This section is from the "Economics In Two Volumes: Volume I. Economic Principles" book, by Frank A. Fetter. Also available from Amazon: Economic
§ 4. The problem of price. Few words are more often on the lips to-day than price. If the price of a thing is high, the thing is dear; if price is low, it is cheap. What makes things cheap or dear ? That question puts the price problem. It is a matter of every-day observation that when things are more plentiful than usual they are pretty sure to be cheaper; when they are scarcer than usual they probably will be dearer. Hens lay few eggs in the winter, but many in the spring. Apples are few on the trees and of poor quality one year, and plentiful the next. Rains are late and inadequate, and the crop of cotton in the South, or of corn in the Middle West, or of hay in the Northeast of the United States is small, and as quantity is small prices are high. Every one knows in this general way about prices and the reasons why prices change. Some men of business become astonishingly skilled in following and anticipating the changes in price of the particular goods in which they deal. But the purpose of the student of economics is not to learn the conditions that influence the prices of particular goods except as they may serve as examples, but rather it is to understand the general nature of all price movements and the principles determining all prices.
The thoro pursuit of this purpose is a large part of the task of economic study.
§ 5. Demand. The phrase demand and supply is very frequently used as an explanation of economic problems, without any clear conception of the meaning of the words. Let us examine the meaning and the difficulties of the phrase.
Demand conveys the idea partly of the intensity of the desire of a trader for a certain good, partly of his having something (a certain amount) which he is willing to give for it, and partly of the amount of goods which he desires to buy at the price. Thus we may define: demand is a certain quantity of goods desired at a certain price, united with the power to give the amount of the price in trade for it. Real demand refers to actual trade, for demand is effective only if desire is backed by the price needed to induce the other party to trade. It is convenient, however, to speak of potential demand as the amount which buyers would be ready to take at some specified price.
The hungry boy looking longingly at the sweetmeats in the confectioner's window, represents mere desire; not until the kind-hearted gentleman gives him a nickel does he represent demand for sweetmeats, and then only in case the sweets are the nickel's worth that he most desires, and not then unless the confectioner is willing to part with the coveted article for a nickel. Demand is actual, desire for a sale-good is effective, only in reference to a certain price, the quantity of the goods which the seller will take for it. We may speak of the intensity of desire, but should say rather the extent (or amount, the number of units) of demand.
§ 6. Supply. Supply is the correlative of demand in the phrase, demand and supply; it is the amount of sale-goods which sellers are actually ready to trade at a given price. Supply implies the existence of desire as surely as does demand. Indeed, supply may be defined as desire for a certain quantity of price-goods, at a certain ratio of exchange, united with the power to give sale-goods for them. Supply should not be confused with the stock in possession. The two may differ greatly, for at a given price a person may choose to offer for trade little or none at all of a good, even tho he has a considerable stock of it on hand. Demand and supply vary as the price changes, but in opposite directions. Demand varies inversely with price (rises as price falls), and supply varies directly with price (rises as price rises).
§ 7. Limits of advantage in isolated barter. In barter the trade can take place only within certain limits of price permitting each party to gain somewhat by the choice. The number of units of sale-goods compared with those of the price (each in some specific unit, as pound, yard, gallon, etc.), expresses the ratio of trade (or ratio-of-exchange). When two farmers "trade even," a horse for a cow, either the horse or the cow may be looked upon as the price of the other good, and the ratio of exchange is 1 to 1. But the fact that in trade one thing is equal to the other does not mean that in either trader's opinion the values of the two things are equal. Indeed the very motive of the trade to each party is that he may get what is to him a more valuable for a less valuable object. To even up a trade something may be given "to boot" and one thing be traded for a group of things, as a gun for a boat and a set of fishing tackle, or one rabbit for a lot of 25 fish.3 It must nearly always be the case that there are several ratios of exchange at which a trader has more or less of a motive to trade.
Where there are only two (or a small number of) traders there is a considerable range for bargaining, or higgling. For example, the owner of the rabbit might be willing to take 20 fish rather than not to trade, and the owner of the fish might rather give 30 fish than go without the rabbit. It is not at all certain that in such a case the trade will be at a ratio arithmetically midway between the extremes. Higgling is illustrated by the old-time American horse trade, in which so much depends on "bluff"; in such cases it is as important to be able to judge character as to judge horses, for the bargain will be concluded at a ratio of price to sale-good which exactly balances the hope of gain and fear of loss by one of the parties. This same margin for higgling appears in most exchanges between two somewhat isolated traders, even in highly developed business.
2 Boot means amends, compensation, from the same root as better, best. thus to make good, to even up a trade.
The effect that duplicate and additional units of a good have on valuation (principle of diminishing gratification) is the most frequent cause of barter. The owner, in accordance with the principle of substitution, seeks to trade some of his stock of a good (those units which correspond to less intense, direct uses) for goods which he lacks entirely or values more highly. A hunter with a large pack will be glad to trade a part of his furs for a part of the farmer's grain and fruit. He thus gives up the satisfaction of his marginal, less intense desires for furs to gratify his more intense desires for grain and fruit. But (having meat to eat) he would not, at any price, trade for food all the furs he has. Thus, when goods are turned to their trade-uses, new levels of actual valuations for each of the two kinds of goods result in place of those existing before the trade.
It should be clear from this chapter that any true trade must be mutual and voluntary. It thus differs from gift-making, stealing, extortion, taxation, etc. True trade is of mutual advantage to the parties, at least is believed to be so at the moment. It is this which makes trade rational. It is a mode of substituting more desirable for less desirable goods.
A popular idea very difficult to uproot is that if one party to a trade gains the other must lose. This idea was generally held in ancient times and in the Middle Ages, and seems to have been connected with the notion that value is something fixed in a good and unchangeable. This seems to have been one reason for the poor opinion held of merchants, tho the frequency of fraud in trade with strangers strengthened this opinion. But if goods having a small value may be given a higher value by being traded, trade and the work of merchants, peddlers, and carriers of all sorts, may be a value-increasing process.