This section is from the "Elementary Principles of Economics" book, by Richard T. Ely and George Ray Wicker. Also available from Amazon: Elementary Principles Of Economics: Together With A Short Sketch Of Economic History
Meaning of the Term. One of the most important and difficult problems in economics, and the central problem in transfers or exchange, as well as in distribution, is that of the determination of value. Why do goods exchange one for another in the proportions that they do? Why do the proportions in which they exchange vary from time to time ? This is the problem which we now have to study.
First of all we must note that there are two closely related but distinct ideas of value, which have been called by the names "subjective value" and "objective value." Let us try to get an understanding of these ideas and of the relation between them. Our study of the law of diminishing utility has shown us that as our stock of any commodity increases, the marginal utility falls ; that is, we care less for an additional portion of it. We satisfy our most intense wants first, and, as our supply increases, our unsatisfied wants grow less and less urgent. If, for example, we had but a very small supply of water, we should use it for drinking purposes only : a first increase might be used for bathing ; a second, for washing dishes and clothes, and so on. The more the supply increases, the less capacity would a gallon have to excite our desire, the less sacrifice would we undergo to get an additional gallon, and the less should we trouble ourselves about the loss of a gallon. It is the marginal utility that determines the economic importance of any commodity in our estimation. These phrases, " capacity to excite desire, marginal utility, economic importance," are synonymous with the term " subjective value." For a brief definition, we may say, " subjective value is the capacity to excite desire." Notice the close relation and yet the sharp contrast here between utility and subjective value. A cubic foot of air has great utility, but it has no value. Yet anything, to have value, must have utility, since it is utility under a condition of scarcity that excites desire. We may sum up the relation of the two things thus: utility is the power to satisfy wants ; subjective value is the power to excite desire.
How Subjective Value is Determined. It is now easy to see how subjective value is determined. It is utility under a condition of scarcity. To possess value, a thing must be able to satisfy wants, and it must exist in less than sufficient quantity to satisfy all wants.
The Idea of Objective or Exchange Value. The idea of objective or exchange value is a simple one. Objective value is the quantitative ratio in which goods or services are exchanged. Thus, if a pound of butter exchanges for four pounds of sugar, we say that it is worth four pounds of sugar, or that its value in terms of sugar is four pounds of that commodity. In our day most commodities are exchanged directly for the single commodity money, and are exchanged only indirectly for those goods or services which we consume. It results that we usually think of value in terms of money ; that is, we think of prices. For price is objective value expressed in terms of money. But if a unit of one commodity exchanges for one dollar, while a unit of another commodity exchanges for two dollars, it is evident that the value of the first commodity is one-half that of the second.
The Relation of Objective to Subjective Value. And now let us compare the two ideas of value. Let us see how out of these individual valuations there results an objective market value. Imagine a market to which eight farmers have each brought a load of corn to sell, and to which eight other persons have come, each of whom wishes to buy a load. Suppose each seller to have settled upon a price per bushel less than which he does not wish to take, and suppose each buyer to have fixed a price more than which he does not intend to pay. Let these estimates be as follows :
Buyers' maximum prices : 69, 67, 65, 63, 61, 60, 59, 58. Sellers' minimum prices : 70, 69, 68, 64, 62, 60, 59, 58.
Assuming that each one is alive to his own interest, and that he does not make a bargain until he is sure that he cannot do better, what will be the market price of corn per bushel ?
The price evidently cannot be 70 cents, for no buyer will pay so much ; it cannot be 65, for since five are willing to sell at this price and only three to buy, the competition of the five in their efforts to sell to the three must bring down the price. Continuing to test each possible price in this way, we get the following table:
At 64 cents there are 3 buyers and 5 sellers. At 63 cents there are 4 buyers and 4 sellers. At 62½ cents there are 4 buyers and 4 sellers. At 62 cents there are 4 buyers and 4 sellers. At 61 cents there are 5 buyers and 3 sellers.
It appears that at 62 and at 63 cents (or at any price between) there are as many buyers as sellers, namely four, and that four loads will be sold at a price somewhere between these limits. These are the prices at which demand and supply are equal.
The actual buyers in this market are those with the estimates 69, 67, 65, 63. The last of these is called the marginal buyer, because with a rise in the price he would be the first to be excluded. The actual sellers are those with the estimates 62, 60, 59, 58. The first of these is called the marginal seller, because with a fall in the price he would be the first to be excluded. Notice that the marginal buyer's estimate the marginal demand price is about equal to the marginal seller's estimate the marginal supply price. We may say, then, that the market price is an equilibrium between the existing state of the supply and the existing state of demand. In a previous chapter on Demand we have sufficiently considered the forces lying back of the buyers' estimates. We must now inquire into the forces governing the sellers' estimates, that is, those lying back of supply.
Different Causes of Scarcity. Scarcity is not everywhere the result of the same cause. First, (1) we may have absolute scarcity, as in the case of paintings by old masters, unique natural products, etc. In such cases the quantity cannot be increased at all. This class of goods is not very important. Secondly, (2) we may have monopoly scarcity, a scarcity caused by the fact that the quantity is under the control of one or more persons who act together to control the offerings of such goods to society. The case of monopoly goods will be discussed separately and at length in the following chapter. Finally, (3) we may have scarcity caused simply by the fact that men must undergo sacrifice in order to increase the quantity. The greater proportion of the goods which we consume fall into this class. A simple way of describing such goods would be to say that they are freely produced.