5. Prices

Suppose that Crusoe exchanges 5000 berries with Jones for 1 cow.  These are the terms or rate of exchange.  If we express one commodity in terms of the other, we obtain the price of that commodity.  In this case, the price of a cow in terms of berries (‘berry-price’) is 5000 berries per cow.  Conversely, the ‘cow-price’ of berries is 1/5000 of a cow per berry.  We say that Crusoe bought 1 cow and sold 5000 berries, and that Jones bought 5000 berries and sold 1 cow.

Note that for this exchange to take place, Crusoe must value the 1 cow at more than the 5000 berries, and Jones must value the 5000 berries more than the 1 cow.  In other words, the value of the good being bought must be more than the price that is demanded for it in exchange.  The reason for all exchanges is to satisfy ends, to make a “psychic gain”.  Both Crusoe and Jones must have expected a psychic gain from this exchange, or else it would not have taken place.

Suppose that Jones possesses 5 cows and is considering whether or not to sell one of them in exchange.  The following is his value scale for possible uses of the marginal unit (the fifth cow):

1. 5000 berries offered by Crusoe.
2. 100 barrels of fish offered by Smith.
3. 4000 berries offered by Brown.
4. Direct-use of the cow (marginal utility of his cow stock).

Since it is the highest on his value scale, Jones will exchange 1 cow for 5000 berries offered by Crusoe.  His psychic gain is 5000 berries, while his psychic loss is the next highest possible use for the cow, 100 barrels of fish. 

Thus, it can be seen that for any specific trade to occur, the marginal utility of the goods received must be greater not only than the marginal utility of the good foregone in direct use, but also the marginal utility of other possible goods that could have been received in exchange.  In other words, even though Jones valued Smith’s 100 barrels of fish higher than the direct use value of his fifth cow, he still did not make that trade, because he had a better offer from Crusoe.

It is evident that Jones will always prefer an offer of more units of one type of good to an offer of fewer units of the same good.  In other words, Jones will always prefer the highest selling price for his good.  The 5000 berries from Crusoe was obviously a better offer than the 4000 berries from Brown.

It might be objected that in some cases Jones may prefer to take Brown’s offer over Crusoe’s.  Perhaps Jones hates Crusoe, or perhaps he lives too far away.  In this case however, the two offers would (by definition of a good: homogeneous units of equal serviceability to the actor) involve different goods.  Berries-from-Crusoe would be a different good from berries-from-Brown, due to the different psychic costs involved in obtaining them.  We say that these psychic costs are non-exchangeable items that enter into the calculations of individuals when making decisions.

So, providing that the psychic costs associated with two different offers are the same, it is evident that:

• The seller will always prefer to sell at the highest possible price.
• The buyer will always prefer to buy at the lowest possible price.

In a barter economy, a good’s price must be expressed in countless different commodity-units.  For example, the price of 1 cow might be 5000 berries, or 100 barrels of fish, or 200 dozens of eggs, or 50 pints of milk.  (This makes accounting, calculating and forecasting very difficult, but this problem is easily overcome by the development of money, when prices can be stated simply in terms of units of the money commodity.)

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