Essentials of Economic Theory / As Applied to Modern Problems of Industry and Public Policy

by John Bates Clark

Natural Value.—This tendency toward cost prices—those which afford to the producers wages for all their labor but no true entrepreneurs' profit—establishes a further law, that of "natural value," and this it is that fixes the standard to which, in the long run, market values, as adjusted by supply and demand, tend to conform. A market value is natural or unnatural according as it does or does not conform to a certain standard, and this ultimate standard itself is the cost of producing the several kinds of goods. What the term cost in this connection really means we must later see; but for the present we may take the common and practical view that it is the amount of money that an entrepreneur must pay out in order to bring the article into existence. If there were very little wheat in the granaries of the world, demand acting on this limited supply would determine the selling price of it, and this price would be high as compared with the cost of raising this grain. It would also be higher than the selling prices of other things which are produced by the same expenditure of labor and capital that has to be made in raising the wheat. The market price would, for the time being, be unnatural and would in due time be brought down; but this would have to be done by the raising of more wheat. In other words, though the selling price of a small supply of wheat may be normal for that amount, the amount supplied is itself abnormally small, and in view of that fact the resulting price is too high to be allowed to continue. As a permanent price it would not be natural. The quantity supplied tends to increase till the market price conforms to the cost of raising the wheat. We have to see, first, how demand fixes the price of a definite amount of anything which is offered for sale and, later, how the quantity offered is controlled.

How Prices are Determined.—It is certain that if, in a given market, we increase the quantity of goods that are to be sold, we lower the price,[1] while, if we diminish the quantity, we raise the price. That is the commercial fact and it furnishes a beginning for a theory of value.

Let us suppose that we have a fixed quantity of goods on hand, that all must be sold, and that no one knows at the outset what price they will bring. There might conceivably go on an inverted kind of auctioning process, in which the sellers at the outset would ask a high rate, sell a few of their goods, and then gradually reduce the price till the last article should be sold. At each reduction of the price the "effectual demand," so-called, would increase. This means that the people who want the article are actually willing to take and pay for larger quantities the lower the price falls. Mere desire does not influence the market, but an "effectual demand" means a desire and a tender of the money that is asked for the goods. It is, in short, an actual purchase and the amount of it becomes larger as the price goes down. People who did not buy the article before now add it to the list of goods that they take for use, and the people who were already taking a certain quantity of it now take more.

Equation of Supply and Effective Demand.—If this effective demand, or amount of goods actually bought and paid for, becomes steadily larger the lower the price becomes, it is clear that, however large the total supply may be, it can all be sold by making the price low enough. It was once thought that this is all we need to know of prices current or market values. At some selling rate or other the quantity actually offered will come to equal the quantity that is actually bought. This is the equation of demand and supply. The quantity offered is here supposed to be fixed and to include all of the article that is in dealers' hands and that has to be sold; and the price, starting at a high rate, is supposed to go down till the sale of the entire quantity is effected.

Varying Demand and Price.—The facts that have just been stated account only in a partial way for the adjustment of market price. One who wishes to trace phenomena to their causes cannot help asking why demand and supply insure the selling of a given amount of goods at one rate rather than at another. If apples are offering at two dollars a barrel, why is it that, in a particular local market, one thousand barrels and no more can, at that rate, be sold? We can readily see that at one dollar a barrel more could be sold than at two, and that at three less would be sold. But why is it that, at two dollars, the definite number of one thousand barrels is the amount that is taken and paid for? Why is the equation of demand and supply established at exactly that price?

Demand and Final Utility.—We come nearer to the cause that acts in adjusting the price of apples when we say that they sell at two dollars a barrel because that sum expresses their "final utility." This means that, if such an auctioning process as we have described were resorted to, the last barrel of apples which would be sold would have to the buyer an amount of utility just equal to that of the final unit of any other article that could have been had for the same money. The auctioning, however, would cause different barrels of apples to sell at different prices, whereas there is something in the working of competition which causes all of them to sell at the same price. It is necessary to see, first, how the price of the "final" one is adjusted and, secondly, how that fixes the price of all the others.

The Law of Diminishing Utility.—We revert here to one of those general laws of economics that we have already stated and see it acting under the conditions of distinctly social life. Goods of a given kind have less and less utility, per unit, the more the user has of them. If you offer him apples in increased quantity, he will value the first part of the supply highly, but will attach less value to the later parts. When the desire for this fruit is fairly well satisfied, he will find other articles of more importance. At the price of two dollars a barrel it is just worth his while to buy a final barrel of them. That quantity, as added to his winter's supply, will give him two dollars' worth of benefit. This means that it will do him as much good as anything else which he can get for the same amount of money.

The Equalization of Final Utilities.—Two dollars spent in adding to his previous stock of other things will do the man in the illustration the same amount of good that he can get from a final barrel of apples, and no more. In the case of goods which are all alike and of which consumers are always glad to use an additional amount, prices tend to adjust themselves in such a way that a final unit of any one which the consumer buys with a dollar is worth just as much to him as a final unit of any other article he buys with that amount. The last dollar paid for apples is as remunerative, in the way of pleasure and benefit secured, as is the last dollar used to improve his wardrobe, to add something to his stock of furniture, to buy tickets to the theater, etc. Apples have, as it were, to compete with clothing, furniture, and amusements for the consumer's favor, and if the vender charges more for them than do the venders of other things having the same power to give pleasure, some of the apples will remain unsold; for though customers will always give as much as they would have to pay for other things of equal final utility, they will not give more.

The Prices of All Increments of Supply Equal.—A consumer always gets a net surplus of benefit from the early increments of the goods he consumes. If the last barrel of apples is worth two dollars,—or, what is the same thing, if the last barrel has in it an amount of utility equal to the final utility of other things that two dollars will buy,—the first barrel has a larger utility; and yet it costs no more than the last one. The sellers of apples, if they expect to dispose of all that they have, must at the outset fix the price at such a point that the very last increment of the supply will successfully compete with other articles for the favor of purchasers. Competition forces them to sell the whole amount so cheaply that the least important part of it may be as important to the purchaser of that part as the corresponding and least important part of the supply of other things. Nothing but a monopoly of the entire available stock would enable them to carry out the auctioning plan and offer the stock piecemeal, so as to get a higher price for the parts offered early. Even then buyers who should perceive the fact that a large part of the stock remained in reserve and that it must ultimately be sold would be able, by delaying their purchases, to get the benefit of a later and lower rate, so that the monopoly itself would be only partially successful in its policy. In the absence of a monopoly venders are compelled to sell all articles of one kind and quality at one price. The man who should fix a higher price on his portion of the supply would be passed by in favor of other sellers who were disposing of their final increments, and his business would quietly drift away from him. There cannot be two prices for one commodity in the same market at the same time. This fact is fundamental. Even the monopoly is able to get different prices for different parts of its output only by offering them at different times; and competing producers cannot do this. They are forced to keep the price of all they offer at a level that expresses its final utility.

The Law of Value affected by the Difficulty of using Two Similar Goods at Once.—There are two imperfections in the common statement of this law of final utility which need to be removed in order that the theory of value, which is based on the law, may be true and useful. The first lies in the assumption that people buy completed articles, such as coats, tables, vehicles, watches, etc., in regular series of units, adding to their stock coat after coat, watch after watch, etc., all just alike, till the utility of the last one becomes so small that it is better to buy other things. On this supposition the price of the whole supply of any such thing corresponds with the utility of the last one in the consumer's series. This fairly well describes the case of commodities like apples, of which men consume now more and now less per day or per week and are always glad to increase the amount they use. Of most kinds of consumers' goods a person wants at one time one unit and no more, and a second unit, if he has to use it himself within the same time in which he uses the first, would be an incumbrance. Its utility would be a negative quantity. Two quite similar coats would never be bought by the same person if he had only his own needs in view and must use both coats through the same period. The first unit of his supply is, for this period, also the last.