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unit of A is equivalent in value to less than k units of B (that is, less than
a has expected and planned for). Since a enters the market expecting (and
willing) to have to sacrifice k units of B in order to be in a position to
buy one unit of A, he will waste no time seeking more advantageous terms.
He might not, in fact, discover the unexpectedly favorable terms on which
he can convert B into A until the close of the day. At the close of the day
he will certainly revise his estimate of tomorrow's relative market price
of A downward, and that of B upward.
Let us suppose that the relative market price of A is too high, and
that of B too low, so that too many people are induced to convert A into
B, as compared with those wishing to convert B into A. Then if a's error
in the estimation of prices kept him back from converting B into A3 this
would tend to accelerate somewhat the market tendency lowering the
relative price of A and raising that of B. At the original prices, some
of those wishing to sell A and buy B are disappointed. If a remained in
ignorance of the opportunities that all these people are prepared to afford
him, more of them will have been disappointed than need have been the
On the other hand, if the relative market price of A is too low, and
that of B too high, so that too many people are led to attempt to convert
B into A, a's ignorance of what is available in the market would not make
any real difference to subsequent market movements. If a had known of
the opportunities available in the market for the conversion of £ into A
and was not to be disappointed in them, someone else instead would have

been disappointed. In any event the market would proceed to price A
relatively higher, and B relatively lower, than before.12

Thus far we have been proceeding on the assumption that any pro-
spective buyer of a commodity is able, in seeking out the best possible
terms, to choose from among a number of holders of the commodity. On
this assumption, any prospective seller of the commodity deliberating upon
the price he should ask for the commodity, knows, as we have seen, that
he will only be wasting his time if he demands a price any higher than the
lowest price asked by his competitors. The possibility of one seller charg-
ing a higher price for a commodity than another seller can arise only from
ignorance on the part of one or other of the sellers or the knowledge on
the part of the first seller that some prospective buyers are ignorant of
the opportunities made available by the second seller. Under these cir-
cumstances the market process ensures that the prices charged by the differ-
ent sellers will move toward each other until the equilibrium price range
is achieved. In other words the competitive market process tends to ensure
that no seller charge a price for a commodity higher than that which the
most eager among the sellers is prepared to accept in order to sell an ad-
ditional unit of it. This state of affairs assumes, of course, that although
the initial commodity endowments of the different market participants
are not alike, nevertheless each commodity is present in significant amounts
in the endowments of a considerable number of participants.
A special case arises when a particular commodity is present each day
in the initial endowment of only one of the participants. This participant
may of course be unwilling to sell any units of this rare commodity. He
may rank each unit of it, which he possesses, higher on his subjective value
scale than any additional quantity of any other commodity. But it is
possible that he might be glad to give up some of this rare commodity in
exchange for appropriate quantities of some other commodities (and this
is of course more likely to be the case when his endowment of the rare
commodity is large, and his endowment of other commodities meager). In
this situation the participant thus favored is in a position to act as a monop-
olist with respect to the commodity he has sole possession of.13
A monopolist is in the unique position of being able to demand a price
for the monopolized commodity without paying regard to prices charged
for the commodity by other sellers, since no such other sellers exist. Al-

12 Similar analysis may be employed to work out the consequences, for the plans of a
and b respectively, of a market where the price of A is more than n times the price of B.
l3The reader may imagine a group of islanders who have divided up their island into
equal holdings, in one of which oil is discovered.

though he knows, like the sellers of any other commodity, that for each
quantity of his commodity there is a price it cannot be sold above, for
him this upper limit is not set by the actions of other sellers of this com-
modity. This upper limit is determined by the subjective valuation of
this commodity of its prospective buyers as compared with other com-
modities. It is misleading, as we shall see, to say that the monopolist is
exempt from competition, but he certainly does not have to meet the
competition of other sellers of his commodity.
The competition that the monopolist does have to meet is from the
actions of sellers of other commodities. When the monopolist asks a
particular price for his commodity, any buyer of a unit of it, with a given
set of market prices for the other commodities, must sacrifice definite
quantities of one or more of these other commodities in order to be able to
buy the unit of the monopolized commodity. The lower the prices ob-
tained by the sellers of other commodities, the larger must be the quanti-
ties of these other commodities that must be sacrificed in order to buy a
unit of the monopolized commodity. Similarly, with given prices of the
other commodities, any increase in the price per unit demanded by the
monopolist again calls for larger sacrifices of other commodities in order
to acquire a unit of the monopolized commodity.
Thus, the monopolist who is attempting to convert his initial commod-
ity endowment into the most desirable commodity bundle possible through
exchange is faced with a special problem. Like every other participant in
the market, he must make estimates of the prices that will rule in the market
for all the other commodities. But whereas other participants must make
an estimate of the market price of every commodity that they sell (one
reason for this being that these prices will set the upper limit to those
that they themselves can demand), a monopolist is not obliged nor is he
able to estimate a market price for the monopolized commodity. He must
himself set the price. He knows that too high a price will lead many
prospective buyers to exchange their own commodities for commodities
other than the monopolized one (where they are able to secure better terms).
On the other hand, it is not difficult to perceive a lower limit to the price
that the monopolist might conceivably be willing to sell any given quantity
of his commodity at. This lower limit is set for a monopolist as for anyone
else by the point at which the subjective sacrifice involved in the sale
of the given quantity of the commodity ranks higher on the seller's value
scale than the additional quantities of other commodities whose purchase
would be made possible by the sale.
No matter what price he charges, the monopolist knows that he can
sell only a smaller quantity than it would be possible to sell at a lower
price. This, by itself, might mean that he would be refusing to sell some
units of the monopolized commodity, even though he actually values the

quantities of other commodities obtainable in exchange for those units
more highly than those units themselves. On the other hand, by keeping
the price higher and thus admittedly reducing the quantity of the monopo-
lized commodity sold, the monopolist may be able to obtain more in ex-
change for the units of his commodity, which he is able to sell at the high
price, than he could obtain by selling a larger quantity at the lower price.
Of course, the competition provided by the sellers of other commodities
may be so effective that the monopolist's most advantageous course of action
must be to charge a very low price indeed. In such a case any increase
in the price would reduce the number of units sold so drastically that the
increase in price for those remaining units that can be sold is insufficient
to make up the lost revenue. The elasticity of demand for the monopo-
lized commodity is of relevance in this regard. The strength of the competi-
tion of other commodities is reflected in the elasticity of demand of the mo-
nopolized commodity at all points on the demand curve. If the demand
curve for the commodity is inelastic at any particular price-quantity point, it
will be better for the monopolist to charge a higher price rather than
that corresponding to the point. With demand inelastic at a certain point,
total revenue is greater with the smaller quantity sold at the higher price.
The particular price that the monopolist will attempt to select will permit
a quantity to be sold that yields more revenue than any other price-quantity
combination. At this stage elasticity of demand will be unitary.14
One particular feature of the monopoly situation is especially worthy
of note. The monopolist's power to force buyers to pay higher prices is
a result of his ability to restrict the quantity of the commodity that he puts
on sale. It is this feature that distinguishes the monopoly price from the
competitive price. When a seller of a commodity is competing with other
sellers of the same commodity, he is not in a position to deliberately raise
the price by holding some of the commodity off the market. Were such
a competing seller to hold back some of his commodity, his customers would
14 The optimum price decision for the monopolist can be illustrated by a diagram.
Let AR be the market demand curve for the monopolized good. This line will therefore
be the monopolist's average revenue line, and the MR line will show his marginal reve-

Figure 7-1
nue. At the point P, marginal revenue is zero (and the point elasticity of demand uni-
tary). At this point the monopolist will be maximizing his revenue. Since he has no
costs (and we are ignoring his own demand for the good), this point is therefore the best
for him.

certainly not be prepared to pay higher prices in order to secure their share
of the reduced supply. They would simply buy elsewhere. But when a
monopolist holds back part of a supply of his commodity (even though
he might be able to sell all of it at a low price, and even though the supply
thus held back is perhaps of no use at all to him personally), he may be
in a position to drive up the price.13 Those most eager to obtain the com-
modity now find that in order to bid it away from other less eager
competing buyers, they must offer prices these other buyers are unable or
unwilling to match. The degree to which a monopolist may be able to
force up the price in this way, depends, as we have seen, on the degree
of competition provided by other commodities, reflected in the elasticity
of demand for the monopolized commodity.
So long as the number of monopolized commodities is not large, as
compared with the total number of commodities on the market, the exist-
ence of monopoly elements in an exchange market does not seriously upset
the analysis of this chapter. Monopoly elements will distort somewhat
both the pattern of prices of the various commodities and the quantities
of them exchanged in the market, but the logic of price determination is
not fundamentally altered. The results are different, but the market proc-
ess operates in an essentially unaltered manner. When we consider the
case of a monopolist-producer, we will return once again to an analysis
of the effects upon the efficiency of the entire market system that are intro-
duced by monopoly elements.

The analysis of this chapter places us in a position to understand the
seething agitation of changing prices that can be expected in any large pure
exchange market, even in the absence of any changes in initial commodity
endowments or changes in tastes.
Each participant in the market will be constantly scanning the latest
prices of the various commodities in making his market plans for the day.
Market participants will be constantly revising their estimates of the prices
they must expect to pay when buying the various commodities, and the
prices they can expect to obtain by selling them, in the light of their ex-
An interesting special case is where the monopolized good is present so plentifully
in the monopolist's endowment, that it would, under competitive conditions, have been
a free good. If the plentiful endowment had been distributed among the endowments
of many participants, none of them could have gained command over other goods
through exchange, by virtue of ownership of this plentifully endowed commodity. Un-
der competition there is so much of the commodity that even the lowest positive price
would bring forth a supply of it on the market in excess of the aggregate quantity that
participants wish to buy. The monopolist, by restricting the quantity that he offers to
the market, may be able to turn the free good into one that commands a positive price.

periences, and disappointments, in yesterday's market. In earlier sections
of this chapter we examined the kind of logic entailed in making decisions
concerning two commodities. In a market with many goods, the same
logic will be constantly applied to every possible pair of commodities and
every possible pair of groups of commodities.
The prices ruling on any one day will reflect the estimates for that day,
on the part of the market participants, of the entire set of relative market
prices. With these estimates in mind, each participant will seek to trans-
form his initial commodity endowment into the most desirable bundle of
commodities he can obtain by buying and selling in the market. His plans
will be made according to the logic of consumer choice discussed in earlier
chapters. He will go out into the market with a plan calling for the pur-
chase of definite quantities of specified commodities, and the sale of quanti-
ties of other commodities, all at the expected prices. These plans of the
various market participants, made on the basis of imperfect and fragmentary
knowledge, are almost certain to fail to mesh completely. There will in-
evitably be disappointed plans, as well as the realization that inferior op-
portunities have been seized at the expense of superior opportunities that
remained unknown.
These disappointments and discoveries will lead to a new set of esti-
mates for the following day and a new set of buying and selling plans.
This kind of agitation will proceed for as long as the set of prices expected
to rule in the market is in anyway different from those that fulfill the con-
ditions for the equilibrium market. Whenever the prices are such that
the relative values of any two commodities, A and B, induces too many
people to convert A into B, as compared with those wishing to convert B
into A, conditions exist that will bring about a readjustment in prices in
the direction of reducing previous "disappointments."
In this process of market agitation the market participants with the
keenest judgment of market conditions will be the most successful. Even
though in this chapter we are not allowing any commodities to be produced,
and are not permitting any activity to be based on speculation, there is still
a range within which the entrepreneur can exercise his peculiar function.
Whenever one man has superior knowledge of what is going on in the vari-
ous sections of the market, he is in a position to buy and sell more advanta-
geously than others. He will be able to buy the goods he wishes to buy
where prices are lowest, and sell those he wishes to sell where prices are high-
est. When his superior knowledge suggests that the same good is available
at different prices in the same market, he will engage in arbitrage to take ad-
vantage of the price differential. In this way some participants will buy
goods in the market only to resell them immediately at a profit. By this
kind of activity the superior knowledge of the entrepreneur is placed at the
disposal of all the participants in a market. More and more people dis«

cover that he is willing to pay higher-than-usual prices in those market areas
where the price of a good is low; more and more others discover that he is
willing to sell for lower-than-usual prices in those market areas where the
price of a good is high. The competition of all the market participants,
each seeking the best opportunities available in the market, places pressure
upon each of them to secure the most accurate market information and, in
turn, to supply the market with the most attractive opportunities possible.
Only in the absence of market equilibrium, and in the state of incom-
plete knowledge on the part of market participants, does market agitation
and entrepreneurial activity emerge. Market equilibrium, and the set of
conditions necessary for the existence of equilibrium prices, represent a
mental construction whose most useful purpose is to help understand the
nature of the market activity that is characteristic of the absence of equi-
librium. Sometimes expressions are used by economists suggesting that the
market situation satisfying the conditions for equilibrium marked out by a
given set of data is achieved, more or less automatically and immediately,
by the mere existence of these data. Such a notion would overlook the
process whereby equilibrium could conceivably be reached. It would be-
stow upon the state of equilibrium an emphasis that hardly fits into the
analysis of any imaginable real world where the basic data of the market,
tastes and initial commodity endowments, are themselves subject to drastic
changes over time.
This becomes immediately apparent when one does, in fact attempt to
apply the analysis of this chapter to a world of change. Thus far we have
been employing "static" assumptions. We have been assuming that each
day each participant is endowed with the same initial commodity bundle
as yesterday; that each day each participant, regardless of past experiences,
has the same tastes as yesterday. The only difference between one market
day and the following one was that plans made for trading during the latter
day are based on estimates of prices learned through the market experience
of the previous day. Agitation in the market was caused by rapid changes
in plans made by the various participants as market experience steadily
spread more information and repeatedly indicated fresh opportunities for
profitable trade. When one superimposes upon this already complicated
picture a particular pattern of unforeseen changes in initial commodity-
endowments and in individual tastes, things become far more complex.
With changes in incomes and tastes, market agitation proceeds from
two analytically distinct sets of causes. First of all, as in our previous
analysis, participants each day will revise their trading plans under the
impact of the disappointments and other market experiences of the previous
trading day. In addition, participants will be revising their plans simply
because they face a new set of conditions. They find themselves with a
scale of values, with respect to additional quantities of the various commodi-

ties, different from yesterday, because they no longer have the same tastes
and attitudes as yesterday, and because they find themselves in possession
of initial stocks of the various commodities different from yesterday. Any
market changes that might have brought trade closer to the equilibrium
pattern, from the standpoint of yesterday's income and tastes, is continually
disrupted by the emergence today of a totally different structure of income
and tastes. Long before equilibrium conditions appropriate to the data
of any one day have been attained, the market is faced with data calling for
a totally different set of equilibrium conditions.
In addition, once we admit changes in tastes and income into our
analysis, we must include the possibility that market participants, in plan-
ning their buying and selling for the day, make guesses concerning the
changes, in the incomes and tastes of other people, that might have taken
place. In other words participants might not rely on the knowledge gained
during the market experience of the previous day. In this way a new
source of imperfection in market knowledge is opened up; namely, that due
to inability to correctly gauge changes in tastes and incomes. On the other
hand, a new range for entrepreneurial activity is opened at the same time.
Those with a keener sense of the tastes and attitudes of others, and those
with swifter access to relevant information, are in a position to foresee more
accurately the set of market prices that will emerge on a particular day and
will be able to profit by exploiting their superior knowledge.
All this suggests that in any real world where static assumptions are
useful only as preliminary tools, the market will be characterized by contin-
ual agitation, a constant seething and absence of placidity. By focusing our
attention on the data relevant for a particular day, we can understand the
changes likely to be generated in the market purely by these data, and then
we can proceed to examine the likely consequences upon individual market
plans generated by the impact of a particular change in tastes or incomes.
In this kind of analysis, the static analysis making up this chapter has its
most fruitful applications.16

Chapter 7 examines the market process as it would proceed in an
economy where no production is possible. The process is based on the
interplay of numerous individual consumer decisions (each consumer being
naturally endowed with some bundle of commodities). The analysis of the

16 In the appendix dealing with multi-period planning, the reader will find (see pp.
311 ft) an outline of how the market process would work in a pure exchange economy
when each of the participants is free to make decisions to transfer consumption from one
period of time to later periods.

market process in such a pure exchange economy will facilitate the analysis
in later chapters of more complex and realistic models.
In the market each individual finds it necessary to compete with others.
He is forced either as buyer or seller to offer opportunities to the market
that are no less attractive than those made by others.
The competitive process can be most easily analyzed by reference to the
market for a single commodity; by imagining what would occur if knowl-
edge were perfect, it is possible to state immediately the conditions for
equilibrium in such a market. The detailed analysis of why these conditions
and no others can be consistent with equilibrium represents the basis for all
further market analysis.
When the perfect-knowledge assumption is abandoned, further analysis
shows how initial buying and selling decisions that fail to dovetail give rise
to "disappointments" and thus lead to revised decisions that are gradually
adjusted toward the equilibrium pattern.
Still further analysis extends the range of inquiry to the market process
involving numerous consumer goods. This case is considerably more
complicated than the preceding one. Nevertheless, once again the state
of affairs that would result from universally perfect knowledge is shown to
be the equilibrium situation for the multi-commodity market. Detailed
analysis shows how the absence of perfect knowledge brings about "mis-
taken" decisions, and how the disappointments suffered as a consequence
convey the information required for revisions of these decisions in the
"right" direction.
By imagining cases where one or more of the commodities appear in
the endowments of only one market participant, it is possible to analyze
how the market process operates in the presence of monopoly. The analysis
of the decisions of a monopolist in a world without production serves as an
introduction to the more complicated monopoly cases to be considered later.
The analysis of a pure exchange economy clarifies why a market may
be expected to be in constant agitation as a consequence of the acquisition
of new knowledge. Moreover it becomes clear, in particular, how such
agitation is set in motion by the activities of entrepreneurs who become
aware, more swiftly than others, of the most advantageous opportunities
Suggested Readings
Böhm-Bawerk, E. v., Capital and Interest, Vol. 2, Positive Theory of Capital,
Libertarian Press, South Holland, Illinois, 1959, Bk. 3, Part B, Chs. 2, 3.
Wicksteed, P. H., Common Sense of Political Economy, Routledge and Kegan Paul
Ltd., London, 1933, pp. 493-526.
Wicksell, K., Lectures on Political Economy, Routledge and Kegan Paul Ltd., Lon-
don, 1951, Vol. 1, Part 1.

In this appendix a diagrammatic exposition is presented of the factors
that determine the equilibrium price of a single non-producible commodity
in a competitive market. This exposition will at the same time clarify the
statement that price is determined by supply and demand.



K" X

Figure 7-2
In Figure 7-2, the horizontal axis measures quantities of the commodity,

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