?hanges in price
They reveal that the equilibrium is established and maintained by the agency of changes in price, and they enable us to lay it down as perhaps the most important thing that can be said about the price of anything that it will tend to be such as will equate demand and supply. But that is not all that they reveal. They reveal also the extreme dependence of both demand and supply upon price. Now this is a fact which it is most important to realize vividly.
It is apt to be obscured by customary modes of speech. In ordinary times the prices of most commodities and services do not change by very much, unless indeed over a long period of years; the amounts demanded and supplied may therefore seem to maintain a fairly constant level; and we may be tempted to speak of Great Britain producing so many million tons of coal, or America consuming so many millions of motor-cars per annum, almost as though these quantities were independent of price considerations.
But we should never forget that there is no service or commodity produced by man, however essential it may seem the demand for or the supply of which might not be reduced to nothing, if the price were sufficiently raised on the one hand, or lowered on the other.
How easy it is sometimes to forget this simple truth may be seen from the mistake so commonly made of supposing, because the peoples of Central Europe were left, on the cessation of the war, starving and destitute of the means of life and the materials of work, that they must necessarily become heavy purchasers of imported goods; without pausing to consider whether the prices were such as they could afford to pay.
The laws enunciated in the preceding chapter constitute the framework and skeleton of all economic analysis; but they do not carry us very far. It is only through the agency of these laws that any influence can affect the price of anything: but what influences may so affect it is a question which we have still to consider. Let us begin with ordinary commodities and ask ourselves, in the light of experience and common sense, upon what factors their price seems mainly to depend?
Two factors spring to mind at once; their cost of production and their usefulness. As regards the former, the case seems clear enough. We may indeed sometimes grumble that the price of this or that commodity is unconscionably high in comparison with its cost; but this only goes to show that we conceive a relation between price and cost as the normal, governing rule. If one commodity cost only a half as much to produce as another, we should think that something had gone very wrong indeed, if the former commodity were sold for the higher price.
But, when we turn to the usefulness of commodities, the case is not so clear. Usefulness has some connection with price, so much is certain; for an entirely useless thing, fit only for the dust-bin (and known to be such, it may be well to add) will fetch no price at all, however costly it may be to produce. But it is not easy to express the connection in quantitative terms. It seems reasonable enough to say that the prices of commodities are roughly proportionate to their costs of production.
But directly we contemplate saying a similar thing of their usefulness, we are pulled up short. As we look round the world, and enumerate the commodities which by common consent are the most useful, salt, water, bread, and so forth, the striking paradox presents itself that these are among the cheapest of all commodities; far cheaper than champagne, motor-cars or ball-dresses, which we could very well get on without.
As things are, of course, a ball dress, or a motor-car costs more to produce than a loaf of bread or a packet of salt; and the common-sense explanation of the paradox seems, therefore, to be that the cost of production is a more weighty influence than the usefulness, or utility, as we will henceforth call it (so as to include the satisfaction we derive from not strictly useful things).
We are thus tempted to conclude that, provided a commodity possesses some utility, its price will be determined by the cost of production, the degree of utility being unimportant.
References: Davidson, P. , & Smolensky, E. (1964). Aggregate supply and demand analysis. New York: Harper & Row. Klein, L. R. (1983). The economics of supply and demand. The Royer lectures. Baltimore, Md: Johns Hopkins University Press. Lee, A. (2006). Supply and demand. New York: Blue Note Records.