Market Theory and the Price System. Israel M. Kirzner

“in the same market” (that is, if they are each in contact with the other and aware of the other’s relative ranking). This is so because it will benefit each man to give some of the good he values less for some of the good he values more. A state of rest, where both men, although in the same market, do not barter, can exist therefore only when both men rank both goods in the same order on their individual scales of value. But if this is so for two goods, it is so for any two goods. Thus, for two men to be in a state of rest with respect to each other, each must rank the marginal quantities of all the goods, which both possess, in exactly the same order as does the other.

      Moreover, if this is the condition for absence of exchange between two men, it must be so also for any two men. Thus, for a market to be at rest, each participant in a market must rank each one of the goods he possesses in exactly the same order of significance, at the margin, as does every other participant in the market.

      To put the same proposition in a different and more useful form, in any market a tendency will exist for each participant to barter in the marketplace so long as the relative marginal utilities to him of all the goods he possesses is in anyway different from those of any other participant with respect to those that he possesses. As each participant exchanges, the marginal utility of given quantities of the goods that he sacrifices rises (in accordance with the law of diminishing utility), while that of given quantities of the goods that he acquires correspondingly falls. The process of exchange thus raises those marginal utilities that had been relatively low (that is, of the goods that the owners for this reason wished to sell) and lowers those marginal utilities that had been relatively higher (that is, of the goods that the owner for this reason wished to buy). Hence, as the exchange process continues, the value scale of each member of the market tends toward consistency with that of every other member, with respect to the goods possessed by each member.

      As men’s tastes change, as for various reasons the quantities and kinds of the commodities and services each man possesses change, the relative marginal utilities of the goods he possesses alter for each participant in the market and thus, again and again, diverge from the rankings of other participants. There is thus constant recurrence of opportunities for each participant to exchange profitably.

      The rates exchanges will take place at, of course, are closely bound up with the degree of divergence between the value scales of different participants. These are matters that will concern us in later chapters. Our discussion has been carried on in barter terms consistent with our assumption that exchange is carried on with the assistance of a medium of exchange that only facilitates, and in no way distorts, the expression by men of their relative valuations of real goods and services.

       SUMMARY

      Acting men, in choosing between available alternatives, arrange them in order of preference. The scale of values made up in this way indicates the relative marginal utilities of different specific quantities of different goods and services. Men act so as to replace a good of lower marginal utility by one of higher marginal utility.

      The marginal utility of successively available additional units to a stock of a commodity steadily diminishes, other things being equal. This is the law of diminishing marginal utility.

      Goods are either related or unrelated. Related goods may be either complementary to one another or substitutes (rivals) for one another. Complements are goods whose marginal utility rises, other things being the same, as the quantity possessed of the others increases. Substitutes are goods whose marginal utility falls, other things being the same, as the quantity of the others increases. Unrelated goods are those whose marginal utilities are unaffected by the quantities possessed of the other.

      The marginal utility view is able to resolve the classical paradox concerning the relative values of diamonds and water. The utility concept is subjective and relative in character. The utility of a good refers to nothing inherent in the good itself and is meaningless unless it refers to a comparison with the utility of something else. Utility is an ordinal concept. No cardinal “units” of utility are implied in utility theory. “Marginal utility” is therefore to be interpreted not as the “rate of change of total utility,” but as the (total) utility afforded by an increment of a good or service.

      The utility theory provides the framework to understand exchange between market participants. Exchange will take place wherever the value scale rankings of two goods possessed by one man are different for him than the corresponding ranking for another man. In a market there is therefore a constant tendency for participants to exchange so that the value scale of each represents rankings identical with that of every other participant, for goods possessed by each of them.

      SUGGESTED READINGS

      Wicksteed, P. H., The Common Sense of Political Economy, Routledge and Kegan Paul Ltd., London, 1933, pp. 1–125.

      Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949, pp. 119–127.

      Rothbard, M., “Toward a Reconstruction of Utility and Welfare Economics,” in On Freedom and Free Enterprise, D. Van Nostrand Co., Inc., Princeton, New Jersey, 1956, pp. 232–243.