§ 1. Concept of the general price level. § 2. Index numbers. § 3. Definition of the standard of deferred payments. § 4. Increasing importance of the standard. § 5. Defectiveness of the gold standard. § 6. Relative values of gold and silver. § 7. Gold production, 1800-1850. § 8. Gold production and price changes, 1850-1873. § 9. The great fall of prices, 1873-1896. § 10. Nature and object of bimetal-ism. § 11. The free-silver movement.

§ 1. Concept of the general price level. The price of any good is some other good or group of goods given for it in trade.1 The standard unit of money coming to be the most convenient expression for price (whether or not money be actually passed from hand to hand in any particular trade), prices usually are monetary prices, and more specifically are prices in gold, or in silver, or in whatever constitutes the standard money unit. But the price of each good is a definite, separate fact, which expresses the ratio at which that commodity is sold. The price of any particular kind of goods may fluctuate in either direction as compared with the prices of other goods at the same time. For example, iron and many other goods may rise while wheat and many other goods fall in price. There is, therefore, no such thing as an actual general change in the prices of goods in terms of money, but it may be seen that the prices of large classes of goods, often of nearly all goods, change upward or downward at the same time and in the same general direction. We thus have need to distinguish between changes in the valuations of particular kinds of goods in terms of each other and general changes in the valuation of a number of different goods in terms of the monetary unit.

1 See Vol. I, p. 45 ff.

To get some idea of whether such a general trend occurs, the algebraic sum of all the changes in the particular prices of a selected group of goods may be taken, and for convenience this may be reduced to an average price (by dividing the sum by the number of articles). Such an average is called a general price, and, when comparing it with the general price of another time, we speak of changes up or down in general prices, or in the general scale of prices, or in the price level.

When gold is the standard unit, its value is the converse of general prices; as prices go up the value of gold goes down, and gold is said to depreciate. As prices go down the value of gold goes up, and gold is said to appreciate. Rising prices mean falling value of gold (and at the same time falling purchasing power), and vice versa.

§ 2. Index numbers. The process of calculating general prices and changes in them has in it, inevitably, something of arbitrariness and incompleteness. For not all prices can be included, but only those of articles of somewhat standardized grades and those that are pretty regularly sold in markets where prices are publicly quoted. No list of articles that can be selected is of equal importance to different persons and classes of persons, at different places, at different times, and for different purposes. And yet the study of general prices as shown by any broadly selected list reveals changes that in some measure affect the interests of every member of the community.

General prices are conveniently compared from one time to another through the use of index numbers. An index number of any article is the per cent that its price at any certain date is of its price at another date (or of the average for a series of prices) taken as a base or standard. Thus if the average price of cotton in the base year were 10 cents (taken as 100) and the price rose to 12 cents, the index number would be 120. A tabular index number is the per cent that the price of a selected group of articles at any certain date is of the price of the same group of articles at a date that has been taken as the base. Numerous tabular index numbers have been worked out for different countries and periods.

Fig. 1. Index Numbers of Prices. The four series of prices here shown begin at different periods: the American in 1840 (Aldrich report 1840-1889 and Bureau of Labor from 1890 on) ; the English in 1846; the German in 1851; the French in 1857. We have adjusted each of these series to a base of the average prices for 1890-1899, in accord with the basic period used by the American Bureau of Labor.

The reader must be on his guard against misunderstanding the diagram. It does not represent the heights of any particular prices of the different countries compared with each other either at any one date or for the entire period. The average prices of selected groups of commodities are compared every year with the average of the prices for 1890 - 1899 in each country, respectively. The important facts to observe are the fluctuations, both their times and their directions, both the larger tidal movements and the lesser wave-like movements within the business cycles. The figure indicates that both American and German average prices have risen somewhat, as compared with the English and French prices, since the period before 1860.

This figure should be studied in connection with that on gold production. The figures indicate that the rapidly growing monetary use of gold offset a large part of the effects of increasing gold production between 1840-1860 and 1884-1914. Between 1884 and 1896 prices actually continued to fall after gold production had begun to climb. Likewise the growing monetary use of gold accentuated strongly the effects between 1873 and 1883 of a comparatively small decrease in gold production.

A chart of the principal index numbers of the leading countries is shown in Figure 1. The fact that from 1862 to 1879 inclusive prices in the United States were expressed in an irredeemable paper standard makes comparisons for that period misleading. A better idea is obtained by using as the base for each of the several series the average of prices in each country for the years 1890 to 1899.

§ 3. Definition of the standard of deferred payments. As a medium of exchange, money comes to be the unit in which most prices are expressed and compared; in other words, it becomes the common denominator of prices.2 This makes it also the most convenient unit in which to express the amount of credit transactions and of existing debts.3 A credit transaction is a trade lengthened in time; one party fulfils his part of the contract by delivering the goods or money, the other party promises to give an equivalent at a later date. The equivalent may be in any kind of goods; for example, in barter one may part with a horse on the promise of a cow to be received later; or a small horse on the promise of a large one; or a flock of sheep on the promise of its return at the end of the year with a part of the increase of the flock. A simple standard in which to express the debt is the thing borrowed, as horse, sheep, wheat, house. Again, the thing to which the value of debts is referred may be a thing quite different from the goods borrowed, and, with the growth of the monetary economy and the use of the interest contract, money comes more and more to be used as the standard. At length the law declares that in the absence of any other agreement, the amount of a debt is to be payable in terms of the unit of standard money, which thus is made legal tender as well as the customary standard of deferred payments. A standard of deferred payments is the thing of value in which, by the law or by contract, the amount of a debt is expressed and payable.

2  See Vol. I, p. 262.

3  See Vol. I, p. 263, on credit transactions, and p. 302, on interest contract.