thus, let us take one grain of gold as the monetary unit under consideration. Let us say that the given market-prices of various goods are as follows:

eggs    —    1 dozen per grain;
butter   —    1 pound per grain;
bread   —    1 loaf per grain;
candy   —    1 bar per grain.

Now each individual will purchase each commodity until the last point at which the marginal utility of the unit exceeds the marginal utility of a grain of gold. For one man, this might mean the purchase of five pounds of butter, three loaves of bread, two bars of candy, etc. This would mean that either a sixth pound of butter or a fourth loaf of bread would have a lower marginal utility than a grain of gold forgone. However, the marginal utility of each good will still differ in rank from that of every other and will not be equal to that of any other.

Another, even more curious doctrine holds that in equilibrium the ratio of the marginal utilities of the various goods equals the ratio of their prices. Without entering in detail into the manner by which these writers arrive at this conclusion, we can see its absurdity clearly, since utilities are not quantities and therefore cannot be divided.

These fallacies stem from a related one: the idea that an individual will act so as to equalize the marginal utility that any good will have in each of its uses. Applied to money, this would imply that the marginal utility of a unit of money is equal for each field of expenditure for each person. This is incorrect, as we have just seen that the marginal utilities of the various goods are not equalized. Successive units of a good are allocated to the most desired end, then to the next most desired satisfaction, etc. If there are several uses for the good, each one involving many possible units, the marginal utility of a unit in each use continues to decline as the supply increases. As goods are purchased, the marginal utility of each good purchased diminishes, and a man may allocate his money first to one use, then to another, and then to the first use again. However, in no case is there any equalization of marginal utilities.

The dogma of the equalization of marginal utilities may best be illustrated in the following passage from perhaps the originator of this line of argument:

Let s be the whole stock of some commodity, and let it be capable of two distinct uses. Then we may represent the two quantities appropriated to these uses by xl and y1, it being a condition that xl plus y1 equal s. The person may be conceived as successively expending small quantities of the commodity; now it is the inevitable tendency of human nature to choose that course which appears to offer the greatest advantage at the moment. Hence, when the person remains satisfied with the distribution he has made, it follows that no alteration would yield him more pleasure; which amounts to saying that an increment of commodity would yield exactly as much utility in one use as in another. Let Δu1, Δu2, be the increments of utility, which might arise respectively from consuming an increment of commodity in the two different ways. When the distribution is completed, we ought to have Δu1 = Δu2 ... The same reasoning ... will evidently apply to any two uses, and hence to all uses simultaneously, so that we obtain a series of equations less numerous by a unit than the number of ways of using the commodity. The general result is that the commodity, if consumed by a perfectly wise being, must be consumed with a maximum production of utility.37

The chief errors here consist in conceiving utility as a certain quantity, a definite function of an increment in the commodity, and in treating the problem in terms of infinitely small steps. Both procedures are fallacious. Utilities are not quantities, but ranks, and the successive amounts of a commodity that are used are always discrete units, not infinitely small ones. If the units are discrete, then the rank of each unit differs from that of every other, and there can be no equalization.

Many errors in discussions of utility stem from an assumption that it is some sort of quantity, measurable at least in principle. When we refer to a consumer’s “maximization” of utility, for example, we are not referring to a definite stock or quantity of something to be maximized. We refer to the highest-ranking position on the individual’s value scale. Similarly, it is the assumption of the infinitely small, added to the belief in utility as a quantity, that leads to the error of treating marginal utility as the mathematical derivative of the integral “total utility” of several units of a good. Actually, there is no such relation, and there is no such thing as “total utility,” only the marginal utility of a larger-sized unit. The size of the unit depends on its relevance to the particular action.38

This illustrates one of the grave dangers of the mathematical method in economics, since this method carries with it the bias of the assumption of continuity, or the infinitely small step. Most writers on economics consider this assumption a harmless, but potentially very useful, fiction, and point to its great success in the field of physics. They overlook the enormous differences between the world of physics and the world of human action. The problem is not simply one of acquiring the microscopic measuring tools that physics has developed. The crucial difference is that physics deals with inanimate objects that move but do not act. The movements of these objects can be investigated as being governed by precise, quantitatively determinate laws, well expressed in terms of mathematical functions. Since these laws precisely describe definite paths of movement, there is no harm at all in introducing simplified assumptions of continuity and infinitely small steps.

Human beings, however, do not move in such fashion, but act purposefully, applying means to the attainment of ends. Investigating causes of human action, then, is radically different from investigating the laws of motion of physical objects. In particular, human beings act on the basis of things that are relevant to their action. The human being cannot see the infinitely small step; it therefore has no meaning to him and no relevance to his action. Thus, if one ounce of a good is the smallest unit that human beings will bother distinguishing, then the ounce is the basic unit, and we cannot simply assume infinite continuity in terms of small fractions of an ounce.

The key problem in utility theory, neglected by the mathematical writers, has been the size of the unit. Under the assumption of mathematical continuity, this is not a problem at all; it could hardly be when the mathematically conceived unit is infinitely small and therefore literally sizeless. In a praxeological analysis of human action, however, this becomes a basic question. The relevant size of the unit varies according to the particular situation, and in each of these situations this relevant unit becomes the marginal unit. There is none but a simple ordinal relation among the utilities of the variously sized units.

The tendency to treat problems of human action in terms of equality of utility and of infinitely small steps is also apparent in recent writings on “indifference maps.” Almost the entire edifice of contemporary mathematical economics in consumption theory has been built on the “indifference” assumption. Its basis is the treatment of large-sized classes of combinations of two goods, between which the individual is indifferent in his valuations. Furthermore, the differences between them are infinitely small, so that smooth lines and tangents can be drawn. The crucial fallacy is that “indifference” cannot be a basis for action. If a man were really indifferent between two alternatives, he could not make any choice between them, and therefore the choice could not be revealed in action. We are interested in analyzing human action. Any action demonstrates choice based on preference: preference for one alternative over others. There is therefore no role for the concept of indifference in economics or in any other praxeological science. If it is a matter of indifference for a man whether he uses 5.1 or 5.2 ounces of butter for example, because the unit is too small for him to take into consideration, then there will be no occasion for him to act on this alternative. He will use butter in ounce units, instead of tenths of an ounce. For the same reason, there are no infinitely small steps in human action. Steps are only those that are significant to human beings; hence, they will always be finite and discrete.

The error in reasoning on the basis of “indifference” is the failure to appreciate the fact that a problem important in the field of psychology may have no significance in the realm of praxeology, to which economics belongs. Psychology deals with the problem of how or why the individual forms value scales, and for this question it is relevant to consider whether the individual is decisive or inclined to be “indifferent” between various alternatives. Praxeology, however, is a logical science based on the existence of action per se; it is interested in explaining and interpreting real action in its universal sense rather than in its concrete content. Its discussion of value scales is therefore a deduction from the nature of human action and not a speculative essay on the internal workings of the mind. It is consequently irrelevant for praxeology whether a man, in having to decide between alternatives A and B, makes a choice firmly and decisively, or whether he decides by tossing a coin. This is a problem for psychology; praxeology is concerned only with the fact that he chooses, for example, A rather than B, and that therefore A ranked higher in his preference scale than B. Utility theory is not concerned with psychology or the internal operations of the mind, but is part of a separate science based on the logical consequences of the simple existence of action.

Neither is praxeology based on behaviorist psychology. In fact, in so far as praxeology touches on psychology, its principles are the reverse of those of behaviorism. As we have seen, far from simply observing action in the same way as we observe and record the movements of stones, praxeology is based on a fundamental distinction between human action and the motion of inorganic matter, namely, that human action is motivated toward the achievement of certain ends. Means and resources are used for the achievement of these ends. Far from leaving mind out of the picture, praxeology rests fundamentally on the basic axiom of action, action caused and put into effect by human minds. However, praxeology is not concerned with the content of these ends, the manner of arriving at them, or their order; it is concerned with analysis of the logical implications of the existence of these ends.

Some writers, in their artificial separation of value scales from real action, have actually gone to the length of attempting to discover people’s indifference maps by means of questionnaires. These attempts, besides being open to the stricture that indifference is not praxeologically valid, fail to realize that value scales can and do change continually and that therefore such questionnaires have no relevance to the business of economics. Economics is interested not in value scales professed in response to questionnaires, but in the values implied by real action. As Ludwig von Mises states, with regard to all attempts to separate value scales from action:

... the scale of value is nothing but a constructed tool of thought. The scale of value manifests itself only in real acting; it can be discerned only from the observation of real acting. It is therefore impermissible to contrast it with real acting and to use it as a yardstick for the appraisal of real actions.39

Since indifference is not relevant to human action, it follows that two alternatives for choice cannot be ranked equally on an individual’s value scale. If they are really ranked equally, then they cannot be alternatives for choice, and are therefore not relevant to action. Hence, not only are alternatives ranked ordinally on every man’s value scale, but they are ranked without ties; i.e., every alternative has a different rank.

The famous illustration used by the indifference theorists to demonstrate the relevance of indifference to human action is the case of Buridan’s ass. This is the fable of the ass who stands, hungry, equidistant from two equally attractive bales of hay, or, thirsty, equidistant from two water holes. Since the two bales or water holes are equally attractive in every way, the ass can choose neither one and must therefore starve. This example is supposed to prove the great relevance of indifference to action and to be an indication of the way that indifference is revealed in action. Compounding confusion, Schumpeter refers to this ass as “perfectly rational.40

In the first place, it is of course difficult to conceive of an ass or a person that could be less rational. He is confronted not with two choices, but with three, the third being to starve where he is. Even on the indifferentists’ own grounds, this third choice will be ranked lower than the other two on the actor’s value scale. He will not choose starvation.

If both the left and right water holes are equally attractive, and he can find no reason for preferring one or the other, the ass or the man will allow pure chance, such as a flip of a coin, to decide on either one. But on one he must and will decide. Again, we are interested in preference as revealed through choice and not in the psychology of preferences. If the flipped coin indicated the left water hole, then the left water hole was finally placed higher on the actor’s value scale, as was revealed when he went toward it. Far from being a proof of the importance of indifference, the case of Buridan’s ass is an excellent demonstration of the fact that indifference can play no part whatever in an analysis of human action.

Another way of attempting a justification of the indifference analysis is to suppose that a man, Jones, chooses each of two alternatives A and B about 50 percent of the time, upon repeated opportunities. This shifting is alleged to be a demonstration that Jones is really indifferent as between the two alternatives. Yet what is the reasonable inference? Clearly, that in some cases, A was preferred to B on Jones’ value scale, and that in the others, the positions were shifted so that B was preferred to A. In no case was there indifference between the two alternatives. The shift of choice indicates a shift in the preference scale, and not indifference on a constant value scale. Of course, if we were dealing with psychology, we could enter into a discussion of intensities of preferences and opine that the man, with respect to his underlying personality, was relatively indifferent rather than intensely biased, as between the two alternatives. But in praxeology we are not interested in the concrete content of his value scales nor in his underlying personality. We are interested in value scales as revealed through choice.

• 36We are omitting possible shifts in rank resulting from the increasing utility of money, which would only complicate matters unduly.
• 37W. Stanley Jevons, The Theory of Political Economy (3rd ed.; London: Macmillan & Co., 1888), pp. 59–60.
• 38See Appendix A below, “The Diminishing Marginal Utility of Money,” and Rothbard, “Toward a Reconstruction of Utility and Welfare Economics.”
• 39Mises, Human Action, p. 102. Dr. Bernardelli justly says:
  If someone asks me in abstracto whether my love for my country is greater than my desire for freedom, I am somewhat at a loss how to answer, but actually having to make a choice between a trip in my country and the danger of losing my freedom, the order of intensities of my desire becomes only too determinate. (Harro F. Bernardelli, “What has Philosophy to Contribute to the Social Sciences, and to Economics in Particular?” Economica, November, 1936, p. 451) Also see our discussion of “consumer surplus” in section 4 above.
• 40Schumpeter, History of Economic Analysis, pp. 94 n. and 1064.

Some writers, while admitting the validity of the law of diminishing marginal utility for all other goods, deny its application to money. Thus, for example, a man may allocate each ounce of money to his most preferred uses. However, suppose that it takes 60 ounces of gold to buy an automobile. Then the acquisition of the 60th ounce, which will enable him to buy an automobile, will have considerably more value than the acquisition of the 58th or of the 59th ounce, which will not enable him to do so.

This argument involves a misconception identical with that of the argument about the “increasing marginal utility of eggs” discussed in chapter 1, above.41 There we saw that it is erroneous to argue that because a fourth egg might enable a man to bake a cake, which he could not do with the first three, the marginal utility of the eggs has increased. We saw that a “good” and, consequently, the “unit” of a good are defined in terms of whatever quantity of which the units give an equally serviceable supply. This last phrase is the key concept. The fourth egg was not equally serviceable as, and therefore not interchangeable with, the first egg, and therefore a single egg could not be taken as the unit. The units of a good must be homogeneous in their serviceability, and it is only to such units that the law of utility applies.

The situation is similar in the case of money. The serviceability of the money commodity lies in its use in exchange rather than in its direct use. Here, therefore, a “unit” of money, in its relevance to individual value scales, must be such as to be homogeneous with every other unit in exchange-value. If another ounce permits a purchase of an automobile, and the issue is relevant to the case in question, then the “unit” of the money commodity must be taken not as one ounce, but as 60 ounces.

All that needs to be done, then, to account for and explain “discontinuities” because of possible large purchases is to vary the size of the monetary unit to which the law of utility and the preferences and choices apply.42 This is what each man actually does in practice. Thus, suppose that a man is considering what to do with 60 ounces of gold. Let us assume, for the sake of simplicity, that he has a choice of parceling out the 60 ounces into five-ounce units. This, we will say, is alternative A. In that case, he decides that he will parcel out each five ounces in accordance with the highest rankings on his utility scale. The first five ounces will be allocated to, or spent on, the most highly valued use that can be served by five ounces; the next five ounces to the next most highly valued use, and so on. Finally, his 12th five ounces he will allocate to his 12th most highly valued use. Now, however, he is also confronted with alternative B. This alternative is to spend the entire 60 ounces on whatever single use will be most valuable on his value scale. This will be the single highest-ranked use for a unit of 60 ounces of money. Now, to decide which alternative course he will take, the man compares the utility of the highest-ranked single use of a lump sum of 60 ounces (say, the purchase of a car) with the utility of the “pack-age”—the expenditure of five ounces on a, five ounces on b, etc. Since the man knows his own preference scale—otherwise he could never choose any action—it is no more difficult to assume that he can rank the utility of the whole package with the utility of purchasing a car than to assume that he can rank the uses of each five ounces. In other words, he posits a unit of 60 ounces and determines which alternative ranks higher on his value scale: purchase of the car or a certain package distribution by five-ounce (or other-sized) units. At any rate, the 60 ounces are distributed to what each man believes will be its highest-ranking use, and the same can be said for each of his monetary exchange decisions.

Here we must stress the fact that there is no numerical relation—aside from pure ordinal rank—between the marginal utilities of the various five-ounce units and the utilities of the 60-ounce units, and this is true even of the package combination of distribution that we have considered. All that we can say is that the utility of 60 ounces will clearly be higher than any one of the utilities of five ounces. But there is no way of determining the numerical difference. Whether or not the rank of the utility of this package is higher or lower than the utility of the car purchase, moreover, can be determined only by the individual himself.

We have reiterated several times that utility is only ranked, and never measurable. There is no numerical relationship whatever between the utility of large-sized and smaller-sized units of a good. Also, there is no numerical relationship between the utilities of one unit and several units of the same size. Therefore, there is no possible way of adding or combining marginal utilities to form some sort of “total utility”; the latter can only be a marginal utility of a large-sized unit, and there is no numerical relationship between that and the utilities of small units.

As Ludwig von Mises states:

Value can rightly be spoken of only with regard to specific acts of appraisal. ... Total value can be spoken of only with reference to a particular instance of an individual ... having to choose between the total available quantities of certain economic goods. Like every other act of valuation, this is complete in itself. ... When a stock is valued as a whole, its marginal utility, that is to say, the utility of the last available unit of it, coincides with its total utility, since the total supply is one indivisible quantity.43

There are, then, two laws of utility, both following from the apodictic conditions of human action: first, that given the size of a unit of a good, the (marginal) utility of each unit decreases as the supply of units increases; second, that the (marginal) utility of a larger-sized unit is greater than the (marginal) utility of a smaller-sized unit. The first is the law of diminishing marginal utility. The second has been called the law of increasing total utility. The relationship between the two laws and between the items considered in both is purely one of rank, i.e., ordinal. Thus, four eggs (or pounds of butter, or ounces of gold) are worth more on a value scale than three eggs, which in turn are worth more than two eggs, two eggs more than one egg, etc. This illustrates the second law. One egg will be worth more than a second egg, which will be worth more than a third egg, etc. This illustrates the first law. But there is no arithmetical relationship between the items apart from these rankings.44

The fact that the units of a good must be homogeneous in serviceability means, in the case of money, that the given array of money prices remains constant. The serviceability of a unit of money consists in its direct use-value and especially in its exchange-value, which rests on its power to purchase a myriad of different goods. We have seen in our study of the money regression and the marginal utility of money that the evaluation and the marginal utility of the money commodity rests on an already given structure of money prices for the various goods. It is clear that, in any given application of the foregoing law, the money prices cannot change in the meantime. If they do, and for example, the fifth unit of money is valued more highly than the fourth unit because of an intervening change in money prices, then the “units” are no longer equally serviceable and therefore cannot be considered as homogeneous.

As we have seen above, this power of the monetary unit to purchase quantities of various goods is called the purchasing power of the monetary unit. This purchasing power of money consists of the array of all the given money prices on the market at any particular time, considered in terms of the prices of goods per unit of money. As we saw in the regression theorem above, today’s purchasing power of the monetary unit is determined by today’s marginal utilities of money and of goods, expressed in demand schedules, while today’s marginal utility of money is directly dependent on yesterday’s purchasing power of money.45

• 41See chapter 1, pp. 73–74.
• 42Cf. the excellent discussion of the sizes of units in Wicksteed, Common Sense of Political Economy, I, 96–101 and 84.
• 43Mises, Theory of Money and Credit, pp. 46–47. Also see Harro F. Bernardelli, “The End of the Marginal Utility Theory,” Economica, May, 1938, pp. 205–07; and Bernardelli, “A Reply to Mr. Samuelson’s Note,” Economica, February, 1939, pp. 88–89.
• 44It must always be kept in mind that “total” and “marginal” do not have the same meaning, or mutual relation, as they do in the calculus. “Total” is here another form of “marginal.” Failure to realize this has plagued economics since the days of Jevons and Walras.
• 45For further analysis of the determination of the purchasing power of money and of the demand for and the supply of money, see chapter 11 below on “Money and Its Purchasing Power.”

Economics has made such extensive use of the term “value” that it would be inexpedient to abandon it now. However, there is undoubtedly confusion because the term is used in a variety of different ways. It is more important to keep distinct the subjective use of the term in the sense of valuation and preference, as against the “objective” use in the sense of purchasing power or price on the market. Up to this chapter, “value” in this book has meant the subjective individual “valuing” process of ranking goods on individual “value scales.”

In this chapter, the term “value of capital” signifies the purchasing power of a durable good in terms of money on the market. If a house can be sold on the market for 250 ounces of gold, then its “capital value” is 250 ounces. The difference between this and the subjective type of value is apparent. When a good is being subjectively valued, it is ranked by someone in relation to other goods on his value scale. When a good is being “evaluated” in the sense of finding out its capital value, the evaluator estimates how much the good could be sold for in terms of money. This sort of activity is known as appraisement and is to be distinguished from subjective evaluation. If Jones says: “I shall be able to sell this house next week for 250 ounces,” he is “appraising” its purchasing power, or “objective exchange-value,” at 250 ounces of gold. He is not thereby ranking the house and gold on his own value scale, but is estimating the money price of the house at some point in the future. We shall see below that appraisement is fundamental to the entire economic system in an economy of indirect exchange. Not only do the renting and selling of consumers’ goods rest on appraisement and on hope of monetary profits, but so does the activity of all the investing producers, the keystone of the entire productive system. We shall see that the term “capital value” applies, not only to durable consumers’ goods, but to all non-human factors of production as well—i.e., land and capital goods, singly and in various aggregates. The use and purchase of these factors rest on appraisement by entrepreneurs of their eventual yield in terms of monetary income on the market, and it will be seen that their capital value on the market will also tend to be equal to the discounted sum of their future yields of money income.26

• 26On appraisement and valuation, cf. Mises, Human Action, pp. 328–30.