Principles of Economics — The Theories of the Commodity and Money


This is the fourth and last part of the series in which I summarize Carl Menger's 'Principles of Economics'. It captures the sixth, seventh and eight chapter of the book, and builds the theoretical framework around the commodity and of money. For previous summaries, see here, here and here.

Chapter VI - Use Value and Exchange Value

1. The Nature of Use Value and Exchange Value

When people become more aware of their economic interests and begin to exchange goods for goods, a situation develops where possession of economic goods gives the possessors the power to obtain goods of other kinds by means of exchange. When this occurs, it is no longer necessary that they have command of the particular goods that are directly necessary for the satisfaction of their particular needs.

As we know, to have value, a good must assure the satisfaction of needs that would not be provided for if we did not have it at our command. But whether it does so in a direct or in an indirect (by exchanging it) manner is irrelevant when the existence of value is in question. We call value in the first case use value, and in the second case we call it exchange value.

2. The Relationship Between the Use Value and the Exchange Value of Goods

In an isolated household economy, economic goods either have use value or they have no value at all to the economizing individuals possessing them. But even in a society in which there is an active commerce, economic goods can be observed that have no exchange value to the economizing individuals possessing them, even though their use value to these same persons is certain. Menger gives a few examples: The crutches of a peculiarly deformed person, notes that can be used only by the writer who made them, family documents, and many similar goods. In a developed civilization, the opposite relationship occurs frequently. The spectacles and optical instruments kept in stock by an optical goods dealer usually have no use value to him, just as surgical instruments have none to the persons who produce and sell them, and as books in foreign languages that can be understood only by a few scholars have none to booksellers. But all these goods ordinarily have an exchange value to these persons. In all cases in which a good has both use value and exchange value to its possessor, the economic value is the one that is the greater.

3. Changes in the Economic Center of Gravity of the Value of Goods

One of the most important tasks of economizing individuals is that of recognizing the economic value of goods - whether their use value or their exchange value is the economic value. It is clear that anything that diminishes the use value of a thing to us may cause the exchange value of the good to become the economic form of value, and that anything that increases the use value of a good to us can have the effect of pushing the significance of its exchange value into the background. An increase or decrease in the exchange value of a good will, other things being equal, have the opposite effect. The main causes of changes in the economic form of value are, according to Menger:

(1) Changes in the importance of the particular satisfaction that a good provides to the economizing individual who has it at his command, if its use value to him is increased or decreased by the change. If a person loses his taste for tobacco or wine, for example, the stock of tobacco or wine in his possession will take on an exchange value for him instead.

(2) Changes in the properties of a good can shift the center of gravity of its economic importance if its use value to the possessor is altered by the change while its exchange value either remains unchanged or does not rise or fall to the same extent. As an example, Menger mentions that clothes, horses, dogs, coaches, and similar objects, usually lose their use value to wealthy people almost entirely if they have an externally visible defect. Their exchange value, although also decreased, increases in importance since the loss in their use value is usually greater to these persons than the loss in their exchange value. Another example: innkeepers and grocers can employ foods having some external defect for their own consumption, since the defect in these goods causes them to lose their exchange value almost completely while their use value often remains more or less the same.

(3) Changes in the quantities of goods at the disposal of economizing individuals can of course shift the center of gravity if its economic importance. An increase in the quantity of a good a person has, almost always causes the use value of each unit of the good to him to diminish and its exchange value to become the more important. For decreases, the opposite relationship holds. Example: The first orange in possession will often have a dominant use value, while the tenth might have a dominant exchange value, and can thus be exchanged for an apple even though an individual prefers oranges to apples.

Chapter VII- The Theory of Commodity

1. The Concept of the Commodity in Its Popular and Scientific Meanings

In an isolated household economy the productive activity is directed to the production of goods necessary for its own consumption. The very nature of such an economy means the production of goods for the purpose of exchange is not occurring. Any division of labor remains very narrowly limited in the confines of the isolated households.

Menger argues that a people can be considered to have taken its first step in economic development when persons who have acquired a certain skill offer their services to society and work up the raw materials of other persons for compensation. An artisan may for example accept bits of clay from customers to produce bowls for payment. A further step in the path of economic development can be regarded as having been taken when the artisans themselves begin to procure the raw materials for their products, even though they still produce these products for the consumers on demand.

Production on demand takes time, and so that drawback has led to the production of goods for uncertain future sale, where, in our example, the artisan is keeping bowls in stock in order to be able to meet requirements at once as they arise. It is this method of supplying society that in the end leads to factories on the one side and to the purchase of ready-made, standardized commodities by consumers on the other side. Products that the producers or middlemen hold in readiness for sale are called commodities. In ordinary usage the term is limited in its application to movable tangible goods (with the exception of money).

The higher the level of civilization attained by a people and the more specialized the production of each economizing individual becomes, the wider become the foundations for economic exchanges and the larger become the absolute and relative amounts of those goods that at any time have commodity character, until finally the economic gains that can be derived from the exploitation of this relationship become large enough to call forth a special class of economizing individuals who take care of the exchange operations for society and who are reimbursed for this with a part of the gains from trade. These are of course the traders and merchants, and now in modern times, simply store owners.

Commodity-character is nothing inherent in a good, no property of it, but merely a specific relationship of a good to the person who has command of it. A good ceases to be a commodity if the economizing individual possessing it gives up his intention of disposing of it, or if it comes into the hands of persons who do not intend to exchange it further but to consume it. Menger gives a few examples: the hat that a hatter, and the silk cloth that a silk merchant, exhibit for sale in their shops are examples of commodities, but they immediately cease to be commodities if the hatter decides to use the hat himself and the silk merchant decides to give the silk cloth as a present to his wife. Packages of sugar and oranges are commodities in the hands of a grocer, but they lose their commodity-character as soon as they have passed into the hands of consumers. Commodity-character is therefore not only no property of goods but usually only a transitory relationship between goods and economizing individuals. As soon as they have reached their economic destination they cease to be commodities and become consumption goods. But where this does not happen, as is the case very frequently, for example, with gold, silver, etc., especially in the form of coins, they continue to be "commodities".

Two things are evident from this, according to Menger: (1) the frequently-stated proposition that money is a "commodity" contributes nothing at all toward explaining the unique position of money among commodities; (2) the view of those who deny the commodity character of money because "money as such, especially in the form of coin, does not serve any consumption purpose" is untenable simply because the same argument can be advanced against the commodity-character of all other goods - even if we were to ignore the fact that there is a misconception of the important function of money in the assumption that it is not consumed.

2. The Marketability of Commodities

A. The outer limits of the marketability of commodities.

As far as Menger is concerned, the marketability (the easiness of which a good can be bought and sold) of commodities is limited in four directions:

(1) Their marketability is limited with respect to the persons to whom they can be sold. The owner of a commodity does not have the power to sell it to any person of his choice. There is always only a definite number of economizing individuals to whom it can be sold. The owner has no chance of selling his commodity to persons who have no requirements for it, who are prevented from purchasing it by legal or physical circumstances, or who have no knowledge of the exchange opportunity offered them, or finally to anyone to whom a given quantity of the commodity in question is not the equivalent of a larger quantity of the good that is offered in exchange for it than is the case with the initial owner of the commodity. Menger compares the number of persons to whom bread and meat can be sold with the number to whom astronomical instruments can be sold. Or the number of persons who purchase wine and tobacco with the number who purchase works in Sanskrit.

(2) The marketability of commodities is limited with respect to the area within which they can be sold. For a commodity to be sold in a specific place, it is necessary that (a) there are no physical or legal barrier to its transportation to that place or to its being offered there for sale, and that (b) the costs and expenses of transportation shall not exhaust the gain that can be derived from the expected exchange opportunity. A rather cheap but heavy commodity like timber, might be unprofitable to transport to a market very far from its origin.

(3) Commodities are limited quantitatively in their marketability. Menger: The publisher of a work on the language of the Tupi Indians, for example, could count on a sale of perhaps 300 copies at a moderate price for the work. But even at the lowest price, he could not count on a sale of more than 600 copies. Popular scientific publications on the contrary may attain sales of 20,000 to 30,000 copies or more.

(4) Finally, commodities are also limited in their marketability with respect to the time periods in which they can be sold. There are goods for which requirements exist only in winter, others for which they exist only in summer. Menger has a few examples: programs for coming festivals or fine art exhibits, and newspapers and articles of fashion, are goods of this sort. In fact, all perishable goods are, by their very nature, restricted in their marketability to a narrow time period. To this should be added the fact that keeping commodities in stock usually involves economic sacrifices on the part of the owner. The effect of storage fees, costs of safekeeping, etc., on the limits of the marketability of commodities in time is similar to the effect of freight charges and other transportation costs on the spatial limits of their marketability.

B. The different degrees of marketability of commodities.

As we have established, a commodity is an economic good intended for sale. But it is not intended for sale unconditionally; the owner of a commodity intends to sell it, but by no means at any price. A jeweller with a stock of watches, Menger argues, could sell off his entire stock in almost any situation imaginable, if he were willing to sell his watches at a low enough price. A leather merchant could clear out his stock too if he were prepared to sell his leather at similar ruinous prices.

Market places, fairs, exchanges, public auctions that are held periodically (as is the case in large sea-ports, for example), and other public institutions of a similar nature, are for the purpose of bringing all persons interested in the pricing of a commodity together at a particular place to ensure the establishment of an economic price. Commodities for which an organized market exists can usually be sold without difficulty by their owners at prices corresponding to the general economic situation. But commodities for which there are poorly organized markets, change hands at inconsistent prices, and sometimes cannot be disposed of at all.

The first cause of differences in the marketability of commodities we have thus seen to be the fact that the number of persons to whom they can be sold is sometimes larger and sometimes smaller, and that the points of concentration of the persons interested in their pricing are sometimes better and sometimes worse organized.

The second cause of differences in the marketability of commodities is thus the fact that the geographical areas within which their sale is confined are sometimes wider and sometimes narrower, and that while there are many trading points within this area at which some commodities can be sold at economic prices, there are only a few such points in the case of other commodities. Owners of commodities of the first category can sell them at will in many places at economic prices, while owners of commodities of the second category can sell them only in a few places over a narrow trading area.

Thirdly, there are commodities for which a lively and well organized speculation exists that absorbs every portion of the available quantity of the commodities coming to market at any time. There are other commodity markets in which speculation is not carried on, or at least not to the same extent, and in which, if they become oversupplied with commodities, either prices fall rapidly, or the commodities brought to market must be taken away unsold. Goods of the first kind can generally be sold in any quantity actually available at a given time with little sacrifice in price, while the owner of a commodity for which no speculation exists can sell quantities exceeding current requirements only with very severe losses or not at all.

Finally, there are commodities for which almost continuous markets exist. Securities and a number of raw materials, in places where there are commodity exchanges, can be marketed every day. There are other commodities that are traded on two or three days of the week. There are usually weekly markets for grains, quarterly fairs for the products of industry, and two or more so-called annual fairs a year for horses and other domestic animals, etc.

C. The facility with which commodities circulate.

In the preceding sections, Menger explained the general and specific causes of differences in the marketability of commodities. At this point one might be inclined to consider the problem of the greater or less facility with which commodities can circulate through several hands as also solved, since the circulation of a commodity through several hands simply consists of a number of single transactions, and to think that a commodity that can be passed without difficulty from the hands of its owner to some other economizing individual should find its way just as easily from the hands of the second owner into those of a third, and so on. But experience shows that this is not true of all commodities.

Some commodities have almost the same marketability in the hands of every economizing individual. As an example, Menger takes gold nuggets. Gold nuggets can pass through any number of hands without any decrease in marketability. Other commodities require special knowledge, skills, permits, or governmental licenses, privileges, etc., for their sale, and are not at all saleable in the hands of an individual who cannot acquire these requisites.

Finally, it is clear that commodities whose marketability is restricted to a small number of persons, whose area of sale is limited, which can be preserved only for a short time, etc., are not capable of circulating freely. In that sense, we find that for a commodity to be capable of circulating freely it must be saleable in the widest sense of the term to every economizing individual through whose hands it may pass, and to each of these persons it must be saleable, not in one respect alone, but in all four of the characters discussed above.

Chapter VIII - The Theory of Money

1. The Nature and Origin of Money

In the early stages of trade, when economizing individuals are only slowly awakening to knowledge of the economic gains that can be derived from exchange opportunities, their attention is directed only to the most obvious of such opportunities. In considering the goods he will acquire in trade, each individual takes note only of their use value to himself. Hence the exchange transactions that are actually performed are restricted to situations in which economizing individuals have goods in their possession that have a smaller use value to them than goods in the possession of other economizing individuals who value the same goods in reverse fashion. Menger has an example: A has a sword that has a smaller use value to him than B's plough, while to B the same plough has a smaller use value than A's sword. In the beginning, all exchange transactions actually performed are restricted to cases of this sort.

It is not difficult to see that the number of exchanges actually performed will be very limited under these conditions. How rarely does it happen that a good in the possession of one person has a smaller use value to him than another good owned by another person who values these goods in precisely the opposite way at the same time? And even when this relationship is present, how much rarer still must situations be in which the two persons actually meet each other? A has a fishing net that he would like to exchange for a quantity of hemp. For him to be in a position actually to perform this exchange, it is not only necessary that there be another economizing individual, B, who is willing to give a quantity of hemp corresponding to the wishes of A for the fishing net, but also that the two economizing individuals meet each other.

To further illustrate the difficulties discussed above, Menger has another example. Assume that a smith of the Homeric age has fashioned two suits of copper armor and wants to exchange them for copper, fuel, and food. He goes to market and offers his products for these goods. He would doubtless be very pleased if he were to encounter persons there who wish to purchase his armor and who, at the same time, have for sale all the raw materials and foods that he needs. But this is obviously just chance if, among the small number of persons who at any time wish to purchase such a specific good, he should find any who are offering precisely the goods that he himself needs. Instead, possession of other commodities would considerably facilitate his search for persons who have just the goods he needs. In the times of Homer, Menger argues, cattle were often the most saleable of all commodities. An so even if the armorer is already sufficiently provided with cattle for his direct requirements, he would be acting uneconomically if he did not give his armor for a number of additional cattle, that he then in turn could use to acquire the goods that he wanted.

As each economizing individual becomes increasingly more aware of his economic interest, he is led by this, without any agreement, without legislative compulsion, and even without regard to the public interest, to give his commodities in exchange for other more saleable commodities, even if he does not need them for any immediate consumption purpose. With economic progress, therefore, we can observe the phenomenon of a certain number of goods, especially those that are most easily saleable at a given time and place, becoming acceptable to everyone in trade, and thus capable of being given in exchange for any other commodity. These goods are what we call money.

Within the boundaries of a state, the legal order usually has an influence on the money-character of commodities which, though small, cannot be denied. The origin of money (as distinct from coin, which is only one variety of money) is, as we have seen, entirely natural and thus displays legislative influence only in some instances. Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence. Certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state.

2. The Kinds of Money Appropriate to Particular Peoples and to Particular Historical Periods

As we have discussed, money is not the product of an agreement on the part of economizing men, nor the product of legislative acts. No one invented it. As economizing individuals became increasingly aware of their economic interest, they everywhere attained the knowledge that surrendering less saleable commodities for others of greater saleability brings them closer to the acquirement that would satisfy their needs. Thus, with the progressive development of an economy, money came to exist in numerous civilizations independently.

In the earliest periods of economic development, cattle seem to have been the most saleable commodity among most peoples of the ancient world. Domestic animals constituted the main item of the wealth of nomads and peoples passing from a nomadic society to agriculture. The trade and commerce of the ancient Greeks showed no trace of coined money even as late as the time of Homer. Barter still prevailed, and wealth consisted of herds of cattle. Payments were made in cattle. Prices were reckoned in cattle. And cattle were used for the payment of fines. Menger brings up various other examples of cattle money as well.

The gradual formation of cities inhabited by a population devoted primarily to industry, must have had the result of simultaneously diminishing the marketability of cattle and increasing the marketability of many other commodities, especially the metals in use. The artisan who began to trade with the farmer was seldom in a position to accept cattle as money; for a city dweller, the temporary possession of cattle involved not only discomforts, but also considerable economic sacrifices like the keeping and feeding of cattle. Cattle ceased to be the most saleable of commodities, the economic form of money, and finally ceased to be money at all.

Among the metals that were at first principally worked by men because of their ease of extraction and malleability were copper, silver, gold, and in some cases also iron. The monetary transition took place quite smoothly when it became necessary, since metallic implements and the raw metal itself had doubtless already been in use everywhere as money in addition to cattle-currency, for the purpose of making small payments. This transition did not take place abruptly, nor did it take place in the same way among all peoples. The newer metallic standard may have been in use for a long time along with the older cattle-standard before it replaced the latter completely.

The fact that for example slaves and salt became money in the interior of Africa, and that cakes of wax on the upper Amazon, cod in Iceland and Newfoundland, tobacco in Maryland and Virginia, sugar in the British West Indies, and ivory in the vicinity of the Portuguese colonies, took on the functions of money is explained by the fact that these goods were the main articles exported from these places. Thus they acquired, just as did furs among hunting tribes, a considerable marketability.

And so money presents itself to us, in its special locally and temporally different forms, not as the result of an agreement, legislative compulsion, or mere chance, but as the natural product of differences in the economic situation of different peoples at the same time, or of the same people in different periods of their history.

3. Money as a "Measure of Price" and as the Most Economic Form for Storing Exchangeable Wealth

Since the progressive development of trade and the functioning of money give rise to an economic situation in which commodities of all kinds are exchanged for each other, and since the limits within which prices are formed become ever narrower under the influence of competition, it was easy for the idea to arise that all commodities will stand, at a given place and at a given time, in a certain price relationship to each other, on the basis of which they can be exchanged for each other at will.

In Menger's discussion of price theory, however, he has shown that equivalents of goods in the objective sense of the term cannot be observed anywhere in the economy of men, and that the entire theory that presents money as the "measure of the exchange value" of goods disintegrates into nothingness, since the basis of the theory is an error.

It is true that several economic objectives of practical life have given rise to a need for valuations of approximate exactness, especially valuations in terms of money. Where only an approximate correctness of the estimates is required, average prices can properly serve as the basis of valuation, since they are generally most suitable for this purpose. But it is clear that this method of valuing goods must prove itself completely insufficient and even wrong wherever a higher degree of precision becomes necessary. When an exact valuation of goods is necessary, three things must be distinguished according to the intention of the person making the estimate. He must direct his attention to estimating (1) the price at which certain goods, if brought to market, can be sold, (2) the price at which goods of a certain kind and quality can be bought on the market, and (3) the quantity of commodities or the sum of money that is the equivalent, to the particular individual himself, of a good or of a quantity of goods.

The basis for making the first two estimates follows from what has been said. Price formation always takes place between two extremes, the lower of which may also be called the demand price (the price at which the commodity is asked for on the market) and the higher of which may also be called the supply price (the price at which the commodity is offered for sale on the market). The former will generally be the basis for making the first estimate and the latter the basis for making the second. The third estimate is more difficult since it involves the special position that the good or quantity of goods whose equivalent (in a subjective sense) is under consideration occupies in the economy of the economizing individual.

Although the theory of "exchange value" in general, and as a necessary consequence, the theory of money as a "measure of exchange value" in particular, must be designated as untenable after what has been said, observation of the nature and function of money teaches us nevertheless that the various estimates just discussed are usually most suitably made in terms of money. The purpose of the first two valuations is the estimation of the quantities of goods for which a commodity may be bought or sold at a given time on a given market. These quantities of goods will ordinarily consist only of money if the prospective transactions are actually performed, and knowledge of the sums of money for which a commodity can be purchased or sold is naturally the immediate objective of the economic task of valuation.

If we summarize what has been said, we can conclude that the commodity that has become money is also the commodity in which valuations answering the practical purposes of economizing men and in which accumulations of funds for exchange purposes can most appropriately be made. Metallic money has answered these purposes to a high degree. But it appears that it is just as certain that the functions of being a "measure of value" and a "store of value" must not be attributed to money as such, since these functions are of a merely accidental nature and are not an essential part of the concept of money.

4. Coinage

From the earlier discussions on the nature and origin of money, it appears that the precious metals naturally became the economic form of money in civilizations. But the use of the precious metals for monetary purposes is accompanied by some defects whose removal had to be attempted by economizing men. The main defects involved in the use of the precious metals for monetary purposes are: (1) the difficulty of determining their genuineness and degree of fineness, and (2) the necessity of dividing the hard material into pieces appropriate to each particular transaction. These difficulties cannot be removed easily without loss of time and other economic sacrifices.

The testing of the genuineness of precious metals and their degree of fineness requires the use of chemicals and specific labor services, since it can be undertaken only by experts. The division of the hard metals into pieces of the weights needed for particular transactions is an operation which, because of the exactness necessary, not only requires labor, loss of time, and precision instruments, but is also accompanied by a not inconsiderable loss of the precious metal itself (because of the loss of chips and as the result of repeated smelting).

The first of the two difficulties, the determination of the degree of fineness of the metal, seems to have been the one whose removal appeared to be first in importance to economizing men. A stamp impressed by a public official or some reliable person on a metal bar guaranteed, not its weight, but its degree of fineness, and exempted the possessor, when he passed the metal on to other persons who appreciated the reliability of the stamp, from the burdensome and expensive assay test. Metal so stamped still had to be weighed, as before, but its fineness required no further examination.

In some cases at the same time, economizing men appear to have hit upon the idea of also designating the weight of the pieces of metal in similar fashion, and of dividing the metals from the beginning into pieces that were reliably marked with their weight as well as their fineness. This was naturally best accomplished by dividing the precious metal into small pieces corresponding to the needs of trade, and by marking the metal in such a way that no significant part could be removed from the pieces without the removal becoming immediately apparent. This aim was achieved by coining the metal, and it was in this way that our coins came into being.

Governments have therefore usually accepted the obligation of stamping the coins necessary for trade. But they have so often and so greatly misused their power that economizing individuals eventually almost forgot the fact that a coin is nothing but a piece of precious metal of fixed fineness and weight, for which fineness and full weight the honesty and rectitude of the mint constitute a guarantee. Doubts even arose as to whether money is a commodity at all. Indeed, it was finally declared to be something entirely imaginary resting solely on human convenience. The fact that governments treated money as if it actually had been merely the product of the convenience of men in general and of their legislative whims in particular contributed therefore in no small degree to furthering errors about the nature of money.