WEBVTT NOTE 2.05. Determination of Price: Equilibrium Price 1 00:00:00.000 --> 00:00:07.040 5. Determination of Price, Equilibrium Price 2 00:00:07.040 --> 00:00:12.600 One of the most important problems in economic analysis is the question, what principles 3 00:00:12.600 --> 00:00:19.520 determine the formation of prices on the free market? What can be said by logical derivation 4 00:00:19.520 --> 00:00:25.280 from the fundamental assumption of human action in order to explain the determination 5 00:00:25.280 --> 00:00:39.000 It is most convenient to begin with a case of isolated exchange, a case where only two 6 00:00:39.000 --> 00:00:43.880 isolated parties are involved in the exchange of two goods. 7 00:00:43.880 --> 00:00:50.280 For example, Johnson and Smith are considering a possible exchange of a horse of the former 8 00:00:50.280 --> 00:00:54.080 for some barrels of fish possessed by the latter. 9 00:00:54.080 --> 00:00:59.880 The question is, what can economic analysis say about the determinants of the exchange 10 00:00:59.880 --> 00:01:05.040 rate established between the two goods in the exchange? 11 00:01:05.040 --> 00:01:10.840 An individual will decide whether or not to make an exchange on the basis of the relative 12 00:01:10.840 --> 00:01:14.560 positions of the two goods on his value scale. 13 00:01:14.560 --> 00:01:21.400 Thus, suppose the value scale of Smith, the possessor of the fish, is as follows. 14 00:01:21.400 --> 00:01:25.680 His highest value, 103 barrels of fish. 15 00:01:25.680 --> 00:01:30.200 His second highest value, 102 barrels of fish. 16 00:01:30.200 --> 00:01:35.000 His third highest value, 101 barrels of fish. 17 00:01:35.000 --> 00:01:38.360 His fourth highest value, a horse. 18 00:01:38.360 --> 00:01:42.700 His fifth highest value, 100 barrels of fish. 19 00:01:42.700 --> 00:01:47.080 His sixth highest value, 99 barrels of fish. 20 00:01:47.080 --> 00:01:49.080 The Theory of Money and Credit 21 00:02:17.080 --> 00:02:26.080 If the horse in terms of the fish offered by Smith is 100 barrels or less, then Smith will make the exchange. 22 00:02:26.080 --> 00:02:33.080 If the price is 101 barrels or more, then the exchange will not be made. 23 00:02:33.080 --> 00:02:37.080 Suppose Johnson's value scale looks like this. 24 00:02:37.080 --> 00:02:41.080 Johnson's highest value, 104 barrels of fish. 25 00:02:41.080 --> 00:02:46.080 His second highest value, 103 barrels of fish. 26 00:02:46.080 --> 00:02:54.680 3rd highest value 102 barrels of fish, his 4th highest value a horse, his 5th highest 27 00:02:54.680 --> 00:03:03.520 value 101 barrels of fish, his 6th highest value 100 barrels of fish, his 7th highest 28 00:03:03.520 --> 00:03:07.440 value 99 barrels of fish. 29 00:03:07.440 --> 00:03:13.920 Then Johnson will not give up his horse for less than 102 barrels of fish. 30 00:03:13.920 --> 00:03:19.840 If the price offered for his horse is less than 102 barrels of fish, he will not make 31 00:03:19.840 --> 00:03:21.560 the exchange. 32 00:03:21.560 --> 00:03:28.000 Here it is clear that no exchange will be made, for at Johnson's minimum selling price 33 00:03:28.000 --> 00:03:34.960 of 102 barrels of fish, it is more beneficial for Smith to keep the fish than to acquire 34 00:03:34.960 --> 00:03:36.640 the horse. 35 00:03:36.640 --> 00:03:42.960 In order for an exchange to be made then, the minimum selling price of the seller must 36 00:03:42.960 --> 00:03:48.540 Must be lower than the maximum buying price of the buyer for that good. 37 00:03:48.540 --> 00:03:55.200 In this case, it must be lower than the price of 100 barrels of fish per horse. 38 00:03:55.200 --> 00:04:00.940 Suppose that this condition is met, and Johnson's value scale is as follows. 39 00:04:00.940 --> 00:04:05.000 Johnson's highest value, 84 barrels of fish. 40 00:04:05.000 --> 00:04:09.260 Johnson's second highest value, 83 barrels of fish. 41 00:04:09.260 --> 00:04:13.400 His third highest value, 82 barrels of fish. 42 00:04:13.400 --> 00:04:17.420 His fourth highest value, 81 barrels of fish. 43 00:04:17.420 --> 00:04:20.540 His fifth highest value, a horse. 44 00:04:20.540 --> 00:04:24.520 His sixth highest value, 80 barrels of fish. 45 00:04:24.520 --> 00:04:29.900 His seventh highest value, 79 barrels of fish. 46 00:04:29.900 --> 00:04:36.520 Johnson will sell the horse for any amount of fish at or above 81 barrels. 47 00:04:36.520 --> 00:04:40.800 This then is his minimum selling price for the horse. 48 00:04:40.800 --> 00:04:47.180 With this as Johnson's value scale, and Smith's as previously described, what price will they 49 00:04:47.180 --> 00:04:52.040 agree upon for the horse, and conversely for the fish? 50 00:04:52.040 --> 00:04:58.240 All analysis can say about this problem is that since the exchange must be for the mutual 51 00:04:58.240 --> 00:05:05.020 benefit of both parties, the price of the good in isolated exchange will be established 52 00:05:05.020 --> 00:05:10.860 Somewhere Between the Maximum Buying Price and the Minimum Selling Price 53 00:05:10.860 --> 00:05:18.540 That is, the price of the horse will be somewhere between 100 barrels and 81 barrels of fish. 54 00:05:18.540 --> 00:05:25.420 Similarly, the price of the fish will be set somewhere between one eighty-first and one 55 00:05:25.420 --> 00:05:32.300 one-hundredth of a horse per barrel. We cannot say at which point the price will be set. 56 00:05:32.300 --> 00:05:38.900 That depends on the data of each particular case, on the specific conditions prevailing. 57 00:05:38.900 --> 00:05:43.780 In particular, it will depend upon the bargaining skill of the two individuals. 58 00:05:43.780 --> 00:05:49.860 Clearly, Johnson will try to set the price of the horse as high as possible, while Smith 59 00:05:49.860 --> 00:05:53.400 will try to set the price as low as possible. 60 00:05:53.400 --> 00:05:58.580 This is based on the principle that the seller of the product tries to obtain the highest 61 00:05:58.580 --> 00:06:12.580 We cannot predict the point that the two will agree on except that it will be somewhere in this range set by the two points. 62 00:06:12.580 --> 00:06:20.580 Of course, given other value scales, the final prices might be determinate at our point or within a narrow range. 63 00:06:20.580 --> 00:06:42.940 Now, let us gradually remove our assumption of isolated exchange. 64 00:06:42.940 --> 00:06:49.940 Let us first assume that Smith has a competitor, Brown, a rival in offering fish for the desired 65 00:07:19.940 --> 00:07:26.940 of Money, The Theory of Money and State, The Theory of Money and State, The Theory of Money 66 00:07:49.940 --> 00:08:16.940 Johnson's highest value is 93 barrels of fish. His second highest, 92 barrels of fish. His third highest, 91 barrels of fish. His fourth highest, a horse. His fifth highest, 90 barrels of fish. His maximum buying price. Sixth highest, 89 barrels of fish. Seventh highest, 88 barrels of fish. 67 00:08:16.940 --> 00:08:24.860 Brown's highest value is 84 barrels of fish, second highest 83 barrels of fish, third highest 68 00:08:24.860 --> 00:08:33.960 82 barrels of fish, fourth highest 81 barrels of fish, his minimum selling price, fifth 69 00:08:33.960 --> 00:08:43.620 highest a horse, sixth highest 80 barrels of fish, seventh highest 79 barrels of fish. 70 00:08:43.620 --> 00:08:48.340 Brown and Smith are competing for the purchase of Johnson's horse. 71 00:08:48.340 --> 00:08:54.820 Clearly, only one of them can make the exchange for the horse, and since their goods are identical 72 00:08:54.820 --> 00:09:01.020 to Johnson, the latter's decision to exchange will be decided by the price offered for the 73 00:09:01.020 --> 00:09:02.020 horse. 74 00:09:02.020 --> 00:09:07.300 Obviously, Johnson will make the exchange with that potential buyer who will offer the 75 00:09:07.300 --> 00:09:09.340 highest price. 76 00:09:09.340 --> 00:09:15.560 Their value scales are such that Smith and Brown can continue to overbid each other as 77 00:09:15.560 --> 00:09:21.980 long as the price range is between 81 and 90 barrels of fish per horse. 78 00:09:21.980 --> 00:09:29.120 Thus, if Smith offers Johnson an exchange at 82 barrels per horse, Brown can compete 79 00:09:29.120 --> 00:09:34.520 by raising the bid to 84 barrels of fish per horse, etc. 80 00:09:34.520 --> 00:09:41.680 This can continue, however, only until Brown's maximum buying price has been exceeded. 81 00:09:41.680 --> 00:09:48.760 If Smith offers 91 barrels for the horse, it no longer pays for Brown to make the exchange, 82 00:09:48.760 --> 00:09:51.080 and he drops out of the competition. 83 00:09:51.080 --> 00:09:57.920 Thus, the price in the exchange will be high enough to exclude the less capable or less 84 00:09:57.920 --> 00:10:04.280 urgent buyer, the one whose value scale does not permit him to offer as high a price as 85 00:10:04.280 --> 00:10:07.520 as the other, more capable buyer. 86 00:10:07.520 --> 00:10:13.440 We do not know exactly what the price will be, but we do know that it will be set by 87 00:10:13.440 --> 00:10:20.540 bargaining somewhere at or below the maximum buying price of the most capable buyer and 88 00:10:20.540 --> 00:10:25.640 above the maximum buying price of the next most capable buyer. 89 00:10:25.640 --> 00:10:31.960 It will be somewhere between 100 barrels and 91 barrels, and the exchange will be made 90 00:10:31.960 --> 00:10:33.300 with Smith. 91 00:10:33.300 --> 00:10:39.240 We see that the addition of another competing buyer for the product considerably narrows 92 00:10:39.240 --> 00:10:44.640 the zone of bargaining in determining the price that will be set. 93 00:10:44.640 --> 00:10:51.500 This analysis can easily be extended to a case of one seller and n number of buyers, 94 00:10:51.500 --> 00:10:55.100 each offering the same commodity in exchange. 95 00:10:55.100 --> 00:11:01.460 Thus suppose that there are five potential buyers for the horse, all offering fish, whose 96 00:11:01.460 --> 00:11:04.500 His value scales are as follows. 97 00:11:04.500 --> 00:11:08.600 Smith's highest value, 101 barrels of fish. 98 00:11:08.600 --> 00:11:11.380 His second highest value, a horse. 99 00:11:11.380 --> 00:11:15.340 His third highest value, 100 barrels of fish. 100 00:11:15.340 --> 00:11:19.500 A's highest value, 100 barrels of fish. 101 00:11:19.500 --> 00:11:22.340 His second highest value, a horse. 102 00:11:22.340 --> 00:11:26.660 His third highest value, 99 barrels of fish. 103 00:11:26.660 --> 00:11:30.820 B's highest value, 98 barrels of fish. 104 00:12:00.820 --> 00:12:07.460 With only one horse to be disposed of to one buyer, the buyers overbid each other until 105 00:12:07.460 --> 00:12:10.380 each must drop out of the competition. 106 00:12:10.380 --> 00:12:18.260 Finally, Smith can outbid A, his next most capable competitor, only with a price of 100 107 00:12:18.260 --> 00:12:19.740 barrels of fish. 108 00:12:19.740 --> 00:12:26.220 We see that in this case the price in the exchange is uniquely determined once the various 109 00:12:26.220 --> 00:12:33.700 This value scales are given at 100, since at a lower price A is still in the bidding, 110 00:12:33.700 --> 00:12:38.820 and at a higher price no buyer will be willing to conclude the exchange. 111 00:12:38.820 --> 00:12:45.080 At any rate, even if the value scales are not such as to determine the price uniquely, 112 00:12:45.080 --> 00:12:50.280 the addition of more competitors greatly narrows the bargaining zone. 113 00:12:50.280 --> 00:12:56.520 The general rule still holds, the price will be between the maximum buying price of the 114 00:12:56.520 --> 00:13:03.740 most capable and that of the next most capable competitor, including the former and excluding 115 00:13:03.740 --> 00:13:05.780 the latter. 116 00:13:05.780 --> 00:13:12.320 Auction sales are examples of markets for one unit of a good with one seller and many 117 00:13:12.320 --> 00:13:13.800 buyers. 118 00:13:13.800 --> 00:13:19.320 It is also evident that the narrowing of the bargaining zone has taken place in an upward 119 00:13:19.320 --> 00:13:41.320 The case of one-sided competition of many sellers with just one buyer is the direct converse of the above, and may be considered by merely reversing the example and considering the price of the fish instead of the price of the horse. 120 00:13:41.320 --> 00:13:58.320 As more sellers of the fish competed to conclude the exchange with the one buyer, the zone of determination of the price of fish narrowed, although this time in a downward direction, and to the further advantage of the buyer. 121 00:13:58.320 --> 00:14:08.320 As more sellers were added, each tried to underbid his rival to offer a lower price for the product than his competitors. 122 00:14:08.320 --> 00:14:15.720 The sellers continued to underbid each other until all but the one seller were excluded from the market. 123 00:14:15.720 --> 00:14:29.020 In a case of many sellers and one buyer, the price will be set at a point between the minimum selling price of the second most capable and that of the most capable competitor, 124 00:14:29.020 --> 00:14:35.620 strictly at a point below the former and down to or including the latter. 125 00:14:35.620 --> 00:14:46.620 In the final example above, the point was pushed down to be uniquely determined at the latter point, one one hundredth horse per barrel. 126 00:14:46.620 --> 00:14:55.620 We have so far considered the cases of one buyer and more than one seller, and of one seller and more than one buyer. 127 00:14:55.620 --> 00:15:04.620 We now come to the only case with great importance in a modern complex economy based on an intricate network of exchanges, 128 00:15:04.620 --> 00:15:15.500 Let us, therefore, consider a market with any number of competing buyers and sellers. 129 00:15:15.500 --> 00:15:22.380 Any product could be considered, but our hypothetical example will continue to be the sale of horses 130 00:15:22.380 --> 00:15:29.920 in exchange for fish, with the horses as well as the fish considered by all parties as homogeneous 131 00:15:29.920 --> 00:15:32.540 units of the same good. 132 00:15:32.540 --> 00:15:38.620 The following is a list of the maximum buying prices of the various buyers, based on the 133 00:15:38.620 --> 00:15:43.180 valuations on their respective value scales. 134 00:15:43.180 --> 00:15:44.820 Buyers of horses. 135 00:15:44.820 --> 00:15:51.180 First buyer, X1, maximum buying price, 100 barrels of fish. 136 00:15:51.180 --> 00:15:56.900 Buyer X2's, maximum buying price, 98 barrels of fish. 137 00:15:56.900 --> 00:16:02.300 Buyer X3's Maximum Buying Price, 95 Barrels of Fish 138 00:16:02.300 --> 00:16:08.160 Buyer X4's Maximum Buying Price, 91 Barrels of Fish 139 00:16:08.160 --> 00:16:14.220 Buyer X5's Maximum Buying Price, 89 Barrels of Fish 140 00:16:14.220 --> 00:16:20.220 Buyer X6's Maximum Buying Price, 88 Barrels of Fish 141 00:16:20.220 --> 00:16:26.120 Buyer X7's Maximum Buying Price, 86 Barrels of Fish 142 00:16:26.120 --> 00:16:32.040 Buyer X8's maximum buying price, 85 barrels of fish. 143 00:16:32.040 --> 00:16:38.960 Buyer X9's maximum buying price, 83 barrels of fish. 144 00:16:38.960 --> 00:16:46.160 The following is a list of the minimum selling prices of the various sellers on the market. 145 00:16:46.160 --> 00:16:47.680 Sellers of horses. 146 00:16:47.680 --> 00:16:54.240 The first seller, Z1, has a minimum selling price of 81 barrels of fish. 147 00:16:54.240 --> 00:16:59.240 Z2's minimum selling price, 83 barrels of fish. 148 00:16:59.240 --> 00:17:04.240 Z3's minimum selling price, 85 barrels of fish. 149 00:17:04.240 --> 00:17:09.240 Z4's minimum selling price, 88 barrels of fish. 150 00:17:09.240 --> 00:17:14.240 Z5's minimum selling price, 89 barrels of fish. 151 00:17:14.240 --> 00:17:19.240 Z6's minimum selling price, 90 barrels of fish. 152 00:17:19.240 --> 00:17:38.480 The most capable buyer of horses we recognize as Smith, with a buying price of 100 barrels. 153 00:17:38.480 --> 00:17:44.840 Johnson is the most capable seller, the seller with the lowest minimum selling price, at 154 00:17:44.840 --> 00:17:46.640 81 barrels. 155 00:17:46.640 --> 00:17:52.840 The problem is to find the principle by which the price or prices of the exchanges of horses 156 00:17:52.840 --> 00:17:55.080 will be determined. 157 00:17:55.080 --> 00:17:59.380 Now let us first take the case of X1, Smith. 158 00:17:59.380 --> 00:18:05.560 It is clear that it is to the advantage of Smith to make the exchange at a price of 100 159 00:18:05.560 --> 00:18:07.120 barrels for the horse. 160 00:18:07.120 --> 00:18:13.720 Yet, it is to Smith's greater advantage to buy the good at the lowest possible price. 161 00:18:13.720 --> 00:18:19.440 He is not engaged in overbidding his competitors merely for the sake of overbidding. 162 00:18:19.440 --> 00:18:24.040 He will try to obtain the good for the lowest price that he can. 163 00:18:24.040 --> 00:18:29.880 Therefore Smith will prefer to begin bidding for a horse at the lowest prices offered by 164 00:18:29.880 --> 00:18:36.480 his competitors, and only raise the offered price if it becomes necessary to do so in 165 00:18:36.480 --> 00:18:39.880 order to avoid being shut out of the market. 166 00:18:39.880 --> 00:18:45.660 Similarly, Johnson would make an advantageous sale at a price of 81 barrels. 167 00:18:45.660 --> 00:18:51.300 However, he is interested in selling his product at the highest possible price. 168 00:18:51.300 --> 00:18:57.540 He will underbid his competitor only if it becomes necessary to do so in order to avoid 169 00:18:57.540 --> 00:19:02.000 being shut out of the market without making a sale. 170 00:19:02.000 --> 00:19:08.340 It is evident that buyers will tend to start negotiations by offering as low prices as 171 00:19:08.340 --> 00:19:14.340 as possible, while sellers will tend to start by asking for as high a price as they think 172 00:19:14.340 --> 00:19:15.740 they can obtain. 173 00:19:15.740 --> 00:19:22.700 Clearly, this preliminary testing of the market will tend to be more prolonged in a new market, 174 00:19:22.700 --> 00:19:28.540 where conditions are unfamiliar, while it will tend to be less prolonged in an old market, 175 00:19:28.540 --> 00:19:34.020 where the participants are relatively familiar with the results of the price formation process 176 00:19:34.020 --> 00:19:47.220 Let us suppose that buyers begin by offering the low price of 82 barrels for a horse. 177 00:19:47.220 --> 00:19:52.240 Here is a price at which each of the buyers would be glad to make a purchase, but only 178 00:19:52.240 --> 00:19:57.560 one seller, Z1, would be willing to sell at 82. 179 00:19:57.560 --> 00:20:03.300 It is possible that Z1, through ignorance, might conclude the exchange with some one 180 00:20:03.300 --> 00:20:05.300 The Theory of Money and Credit 181 00:20:33.300 --> 00:20:35.300 The Theory of Money and Credit 182 00:21:03.300 --> 00:21:18.300 As the offering price rises, the least capable buyers, as in the previous case, begin to be excluded from the market. 183 00:21:18.300 --> 00:21:27.300 A price of 84 will bring two sellers into the market, but will exclude X9 from the buyer's side. 184 00:21:27.300 --> 00:21:34.160 As the offering price rises, the disproportion between the amount offered for sale and the 185 00:21:34.160 --> 00:21:40.220 amount demanded for purchase at the given price diminishes, but as long as the latter 186 00:21:40.220 --> 00:21:47.900 is greater than the former, mutual overbidding of buyers will continue to raise the price. 187 00:21:47.900 --> 00:21:53.580 The amount offered for sale at each price is called the supply. 188 00:21:53.580 --> 00:22:00.500 The amount demanded for purchase at each price is called the demand. Evidently, at the first 189 00:22:00.500 --> 00:22:08.220 price of 82, the supply of horses on the market is one. The demand for horses on the market 190 00:22:08.220 --> 00:22:15.660 is nine. Only one seller would be willing to sell at this price, while all nine buyers 191 00:22:15.660 --> 00:22:22.320 would be willing to make their purchase. This reflects the progressive entry into the market 192 00:22:22.320 --> 00:22:28.400 of the Sellers as the Price Increases and the Dropping Out of the Buyers as the Price 193 00:22:28.400 --> 00:22:29.920 Increases. 194 00:22:29.920 --> 00:22:37.720 As was seen above, as long as the demand exceeds the supply at any price, buyers will continue 195 00:22:37.720 --> 00:22:42.660 to overbid and the price will continue to rise. 196 00:22:42.660 --> 00:22:49.900 The converse occurs if the price begins near its highest point, thus if sellers first demand 197 00:22:49.900 --> 00:22:57.580 At a price of 101 barrels for the horse, there will be eight eager sellers and no buyers. 198 00:22:57.580 --> 00:23:04.340 At a price of 99, the sellers may find one eager buyer, but chances are that a sale will 199 00:23:04.340 --> 00:23:05.900 not be made. 200 00:23:05.900 --> 00:23:11.300 The buyer will realize that there is no point in paying such a high price, and the other 201 00:23:11.300 --> 00:23:18.300 sellers will eagerly underbid the one who tries to make the sale at the price of 99. 202 00:23:18.300 --> 00:23:25.900 Thus, when the price is so high that the supply exceeds the demand at that price, underbidding 203 00:23:25.900 --> 00:23:29.660 of suppliers will drive the price downward. 204 00:23:29.660 --> 00:23:36.460 As the tentative price falls, more sellers are excluded from the market, and more buyers 205 00:23:36.460 --> 00:23:38.860 enter it. 206 00:23:38.860 --> 00:23:44.640 If the overbidding of buyers will drive the price up whenever the quantity demanded is 207 00:23:44.640 --> 00:23:50.020 is greater than the quantity supplied, and the underbidding of sellers drives the price 208 00:23:50.020 --> 00:23:56.340 down whenever supply is greater than demand, it is evident that the price of the good will 209 00:23:56.340 --> 00:24:03.420 find a resting point where the quantity demanded is equal to the quantity supplied, that is, 210 00:24:03.420 --> 00:24:06.180 where supply equals demand. 211 00:24:06.180 --> 00:24:13.220 At this price and at this price only, the market is cleared, that is, there is no incentive 212 00:24:13.220 --> 00:24:19.620 5 for buyers to bid prices up further or for sellers to bid prices down. 213 00:24:19.620 --> 00:24:27.720 In our example, this final or equilibrium price is 89, and at this price 5 horses will 214 00:24:27.720 --> 00:24:30.260 be sold to 5 buyers. 215 00:24:30.260 --> 00:24:36.060 This equilibrium price is the price at which the good will tend to be set and sales to 216 00:24:36.060 --> 00:24:38.140 be made. 217 00:24:38.140 --> 00:24:44.420 It is possible that the equilibrium point will not be uniquely determined at one definite 218 00:24:44.420 --> 00:24:45.420 price. 219 00:24:45.420 --> 00:24:50.100 Thus, the pattern of supply and demand schedules might be as follows. 220 00:24:50.100 --> 00:24:56.460 At a price of 89, 5 are supplied and 6 are demanded. 221 00:24:56.460 --> 00:25:02.700 At a price of 90, 6 are supplied and 5 are demanded. 222 00:25:02.700 --> 00:25:09.040 The inequality is the narrowest possible, but there is no one point of equality. 223 00:25:09.040 --> 00:25:15.020 In that case, if the units are further divisible, then the price will be set to clear the market 224 00:25:15.020 --> 00:25:21.380 at a point in between, say 89.5 barrels of fish per horse. 225 00:25:21.380 --> 00:25:28.320 If both goods being exchanged are indivisible further, however, such as cows against horses, 226 00:25:28.320 --> 00:25:34.760 And the equilibrium price will be either 89 or 90, and this will be the closest approach 227 00:25:34.760 --> 00:25:39.080 to equilibrium, rather than equilibrium itself. 228 00:25:39.080 --> 00:25:46.960 Specifically, the sales will be made to the five most capable buyers at that price, X1, 229 00:25:46.960 --> 00:25:51.480 X2, X3, X4 and X5. 230 00:25:51.480 --> 00:25:57.700 The other less capable or less urgent buyers are excluded from the market, because their 231 00:25:57.700 --> 00:25:59.700 The Theory of Money and Credit 232 00:26:27.700 --> 00:26:34.260 The minimum selling price is 89, is just able to make his sale at 89. 233 00:26:34.260 --> 00:26:40.600 He is the marginal seller, the seller at the margin, the one who would be excluded with 234 00:26:40.600 --> 00:26:43.100 a slight fall in price. 235 00:26:43.100 --> 00:26:48.900 On the other hand, X5 is the least capable of the buyers who have been able to stay in 236 00:26:48.900 --> 00:26:49.900 the market. 237 00:26:49.900 --> 00:26:57.340 He is the marginal buyer, the one who would be excluded by a slight rise in price. 238 00:26:57.340 --> 00:27:02.500 Since it would be foolish for the other buyers to pay more than they must to obtain their 239 00:27:02.500 --> 00:27:09.200 supply, they will also pay the same price as the marginal buyer, that is, 89. 240 00:27:09.200 --> 00:27:14.340 Similarly, the other sellers will not sell for less than they could obtain. 241 00:27:14.340 --> 00:27:19.740 They will sell at the price permitting the marginal seller to stay in the market. 242 00:27:19.740 --> 00:27:26.840 Evidently, the more capable or more urgent buyers and sellers, the supramarginal, which 243 00:27:26.840 --> 00:27:32.960 which includes the marginal, obtain a psychic surplus in this exchange, for they are better 244 00:27:32.960 --> 00:27:37.600 off than they would have been if the price had been higher or lower. 245 00:27:37.600 --> 00:27:44.740 However, since goods can be ranked only on each individual's value scale, and no measurement 246 00:27:44.740 --> 00:27:51.720 of psychic gain can be made either for one individual or between different individuals, 247 00:27:51.720 --> 00:27:57.200 A little of value can be said about this psychic gain, except that it exists. 248 00:27:57.200 --> 00:28:02.640 We cannot even make the statement, for example, that the psychic gain in exchange obtained 249 00:28:02.640 --> 00:28:06.800 by X1 is greater than that of X5. 250 00:28:06.800 --> 00:28:12.600 The excluded buyers and sellers are termed sub-marginal. 251 00:28:12.600 --> 00:28:18.520 The specific feature of the clearing of the market performed by the equilibrium price 252 00:28:18.520 --> 00:28:25.640 is that at this price alone, all those buyers and sellers who are willing to make exchanges 253 00:28:25.640 --> 00:28:34.600 can do so. At this price, five sellers with horses find five buyers for the horses. All who wish to 254 00:28:34.600 --> 00:28:42.120 buy and sell at this price can do so. At any other price, there are either frustrated buyers or 255 00:28:42.120 --> 00:28:43.120 For Frustrated Sellers 256 00:28:43.120 --> 00:28:49.920 Thus, at a price of eighty-four, eight people would like to buy at this price, but only 257 00:28:49.920 --> 00:28:52.100 two horses are available. 258 00:28:52.100 --> 00:28:58.840 At this price, there is a great amount of unsatisfied demand, or excess demand. 259 00:28:58.840 --> 00:29:06.040 Conversely, at a price of, say, ninety-five, there are seven sellers eager to supply horses, 260 00:29:06.040 --> 00:29:09.320 but only three people willing to demand horses. 261 00:29:09.320 --> 00:29:16.880 Thus, at this price there is unsatisfied supply or excess supply. 262 00:29:16.880 --> 00:29:24.760 Other terms for excess demand and excess supply are shortage and surplus of the good. 263 00:29:24.760 --> 00:29:31.620 Aside from the universal fact of the scarcity of all goods, a price that is below the equilibrium 264 00:29:31.620 --> 00:29:39.040 price creates an additional shortage of supply for demanders, while a price above equilibrium 265 00:29:39.040 --> 00:29:45.520 Some creates a surplus of goods for sale as compared to demands for purchase. 266 00:29:45.520 --> 00:29:51.600 We see that the market process always tends to eliminate such shortages and surpluses 267 00:29:51.600 --> 00:29:58.980 and establish a price where demanders can find a supply and suppliers a demand. 268 00:29:58.980 --> 00:30:04.820 It is important to realize that this process of overbidding of buyers and underbidding 269 00:30:04.820 --> 00:30:11.260 Bidding of sellers always takes place in the market, even if the surface aspects of the 270 00:30:11.260 --> 00:30:17.980 specific case make it appear that only the sellers or buyers are setting the price. 271 00:30:17.980 --> 00:30:25.020 Thus, a good might be sold in retail shops with prices simply quoted by the individual 272 00:30:25.020 --> 00:30:26.020 seller. 273 00:30:26.020 --> 00:30:31.060 But the same process of bidding goes on in such a market as in any other. 274 00:30:31.060 --> 00:30:36.880 If the sellers set their prices below the equilibrium price, buyers will rush to make 275 00:30:36.880 --> 00:30:42.600 their purchases, and the sellers will find that shortages develop, accompanied by queues 276 00:30:42.600 --> 00:30:46.880 of buyers eager to purchase goods that are unavailable. 277 00:30:46.880 --> 00:30:52.680 Realizing that they could obtain higher prices for their goods, the sellers raise their quoted 278 00:30:52.680 --> 00:30:54.840 prices accordingly. 279 00:30:54.840 --> 00:31:00.580 On the other hand, if they set their prices above the equilibrium price, surpluses of 280 00:31:00.580 --> 00:31:07.000 of Unsold Stocks will appear, and they will have to lower their prices in order to move 281 00:31:07.000 --> 00:31:12.720 their accumulation of unwanted stocks and to clear the market. 282 00:31:12.720 --> 00:31:18.640 The case where buyers quote prices and therefore appear to set them is similar. 283 00:31:18.640 --> 00:31:24.780 If the buyers quote prices below the equilibrium price, they will find that they cannot satisfy 284 00:31:24.780 --> 00:31:27.780 all their demands at that price. 285 00:31:27.780 --> 00:31:31.700 As a result, they will have to raise their quoted prices. 286 00:31:31.700 --> 00:31:37.840 On the other hand, if the buyers set the prices too high, they will find a stampede of sellers 287 00:31:37.840 --> 00:31:43.820 with unsaleable stocks, and will take advantage of the opportunity to lower the price and 288 00:31:43.820 --> 00:31:45.220 clear the market. 289 00:31:45.220 --> 00:31:51.520 Thus, regardless of the form of the market, the result of the market process is always 290 00:31:51.520 --> 00:31:57.680 is to tend toward the establishment of the equilibrium price via the mutual bidding of 291 00:31:57.680 --> 00:32:00.280 buyers and sellers. 292 00:32:00.280 --> 00:32:06.340 It is evident that if we eliminate the assumption that no preliminary sales were made before 293 00:32:06.340 --> 00:32:13.080 the equilibrium price was established, this does not change the results of the analysis. 294 00:32:13.080 --> 00:32:20.740 Even if, through ignorance and error, a sale was made at a price of $81 or $99, these prices 295 00:32:20.740 --> 00:32:26.540 This still will be ephemeral and temporary, and the final price for the good will tend 296 00:32:26.540 --> 00:32:29.860 to be the equilibrium price. 297 00:32:29.860 --> 00:32:36.980 Once the market price is established, it is clear that one price must rule over the entire 298 00:32:36.980 --> 00:32:37.980 market. 299 00:32:37.980 --> 00:32:43.900 This has already been implied by the fact that all buyers and sellers will tend to exchange 300 00:32:43.900 --> 00:32:47.800 at the same price as their marginal competitors. 301 00:32:47.800 --> 00:32:54.440 There will always be a tendency on the market to establish one and only one price at any 302 00:32:54.440 --> 00:32:56.720 time for a good. 303 00:32:56.720 --> 00:33:03.120 Thus, suppose that the market price has been established at 89, and that one crafty seller 304 00:33:03.120 --> 00:33:07.200 tries to induce a buyer to buy at 92. 305 00:33:07.200 --> 00:33:13.320 It is evident that no buyer will buy at 92 when he knows that he can buy on the regular 306 00:33:13.320 --> 00:33:15.360 market at 89. 307 00:33:15.360 --> 00:33:21.440 Similarly, no seller will be willing to sell at a price below the market if he knows that 308 00:33:21.440 --> 00:33:25.040 he can readily make his sale at 89. 309 00:33:25.040 --> 00:33:31.120 If for example an ignorant seller sells a horse at 87, the buyer is likely to enter 310 00:33:31.120 --> 00:33:35.400 the market as a seller to sell the horse at 89. 311 00:33:35.400 --> 00:33:41.700 Such drives for arbitrage gains, buying and selling to take advantage of discrepancies 312 00:33:41.700 --> 00:33:48.740 in the price of a good act quickly to establish one price for one good over the entire market. 313 00:33:49.540 --> 00:33:56.820 Such market prices will tend to change only when changing supply and demand conditions alter the 314 00:33:56.820 --> 00:34:04.820 equilibrium price and establish a condition of excess supply or excess demand where before 315 00:34:04.820 --> 00:34:12.740 The market had been cleared. It is evident that as the price increases, new suppliers with higher 316 00:34:12.740 --> 00:34:19.540 minimum selling prices are brought into the market, while demanders with low maximum buying prices 317 00:34:19.540 --> 00:34:26.660 will begin to drop out. Therefore, as the price decreases, the quantity demanded must always 318 00:34:26.660 --> 00:34:53.660 The tabulation of supply offered at any given price is known as the supply schedule. Similarly, the tabulation of demand is the demand schedule. 319 00:34:53.660 --> 00:35:00.740 The direct determinants of the price are the marginal buyers and sellers, while the valuations 320 00:35:00.740 --> 00:35:06.700 of the supermarginal people are important in determining which buyers and sellers will 321 00:35:06.700 --> 00:35:08.620 be at the margin. 322 00:35:08.620 --> 00:35:15.460 The valuations of the excluded buyers and sellers far beyond the margin have no direct 323 00:35:15.460 --> 00:35:18.500 influence on the price. 324 00:35:18.500 --> 00:35:24.480 Up to this point we have assumed for the sake of simplicity and clarity that each demander 325 00:35:24.480 --> 00:35:31.200 as well as each supplier was limited to one unit of the good, the price of which we have 326 00:35:31.200 --> 00:35:34.320 been concentrating on, the horse. 327 00:35:34.320 --> 00:35:40.860 Now we can remove this restriction and complete our analysis of the real world of exchange 328 00:35:40.860 --> 00:35:48.180 by permitting suppliers and demanders to exchange any number of horses that they may desire. 329 00:35:48.180 --> 00:35:53.960 It will be seen immediately that the removal of our implicit restriction makes no substantial 330 00:35:53.960 --> 00:35:55.800 change in the analysis. 331 00:35:55.800 --> 00:36:01.640 Thus, let us revert to the case of Johnson, whose minimum selling price for a horse was 332 00:36:01.640 --> 00:36:04.120 81 barrels of fish. 333 00:36:04.120 --> 00:36:08.640 Let us now assume that Johnson has a stock of several horses. 334 00:36:08.640 --> 00:36:15.040 He is willing to sell one horse, the first, for a minimum price of 81 barrels, since on 335 00:36:15.040 --> 00:36:22.080 In his value scale, he places the horse between 81 and 80 barrels of fish. 336 00:36:22.080 --> 00:36:27.240 What will be Johnson's minimum selling price to part with his second horse? 337 00:36:27.240 --> 00:36:32.720 We have seen earlier in this chapter that according to the law of marginal utility, 338 00:36:32.720 --> 00:36:39.720 as a man's stock of goods declines, the value placed on each unit remaining increases. 339 00:36:39.720 --> 00:36:47.320 Conversely, as a man's stock of goods increases, the marginal utility of each unit declines. 340 00:36:47.320 --> 00:36:55.620 Therefore, the marginal utility of the second horse, or strictly, of each horse after the first horse is gone, 341 00:36:55.620 --> 00:36:59.820 will be greater than the marginal utility of the first horse. 342 00:36:59.820 --> 00:37:06.120 This will be true even though each horse is capable of the same service as every other. 343 00:37:06.120 --> 00:37:11.120 Similarly, the value of parting with a third horse will be still greater. 344 00:37:11.120 --> 00:37:17.120 On the other hand, while the marginal utility placed on each horse given up increases, 345 00:37:17.120 --> 00:37:24.120 the marginal utility of the additional fish acquired in exchange will decline. 346 00:37:24.120 --> 00:37:33.120 The result of these two factors is, inevitably, to raise the minimum selling price for each successive horse sold. 347 00:37:33.120 --> 00:37:39.480 Thus, suppose the minimum selling price for the first horse is 81 barrels of fish. 348 00:37:39.480 --> 00:37:44.920 When it comes to the second exchange, the value foregone of the second horse will be 349 00:37:44.920 --> 00:37:50.840 greater, and the value of the same barrels in exchange will decline. 350 00:37:50.840 --> 00:37:56.740 As a result, the minimum selling price below which Johnson will not sell the horse will 351 00:37:56.740 --> 00:37:59.280 increase, say, to 88. 352 00:37:59.280 --> 00:38:06.120 Thus, as the seller's stock dwindles, his minimum selling price increases. 353 00:38:06.120 --> 00:38:10.320 Johnson's value scale may appear as follows. 354 00:38:10.320 --> 00:38:17.720 Johnson's highest value is 100 barrels of fish, followed by 99 barrels of fish, followed 355 00:38:17.720 --> 00:38:26.660 by a fourth horse, followed by 98 barrels of fish, followed by 97 barrels of fish, followed 356 00:38:56.660 --> 00:39:02.600 Followed by eighty-seven barrels, followed by eighty-six barrels, followed by eighty-five 357 00:39:02.600 --> 00:39:20.900 barrels, followed by eighty-four barrels, followed by l 358 00:39:20.900 --> 00:39:29.140 The selling prices are 81, 88, 95 and 99 barrels of fish. 359 00:39:29.140 --> 00:39:36.540 On the basis of this value scale, Johnson's own individual supply schedule can be constructed. 360 00:39:36.540 --> 00:39:45.820 He will supply 0 horses up to a price of 80, 1 horse at a price between 81 and 87, 2 horses 361 00:39:45.820 --> 00:39:54.760 With the price between $88 and $94, three horses at a price of $95 to $98 and four horses 362 00:39:54.760 --> 00:39:58.160 at a price of $99 and above. 363 00:39:58.160 --> 00:40:01.940 The same can be done for each seller in the market. 364 00:40:01.940 --> 00:40:08.700 Where the seller has only one horse to sell, the supply schedule is constructed as before. 365 00:40:08.700 --> 00:40:15.120 It is clear that a market supply schedule can be constructed simply by adding the supplies 366 00:40:15.120 --> 00:40:27.120 The Essentials of the Foregoing Analysis of Market Supply Remain Unchanged 367 00:40:45.120 --> 00:40:46.120 9. 368 00:40:46.120 --> 00:40:51.960 The fact that it is one man that is supplying the new units, rather than different men, 369 00:40:51.960 --> 00:40:55.280 does not change the results of the analysis. 370 00:40:55.280 --> 00:41:02.440 What it does is to reinforce the rule that the supply must always remain unchanged or 371 00:41:02.440 --> 00:41:06.160 increase, with an increase in price. 372 00:41:06.160 --> 00:41:11.720 For in addition to the fact that new suppliers will be brought into the market with an increase 373 00:41:11.720 --> 00:41:16.720 The same supplier will offer more units of the good. 374 00:41:16.720 --> 00:41:30.720 Thus the operation of the law of marginal utility serves to reinforce the rule that the supply cannot decrease at higher prices, but must increase or remain the same. 375 00:41:30.720 --> 00:41:34.720 The exact converse occurs in the case of demand. 376 00:41:34.720 --> 00:41:39.960 Suppose that we allow buyers to purchase any desired number of horses. 377 00:41:39.960 --> 00:41:46.800 We remember that Smith's maximum buying price for the first horse was 100 barrels of fish. 378 00:41:46.800 --> 00:41:52.420 If he considers buying a second horse, the marginal utility of the additional horse will 379 00:41:52.420 --> 00:41:58.080 be less than the utility of the first one, and the marginal utility of the same amount 380 00:41:58.080 --> 00:42:02.320 of fish that he would have to give up will increase. 381 00:42:02.320 --> 00:42:09.260 If the marginal utility of the purchases declines as more are made, and the marginal utility 382 00:42:09.260 --> 00:42:16.300 of the good given up increases, these factors result in lower maximum buying prices for 383 00:42:16.300 --> 00:42:18.720 each successive horse bought. 384 00:42:18.720 --> 00:42:26.720 Thus, Smith's value scale might appear as follows, Smith's highest value 102 barrels 385 00:42:26.720 --> 00:42:28.720 The Theory of Money and Credit 386 00:43:26.720 --> 00:43:30.720 An individual demand schedule for Smith can be constructed. 387 00:43:30.720 --> 00:43:35.720 Smith will demand four horses at a price of 83 and below, 388 00:43:35.720 --> 00:43:43.720 three horses at a price of 84 to 89, two horses at a price of 90 to 94, 389 00:43:43.720 --> 00:43:52.720 one horse at a price of 95 to 100, and zero horses at a price of 101 or over. 390 00:43:52.720 --> 00:43:58.720 Such individual demand schedules can be made for each buyer on the market. 391 00:43:58.720 --> 00:44:07.720 It is evident that the effect of allowing more than one unit to be demanded by each buyer brings in the law of marginal utility, 392 00:44:07.720 --> 00:44:17.720 to reinforce the aforementioned rule that the demand must either increase or remain unchanged as the price decreases, 393 00:44:17.720 --> 00:44:25.040 for added to the fact that lower prices bring in previously excluded buyers each 394 00:44:25.040 --> 00:44:31.280 individual will tend to demand more as the price declines since the maximum 395 00:44:31.280 --> 00:44:36.240 buying prices will be lower with the purchase of more units in accordance 396 00:44:36.240 --> 00:44:42.760 with the law of marginal utility let us now sum up the factors determining 397 00:44:42.760 --> 00:44:45.800 Making Prices in Interpersonal Exchange 398 00:44:45.800 --> 00:44:52.320 One price will tend to be established for each good on the market, and that price will tend 399 00:44:52.320 --> 00:44:58.180 to be the equilibrium price, determined by the intersection of the market's supply and 400 00:44:58.180 --> 00:45:00.160 demand schedules. 401 00:45:00.160 --> 00:45:06.320 Those making the exchanges at this price will be the supramarginal and marginal buyers and 402 00:45:06.320 --> 00:45:12.760 and The Seller's, while the less capable or sub-marginal will be excluded from the sale 403 00:45:12.760 --> 00:45:18.440 because their value scales do not permit them to make an exchange, their maximum buying 404 00:45:18.440 --> 00:45:23.800 prices are too low, or their minimum selling prices too high. 405 00:45:23.800 --> 00:45:29.180 The market supply and demand schedules are themselves determined by the minimum selling 406 00:45:29.180 --> 00:45:36.180 prices and maximum buying prices of all the individuals in the market, the latter in total. 407 00:45:36.320 --> 00:45:49.320 are determined by the placing of the units to be bought and sold on the individual's value scales, these rankings being influenced by the law of marginal utility. 408 00:45:49.320 --> 00:45:58.320 In addition to the law of marginal utility, there is another factor influencing the rankings on each individual's value scale. 409 00:45:58.320 --> 00:46:07.320 It is obvious that the amount that Johnson will supply at any price is limited by the stock of goods that he has available. 410 00:46:07.320 --> 00:46:17.320 Thus, Johnson may be willing to supply a fourth horse at a price of 99, but if this exhausts his available stock of horses, 411 00:46:17.320 --> 00:46:23.320 no higher price will be able to call forth a larger supply from Johnson. 412 00:46:23.320 --> 00:46:29.320 At least this is true as long as Johnson has no further stock available to sell. 413 00:46:29.320 --> 00:46:36.120 Thus, at any given time, the total stock of the good available puts a maximum limit on 414 00:46:36.120 --> 00:46:40.400 the amount of the good that can be supplied in the market. 415 00:46:40.400 --> 00:46:46.500 Conversely, the total stock of the purchasing good will put a maximum limit on the total 416 00:46:46.500 --> 00:46:53.280 of the sale good that any one individual or the market can demand. 417 00:46:53.280 --> 00:46:58.720 At the same time that the market's supply and demand schedules are setting the equilibrium 418 00:46:58.720 --> 00:47:07.360 price, they are also clearly setting the equilibrium quantity of both goods that will be exchanged. 419 00:47:07.360 --> 00:47:18.560 In our previous example, the equilibrium quantities exchanged are 5 horses and 5 x 89 or 445 barrels 420 00:47:18.560 --> 00:47:22.240 Tools of Fish for the aggregate of the market.