Introduction to Economic Reasoning - Chapter 8: Money: Part 1

The discussions about labor and price controls have depended upon the same basic principles of economics identified in earlier chapters.

One of these principles is that if two parties expect to benefit from a trade, they will trade. If one or both parties do not expect to benefit, there will be no trade. If and only if both parties expect to benefit will a trade take place. An actor chooses to trade because he believes doing so will maximize his utility compared to other alternatives. (Remember utility does not necessarily mean psychological satisfaction).

A trade will not take place if at least one of the actors does not want what the other has. If the other actor, however, finds something else his trading partner wants, a trade will take place. In other words, just because at least on actor does not want what the other has does not mean an exchange won’t take place. It will take place of this other actor finds what his trading partner wants.

The implication of the forgoing discussion is that one may value a good more than some other good not for the benefits the good itself provides, but for the other goods for which that good can be exchanged. When one trades for a good in order to trade that good for another good, he is engaging in indirect exchange.

An indirect exchange can become even more complicated if it takes two, three or more exchanges in order to obtain a good that one wants to consume.

Indirect exchanges are problematic. First, an actor must find other actors that want he has and have what his potential trading partners want. This is known as a ‘Double Coincidence of Wants.’ Second, an actor in a long series of indirect exchanges may find guess wrong and exchange for something that other actors do not want. Finally, even if an actor guesses correctly, the process of many indirect exchanges takes time and is inefficient. Thus, involved indirect exchanges involve transaction costs.

An actor might avoid transaction costs by engaging in direct exchanges only. In this case, though, the actor would have to produce something that everyone wants. If they produce something that few people want they will not be as successful.

If someone who produces goods that few people want is able to trade the goods they produce for goods many people want, they will then be better able to trade for other goods. They will reduce the occurrence of a double coincidence of wants, and thus reduce their transaction costs. They will, however have to pay a ‘premium’ to obtain goods in greater demand. The holder of goods in greater demand must be paid more in order to give up such goods as they are more valuable. Someone who produces something more in demand, however, would not have to pay as high a premium for the good in greater demand.

A good, such us an orange, will increase in value should it become regarded as a means of exchanging for other goods. Initially a good will begin by being valued for the benefits its consumption brings the actor. Should the actor then see that it is also demanded by other actors as a means of exchange for other goods, its value will increase. Should this value as means of exchange become even more widely dispersed, its value will still increase even more. Dr. Gordon stresses that all one need remember is that a good that people think will be accepted readily in exchange will gain in value.

When certain goods are perceived as more high valued than others in exchange, they will become even more highly demanded by other actors. Their value will exceed those of other goods that had also been used in exchange, which will now be valued less. This process is known as convergence.

Note that the process of convergence does follow from praxeology. Praxeology tells us that people choose their highest preference. If a good can better help them fulfill a preference, an actor will choose it over other goods.