Money and its Evolution and Use in Society: Part II

By: Michael Richards
Goods are not merely consumed, but are produced for consumption. One of the greatest discoveries by the founder of the Austrian School of economics, Carl Menger, is the hierarchy of production. Basically, goods at the lowest order of production are those that are consumed. The goods used to make the consumption goods (production goods) are placed at a higher level based upon where they fit in the production process.
Murray Rothbard used an example of making a ham sandwich in his book, Man, Economy, and the State, to illustrate this principle. The sandwich itself is the consumption good and thus the sandwich is at the lowest level of production. The goods used to make this sandwich are the bread, ham, and cheese and thus are goods of a higher order in the production process. Still higher on the production process are the goods like milk, wheat, flour, and the pig. This example is used to simplify the process as one could go on for days explaining the whole process of machinery, transportation and labor involved in the process of making a ham sandwich. Note, however that these things are also part production process at various stages.
Money is used as a medium by which individual's exchange goods in society. Individual's use money to determine the cost and benefits of producing a product. Entrepreneur's make goods hoping that they will be valued by society. Nothing is produced unless an entrepreneur or allocator of resources expects that society will value the product. However, such knowledge is not known with one hundred percent certainty and are only determined by profits and loss on the market. Thus making the entrepreneur an essential part as a speculator in determining the prices at which profits can be made.
Money is important in this process as it is the common medium of exchange in society. People buy goods with money that they make either through labor or selling their own goods. Goods are allocated based upon the principle of profits and losses at all stages of production.
For example, how does a person who makes milk know that he should sell it to the man who will turn his milk into cheese? Why not sell it for direct consumption or for some other purposes? Also how much milk should be diverted in society for the production of cheese or cream and how much for direct consumption? This is answered by prices in a free economy of private ownership through the pricing mechanism.
Let's say we have a person who is making ham sandwiches for consumers to buy. He determines that he needs cheese, so he goes and offers to buy cheese from a person who produces cheese. The cheese producer will then look at the price this person is offering compared to the prices that other customers, such as a pizza maker, is offering. Another great discovery by Menger is the law of marginal utility. People don't want to buy all of the cheese but instead wish to buy them in units. So the pizza guy may want 100 pounds of cheese, while the ham sandwich producer may only want 50 pounds as this is the amount of cheese necessary to make their businesses profitable. Buy too much, then they have too much in stock and thus suffer losses. Buy too little and that 's profit they may miss out on.
So how are prices set then? Prices are grounded in the consumers' subjective values. If a large number, let's say 100 of consumers are willing to pay for ham sandwiches at 5 dollars, but only 40 customers are willing to pay for the sandwiches at 10 dollars. It is obviously more profitable to sell those ham sandwiches at 5 dollars as the volume of customers is higher than at ten dollars (100*$5= $500 compared to 40*$10=400 dollars. The number of consumers and the price they're willing to pay is what determines what will and will not be produced in the market. Of course the same goes for the sandwich maker. If the price of cheese is too expensive to make a profit, or if he can make higher profits without it, then he won't purchase it from the cheese supplier. This is also true of the producer of milk as he decides what price to set to sell his product to the cheese maker, the cream maker, or simply to the consumer of milk.
Money plays an important role as a medium of exchange because it states how society values things that are produced. If the cost of production is too expensive and no one is willing to buy, then that means simply that the product is not worth producing and that further production is merely a waste of resources. Further if goods are produced at a loss in profits, then that means that the goods are desired but are produced using too much resources that could be used elsewhere or are simply inefficiently produced to be accepted by society.
Without these money prices it would be impossible for the cheese maker to know whether to allocate those resources to the sandwich maker, supermarket, pizza maker, or anyone else who wants to use it. As goods move higher in the scale of production, money prices become more useful in allocating resources in a way that will most please the consumer. It is important that these are market prices based in consumer sovereignty at all levels of production. Thus meaning in a market economy of private ownership of production. Such a process does not exist in socialist economies as they lack the price mechanisms at various stages of production thus really have no means of determining what quantity of goods are to be produced at the higher levels of production.

Money and its Evolution and Use in Society: Part II by Michael Richards is licensed under a Creative Commons Attribution 3.0 Unported License.

The Evolution and Use of Money in Society: Part 1

By Michael Richards
Before there was money, there was barter. When people exchange goods, they exchange because they value the good that they are exchanging for more than the good they are exchanging. Let's say Jack wants to trade his apple for Jill's orange. Jack trades his apple for Jill's oranges because he values Jill's orange more than his apple. Likewise, the only way Jill will trade for the apples is if she values Jack's apples more than her oranges. If she does not, Jack will have a to search out for something to trade his apples for that Jill will want more than her oranges. This type of situation can get complicated.
As time progresses certain goods became popular in society. Let's say three goods; gold, seashells, and clothe, become the latest rage, as people valued it for its ability to make a necklace. If Jill is one of these people who wishes to make her own necklace, Jack will seek one of these materials to trade not only with her, but with as many people as possible who desire these things. Eventually people will desire these things, not for making necklaces, but for their ability to trade with the maximum number of people possible. People will begin to set prices stating that they will exchange a certain number of these goods for a certain number of other peoples' goods. Jill will agree to sell her oranges for 2oz of gold, 10 seashells, or 2 sq. ft. of clothe to Jack who will set the price of his apples accordingly. Thus these three commodities become money as they are the common medium of exchange.
Now due to he abundance of seashells and clothe, individuals will begin to focus their energies to obtain these things in abundance in order to trade with them on the market. Let's say that the number of seashells triples in society and the number of clothe doubles. Jill may see that people seem to be able to buy more oranges than she can produce. In response, she realizes that if she raises her prices, she can buy more things she desires on the market and thus raises prices to 30 seashells and 4 sq ft. of clothe. Jack, who wishes to buy her oranges now must work harder in order to obtain them. However, he also notices that people are buying his apples in excess and decides to raise his prices so that it becomes easier for him to buy the things he wants. This eventually turns into a ripple effect where every merchant begins to raise the price of all their goods and services.
Now those who come in last to raise their prices will be unhappy in this state of affairs as they had to work harder to obtain the goods they want. Unlike the first comers, they did not raise prices so that they could obtain more of the goods they wanted. This is the effects of inflation (which means the increase in the money supply, not prices). Those who benefit from inflation are those who are first to obtain the new money and those who wish borrow money as money has become easier to obtain to pay off their loan. Those who are hurt by inflation are those who save and those who lend since now their money can buy less than it previously could. Deflation (which is a contraction of the money supply) can have the effect that it will take less money to buy goods, as people become more desperate to obtain it. The winners and looser are the opposite of what it would be during a time of inflation: lenders win, borrowers loose. Businesses will also have to adjust to the new prices, which may cause them to temporarily downsize until all prices in society adjusts. In the short term, deflation benefits the consumer and saver as they need less money to buy things.
Now those who come last will begin to see that although the prices of seashells and clothe begin to rise, the price of gold remains relatively constant due to its rarity. They begin to except payment in gold only. This will weaken the market for seashells and clothe as fewer people will agree to use them in exchange. This will continue until gold comes out on top and becomes the sole common medium of exchange and thus the only money society will except.
What this example shows, is that money, the common medium of exchange in society, is really a commodity that follows the same rules of supply and demand as any other commodity. The sole use of any money (regardless of what that money is) is the use of exchange in society. People, however, do not desire money for its own sake but instead value it for what they can exchange it for.Remember, Jack rose prices in response to Jill because he wanted to buy her oranges with the same or less work it took prior to her raising prices. Jack did not want more money just because. He wanted it to buy more goods in society. More money does not equal more wealth and neither is money a determinant of a thing's value. Wealth is the goods and services produced in society. Prices are determined by individuals' subjective valuations of those goods in society and money is valued in its ability to obtain those goods. When people save and invest money, they do so because they are willing to withhold present consumption for future consumption. Therefore money, even in this case, is still valued for its use in exchange only.

The Evolution and Use of Money in Society: Part 1 by Michael Richards is licensed under a Creative Commons Attribution 3.0 Unported License.
Based on a work at academyofhumanaction.blogspot.com.