Chapter Five of Shawn Ritenour’s Foundations of Economics introduces us to the concept of money, which every society has developed to address the problems inherent to a barter economy. In a society where the division of labor has developed to any significant degree, it’s very likely that the producers of the goods and services you want are not interested in what you produce and will be unwilling to engage in direct exchange with you. Thus it becomes necessary for you to acquire a commodity desired by the owners of the things you want from a third party who wants what you produce. If none of the people who want what you produce have any of the things desired by the owners of the things you want, you’ll have to bring in a fourth party to the sequence of exchange, etc.
In any society there are certain goods that everyone wants. Goods of that sort that are also durable, easily divisible, relatively scarce, and portable are good candidates to become money. Ritenour, following the insights of Karl Menger and Ludwig von Mises, states that money, as the most marketable commodity, is an economic good and thus subject to all the laws of economics. This simple proposition is something that many economists fail to grasp or simply deny, but it is a critical concept for understanding how prices work. Ritenour also points out that a key benefit of money is that it makes possible the calculation of profit and loss by entrepreneurs and thus permits the most efficient allocation of resources and greatest economic progress.
The following sections explain the laws of demand and supply. We know from the law of marginal utility that an individual who is able to purchase more than one marginal unit of a good values each additional unit less than the preceding one. Ritenour calls this the law of demand. For any individual, a “demand schedule” can be created showing his willingness to pay different amounts for each additional unit. If the preferences of more people are added to the demand schedule, the “demand curve” tends to even out and become smooth. It shows us the maximum number of units of the particular good people will buy at a given price.
A similar schedule and curve can be constructed for suppliers of any good. Ritenour shows the subjective valuation and marginal utility works for suppliers as well, even though many people assume that costs of production are objective. An important point to consider here is the passage of time. The price of a good that has already been produced cannot be determined by how much it cost to produce that good; those costs are “sunk” and cannot be recovered no matter what price the good will sell for. At the moment of sale, both the seller and buyer determine the price subjectively. Once we understand this, we can build a supply schedule on the basis of sellers’ subjective preferences the same way we did for buyers.
If we overlay the demand and supply schedules of our economy (whatever the size), we’ll see that at some point the two lines will cross. This point shows the “market price” of the good, the point at which the greatest possible number of potential buyers and sellers of that good will have their subjective desires satisfied. At nearly any price there will be some frustrated would-be sellers and some frustrated would-be buyers, but the market price is where the greatest possible number of people will have their wants satisfied. A corollary to this observation is that people who argue for government interventions into the market to fix artificially low or high prices implicitly are arguing for the frustration of more people than is necessary.
Ritenour summarizes the chapter by stating that market exchanges are voluntary and peaceful, and thus are to be preferred to coercive methods of distribution. The price system also provides a motivation for people to serve each other because entrepreneurs profit by providing consumers with what they actually want.