2.07. Speculation and Supply and Demand Schedules

0:007. Speculation and Supply and Demand Schedules We have seen that market price is, in the final analysis, determined by the intersection of the supply and demand schedules. It is now in order to consider further the determinants of these particular schedules. Can we establish any other conclusions concerning the causes We remember that at any given price the amount of a good that an individual will buy or sell is determined by the position of the sale good and the purchase good on his value scale. He will demand a good if the marginal utility of adding a unit of the purchase good is greater Let us further analyze the value scales of the buyers and sellers.

1:08We have seen that the two sources of value that a good may have are direct use value and Exchange Value, and that the higher value is the determinant for the actor. An individual, therefore, can demand a horse in exchange for one of two reasons, its direct use value to him, or the value that he believes it will be able to command in exchange. If the former, then he will be a consumer of the horse's services. If the latter, then he purchases in order to make a more advantageous exchange later. Thus suppose in the foregoing example that the existing market price has not reached equilibrium, that it is now at 85 barrels per horse.

1:56Many demanders may realize that this price is below the equilibrium, and that therefore The Theory of Money and Credit The Theory of Money and Credit The Theory of Money and Credit

3:02Let us suppose the highly unlikely event that all demanders and suppliers are able to forecast exactly the final equilibrium price. What would be the pattern of supply and demand on the market in such an extreme case? It would be as follows. At a price above equilibrium, say 89, no one would demand the good, and suppliers would supply their entire stock. At a price below equilibrium, no one would supply the good, and everyone would demand as much as he could purchase. Such unanimously correct forecasts are not likely to take place in human action.

3:49But this case points up the fact that the more this anticipatory or speculative element enters into supply and demand, the more quickly will the market price tend toward equilibrium. Obviously, the more the actors anticipate the final price, the further apart will be supply and demand at any price differing from equilibrium, the more drastic the shortages The Theory of Money and Credit

4:46Do you assume that the equilibrium price will be lower than it actually is? Does this change the equilibrium price or obstruct the passage to that price? Suppose that the intersection of the supply and demand schedules will be at 85 instead of 89. It is clear that this will be only a provisional resting point for the price. As soon as the price settles at 85, the demanders see that shortages develop at this price, that they would like to buy more than is available, and the overbidding of the demanders raises the price again to the genuine equilibrium price. The same process of revelation of error occurs in the case of errors of anticipation by suppliers and thus the forces of the market tend inexorably toward the establishment of the genuine equilibrium price, undistorted by speculative errors, which tend to reveal themselves and be eliminated.

5:49As soon as suppliers or demanders find that the price that their speculative errors have set is not really an equilibrium, and that shortages and or surpluses develop, their actions tend once again to establish the equilibrium position. The actions of both buyers and sellers on the market may be related to the concepts of psychic revenue, profit and cost. Remember that the aim of every actor is the highest position of psychic revenue, and thus the making of a psychic profit compared to his next best alternative, his cost. Whether or not an individual buys depends on whether it is his best alternative with his given resources, in this case, his fish.

6:40His expected revenue in any action will be balanced against his expected cost. his next best alternative. In this case, the revenue will be either a. the satisfaction of ends from the direct use of the horse, or b. expected resale of the horse at a higher price, whichever has the highest utility to him. His cost will be either a. the marginal utility of the fish given up in direct use, or b. possibly the exchange value of the fish Fish for some other good, or c. the expected future purchase of the horse at a lower price, whichever has the highest utility.

7:26He will buy the horse if the expected revenue is greater. He will fail to buy if the expected cost is greater. The expected revenue is the marginal utility of the added horse for the buyer. The expected cost is the marginal utility of the fish given up. For either revenue or cost, the higher value in direct use or in exchange will be chosen as the marginal utility of the good. Now let us consider the seller. The seller, as well as the buyer, attempts to maximize his psychic revenue by trying to attain a revenue higher than his psychic cost, the utility of the next best alternative he will have to forgo in taking his action.

8:14The seller will weigh the marginal utility of the added sale good, in this case, fish, against the marginal utility of the purchase good given up, the horse, in deciding whether or not to make the sale at any particular price. The psychic revenue for the seller will be the higher of the utilities stemming from from one of the following sources a the value in direct use of the sale good the fish or b the speculative value of re-exchanging the fish for the horse at a lower price in the future the psychic revenue for the seller will be the higher of the utilities stemming from one of the following sources a the value in direct use of the sale good the fish or B. The speculative value of re-exchanging the fish for the horse at a lower price in the future.

9:13The cost of the seller's action will be the highest utility foregone among the following alternatives. A. The value in direct use of the horse given up. Or B. The speculative value of selling at a higher price in the future. For C, the exchange value of acquiring some other good for the horse. He will sell the horse if the expected revenue is greater. He will fail to sell if the expected cost is greater. We thus see that the situations of the sellers and the buyers are comparable. Both act or fail to act in accordance with their estimate of the alternative that will yield them the highest utility.

9:59It is the position of the utilities on the two sets of value scales of the individual buyers and sellers that determines the market price and the amount that will be exchanged at that price. In other words, it is for every good, utility and utility alone that determines the price and the quantity exchanged. Utility and utility alone determines the nature of the supply and demand schedules. It is therefore fallacious to believe, as has been the popular assumption, that utility and costs are equally and independently potent in determining price. Cost is simply the utility of the next best alternative that must be foregone in any action, and it is therefore part and parcel of utility on the individual's value scale.

10:57This cost is, of course, always a present consideration of a future event, even if this future is a very near one. Thus, the foregone utility in making the purchase might be the direct consumption of fish that the actor might have engaged in within a few hours, or it might be the possibility of exchanging for a Cow, whose utility would be enjoyed over a long period of time. It goes without saying, as has been indicated in the previous chapter, that the present consideration of revenue and of cost in any action is based on the present value of expected future revenues and costs. The point is that both the utilities derived and the utilities foregone in any action refer will occur to some point in the future, even if a very near one, and that past costs play no role in human action, and hence in determining price.

12:00The importance of this fundamental truth will be made clear in later chapters.