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Why People Trade

Mises Daily: Tuesday, November 09, 2004 by

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It is the Mises Institute's great pleasure to introduce Carl Menger's 1871 book Principles of Economics to an online audience. This book founded the Austrian School, and is the one that Mises himself credits with teaching him economics. This is essay is drawn from Chapter 4, in which he carefully refines Adam Smith's theory of exchange and finally replaces it with a new view that became associated with the Austrian School. The entire book on Mises.org is made available by special leasing arrangement. Support for this project is greatly appreciated.

"WHETHER THE PROPENSITY OF men to truck, barter, and exchange one thing for another be one of the original principles in human nature, or whether it be the necessary consequence of the faculties of reason and speech,” or what other causes induce men to exchange goods, is a question Adam Smith left unanswered. The eminent thinker remarks only that it is certain that the propensity to barter and exchange is common to all men and is found in no other species of animals.

     First, in order to clarify the problem, suppose that two neighboring farmers each have a great abundance of the same kind of barley after a good harvest, and that there are no barriers to an actual exchange of quantities of barley between them. In this case, the two farmers could give free rein to their propensity to trade, and could exchange 100 bushels or any other quantity of barley back and forth between themselves. Although there is no reason why they should desist from trading in this case if the exchange of goods, by itself, affords pleasure to the participants, I believe nothing is more certain than that these two individuals will forgo trade altogether. If they should nevertheless engage in this sort of exchange, they would be in danger, precisely because of their enjoyment of trade under such circumstances, of being regarded as insane by other economizing individuals.

     Suppose now that a hunter has a great abundance of furs, and hence of materials for clothing, but only a very small store of foodstuffs. His need for clothing is thus fully provided for but his need for food only inadequately. A nearby farmer is assumed to be in precisely the opposite position. Suppose too that there are no barriers to an exchange of the hunter’s foodstuffs for the farmer’s clothing materials. It is evident that an exchange of goods is still less likely in this case than in the first one. If the hunter should exchange a portion of his scanty store of food for a portion of the farmer’s equally scanty stock of furs, the hunter’s surplus clothing materials and the farmer’s surplus of foodstuffs would both become even greater than before the exchange. Since satisfaction of the hunter’s need for food and satisfaction of the farmer’s need for clothing were already insufficiently provided for, the economic position of the traders would be decidedly worsened. No one can maintain, therefore, that these two economizing individuals would experience pleasure from such an exchange. On the contrary, nothing is more certain than that the hunter and farmer will both most firmly resist offers to engage in a trade that would definitely reduce their well-being, or possibly even endanger their lives. If an exchange of this sort had nevertheless taken place, the two men would have nothing more urgent to do than to revoke it.

     The propensity of men to trade must accordingly have some other reason than enjoyment of trading as such. If trading were a pleasure in itself, hence an end in itself, and not frequently a laborious activity associated with danger and economic sacrifice, there would be no reason why men should not engage in trade in the cases just considered and in thousands of others. There would, in fact, be no reason why they should not trade back and forth an unlimited number of times. But everywhere in practical life, we can observe that economizing men carefully consider every exchange in advance, and that a limit is finally reached beyond which two individuals will not continue to trade at any given time.

     Since it has been established that exchange is not an end in itself, and still less itself a pleasure for men, the problem in what follows will be to explain its nature and origin.

     To begin with the simplest case, suppose that two farmers, A and B, have both previously been carrying on isolated household economies. But now, after an unusually good harvest, farmer A has so much grain that he is unable, however profusely he may provide for the satisfaction of his needs, to utilize a portion of it for himself and his household. Farmer B, on the other hand, a neighbor of farmer A, is assumed to have had an excellent vintage in the same year. But his cellar is still filled from previous years, and because he lacks additional containers he is considering pouring out a part of the older wine in storage which dates from an inferior vintage year. Each farmer has a surplus of one good and a serious deficiency of the other. The farmer with a surplus of grain must completely forgo consumption of wine since he has no vineyards at all, and the farmer with a surplus of wine is in want of foodstuffs. Farmer A can permit many bushels of grain to spoil on his fields when a keg of wine would afford him considerable pleasure. Farmer B is about to destroy not merely one but several kegs of wine when he could very well use a few bushels of grain in his household. The first farmer thirsts and the second starves when both could be relieved by the grain A is permitting to spoil on his fields and by the wine B has resolved to pour out. Farmer A could still satisfy his and his family’s need for food as completely as before and indulge besides in the enjoyment of drinking wine, and farmer B could continue to enjoy as much wine as he pleases but would not need to starve. It is therefore evident that we have encountered a case in which, if command of a certain amount of A’s goods were transferred to B and if command of a certain amount of B’s goods were transferred to A, the needs of both economizing individuals could be better satisfied than would be the case in the absence of this reciprocal transfer.

     The case just presented, in which the needs of two persons could be better satisfied than before by a mutual transfer of goods having no value to either of them prior to the exchange, and hence without economic sacrifice on either side, was especially suitable for impressing upon us in the most enlightening manner the nature of the economic relationship leading to trade. But we would construe this relationship too narrowly if we were to confine our attention to cases in which a person who has command of a quantity of one good larger than even his full requirements suffers a deficiency of a second good, while another person has a comparable surplus of this second good and a deficiency of the first. For the relationship in question can also be observed in less obvious cases in which one person possesses goods of which certain quantities have less value to him than quantities of another good owned by a second person who is in the reverse situation.

     As an example, let us suppose that the first of the two isolated farmers has not harvested so much grain that he can allow part of it to spoil on the field without injury to the satisfaction of his needs, and that the second does not have so much wine that he can pour any of it away without similar injury. Instead, each of the two farmers can employ the whole quantity of the good at his command in some fashion useful to himself and his household. The first farmer can employ his whole stock of grain usefully by devoting the quantity remaining after complete provision for the satisfaction of his more important needs to the fattening of his cattle. The second farmer does not have so much wine that he must pour some of it away, but just enough to permit him to distribute a portion to his slaves as a reward for greater effort. Thus, although to the grain farmer a certain portion of his grain (a bushel, for instance) and to the wine grower a certain portion of his wine (a keg, for instance) has only a small value, it nevertheless has some value, since directly or indirectly the satisfaction of certain of his needs depends on that portion. But the fact that a given quantity of grain, a bushel for instance, has a certain value to the first farmer by no means excludes the possibility that a certain quantity of wine, a keg for instance, may have a higher value to him, as would be the case if the enjoyment afforded by a keg of wine has a higher importance to him than the more or less thorough fattening of his cattle. Similarly with the second farmer, the fact that a keg of wine has a certain value to him by no means excludes the possibility that a bushel of wheat may have a higher value to him, as would be the case if it would ensure a more adequate diet for himself and his family, and perhaps even avoidance of the pains of hunger.

     The most general form of the relationship responsible for human trade is therefore as follows: an economizing individual, A, has a certain quantity of a good at his disposal which has a smaller value to him than a given quantity of another good in the possession of another economizing individual, B, who estimates the values of the same quantities of goods in reverse fashion, the given quantity of the second good having a smaller value to him than the given quantity of the first good which is at the disposal of A. Let the quantity of the first good in A’s possession be 10a, and let the quantity of the second good in B’s possession be 10b. Assume the value of the quantity 1a to A to be W, the value of 1b to A if he should obtain command of it to be W + x, the value of 1b to B to be w, and the value of 1a to B if he should obtain command of it to be w + y. It is evident that A would gain a value of x and that B would gain a value of y from a transfer of 1a from A’s possession to B’s and 1b from B’s possession to A’s. In other words, after an exchange, A would find himself in the same position as if a good with a value to him of x had been added to his wealth, and B would find himself in the same position as if a good with a value of y to him had been added to his wealth.

     If, in addition, the two economizing individuals (a) recognize the situation, and (b) have the power actually to perform the transfer of the goods, a relationship exists that makes it possible for them, by a mere agreement, to provide better, or more completely, for the satisfaction of their needs than would be the case if the relationship were not exploited.

     The same principle that guides men in their economic activity in general, that leads them to investigate the useful things surrounding them in nature and to subject them to their command, and that causes them to be concerned about the betterment of their economic positions, the effort to satisfy their needs as completely as possible, leads them also to search most diligently for this relationship wherever they can find it, and to exploit it for the sake of better satisfying their needs. In the situation just described, therefore, the two economizing individuals will make certain that the transfer of goods actually takes place. The effort to satisfy their needs as completely as possible is therefore the cause of all the phenomena of economic life which we designate with the word “exchange.” It should be observed that this term is used in our science in a special sense with a much wider application than in popular or especially than in legal language. For in the economic sense it also includes purchase and sale, and all partial transfers of economic goods (tenancy, rental, lending, etc.) for compensation.

     If we summarize what has just been said we obtain the following propositions as the result of our investigation thus far: The principle that leads men to exchange is the same principle that guides them in their economic activity as a whole; it is the endeavor to ensure the fullest possible satisfaction of their needs. The enjoyment men derive from an economic exchange of goods is the general feeling of pleasure they experience when some event permits them to make a better provision for the satisfaction of their needs than would otherwise have been possible. But the benefits of a mutual transfer of goods depend, as we have seen, on three conditions: (a) one economizing individual must have command of quantities of goods which have a smaller value to him than other quantities of goods at the disposal of another economizing individual who evaluates the goods in reverse fashion, (b) the two economizing individuals must have recognized this relationship, and (c) they must have the power actually to perform the exchange of goods. The absence of but one of these conditions means that an essential prerequisite for an economic exchange is missing, and that an exchange of goods between two economizing individuals is economically impossible.

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Carl Menger (1840-1921) was professor of economics at the University of Vienna and founder of the Austrian School. Entire Text of Principles |  Menger Biography| Works by Menger