Prices and Markets: Theory and History from Smith to Schumpeter via Petty
This real-world example has a detailed theoretical history that is often ignored. Proponents of the superiority of market mechanisms consider a major benefit in what may be summarized as diversity.
The market brings together diverse individual preferences to determine the quantities and prices of a wide range of commodities. These preferences and individual endowments are the given data that form the basis for the supply and demand functions, which in turn determine equilibrium prices that provide all the information required to permit maximum economic utility. Yet, closer inspection of this facade of diversity suggests that its general application requires a presumption of uniformity or homogeneity. Thus, just as the diversity of individual preferences is taken as the data of the economic landscape, the very definition of a commodity that elicits those preferences requires the presumption of uniformity.Start with the question of how choice is exercised through free market exchange. Adam Smith provided the classic response to this question. In his Theory of Moral Sentiments, he noted that, our senses being limited, “they never can carry us beyond our own person, and it is by imagination only that we can form any conception of what are [others’] sensations” (1976, 9). “How selfish so every man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it” (ibid.). This might be called the “Existential Diversity of Individuals.” We might all have similar preferences, but no one would know it. The result, which Smith put forward in The Wealth of Nations, is that exchange takes place by means of each individual trying to please the imagined needs of others: altruistic hedonism.
When Smith argues that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,” he is simply stating what he considered to be an incontrovertible fact that no individual can possibly act benevolently, given the impossibility of knowing the tastes and preferences of others. It is thus in one’s own interest to imagine and try to discover the preferences of others. He then goes on to note that “though it may be true, therefore, that every individual even in his own breast, naturally prefers himself to all mankind, yet he dares not look mankind in the face, and avow that he acts according to this principle”; rather, “he must [...] humble the arrogance of his self-love, and bring it down to something which other men can go along with” (1976, 83). This Existential Diversity thus implies Existential Uncertainty about how one can best satisfy one’s own needs since it relies on satisfying the unknowable needs of others. Thus, Smith argues that these needs can only be discovered through diversity and exchange. The market mechanism is thus a series of multiple bilateral exchanges between diverse individuals with diverse preferences, each seeking to serve their own needs by imagining and seeking to discover and satisfy the needs of others.It is now necessary to identify what is exchanged between these diverse, self-interested individuals. Economists often speak of “commodity exchange,” but if each individual has a different appreciation of what is exchanged, and if what is exchanged satisfies unknown wants, then each thing exchanged must be composed of different perceived characteristics—each of which would appeal to one or more of the diverse needs of diverse individual consumers. This means that there may be as many diverse “commodities” as individuals involved in each of the millions of exchanges that take place in the market, since each person evaluates them differently and considers them a different commodity because each satisfies a different need or preference.
The market will thus be comprised of the bilateral exchanges of a multitude of unique commodities identified by their different characteristics.Now, if all exchange is bilateral, what is the counterpart in these exchanges? The answer is usually other commodities, but traditional theory suggests that in a market economy, efficiency considerations should lead to the creation of an intermediary or standard commodity, usually called “money” But this raises another question of what commodity will serve as money.
The traditional answer is that it is a commodity that becomes uniformly accepted by reducing transactions costs, that is, it has a common property. Thus, the first condition for the existence of exchange is the existence of a commodity that does not represent diverse characteristics to each individual but satisfies a common need of all in exchange. Here begins the need of a functioning market economy to eliminate diversity and introduce uniformity.
Historically, precious metals, even though they have diverse particular characteristics, have been the commodity that served this purpose—but only when they are minted by a sovereign into coin to guarantee the required uniformity. But even in the case of minted coin, most economies that used metallic currency experienced the circulation of many different types of coinage, with different metallic content and different weight due to wear and tear and clipping. Thus, coins were in fact highly diverse, and were reduced to the underlying metal content by the application of a uniform market price. It is interesting that historically the difficulties in ensuring uniformity led to the adoption of a notional “unit of account,” what Luigi Einaudi called “imaginary money,” which was uniform by definition.
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