Exchange Creates Value
Different from Adam Smith who presumed in his Wealth of Nations that the division of labor was caused by the “propensity to truck, barter, and exchange” as a part of human nature, Carl Menger explains the practice of exchanging goods as the result of its usefulness for human well-being. There must be more to it than pleasure when humans exchange goods. In fact, it makes no sense to exchange goods of equivalent value. As Menger explains, the reason to exchange goods must come from the circumstance that the same good has different values for different persons. The voluntary transfer of one good from A to B in exchange for another good from B to A results from the intention to increase the individual degree of satisfaction of each participant in the exchange (Grundsätze, p. 156).
Exchange results from the same principle that guides people in their economic activity in general. Trying to improve one’s economic situation leads people to carry out the transfer of assets. The exchange of goods thus creates additional value for both partners. The principle behind exchange is the same one that guides all economic activity, that is, the search for the maximum satisfaction of desires. Success in improving one’s well-being through exchange therefore depends on three factors. First, the existence of different value estimates; second, the knowledge of this relationship; and third, the ability to exchange. In this perspective, the exchange of goods is a good in itself.
People exchange value differences with the result that compared to the situation before the exchange each of the exchange partners is better off after the exchange. When the utility that results from the exchange is exhausted, the exchange reaches its limit and people cease to exchange additional quantities. “This limit is reached when there is no longer any quantity of goods in the possession of one of the two counterparties that would have a lower value to him than a quantity of another good that is available to the second counterparty, while at the same time, for that person, the inverse proportion of appreciation occurs” (p. 167).
In as much as people search to find and create new goods that are useful, they look out for opportunities to exchange goods. Exchange spreads around the world driven by the natural human tendency to find ways to improve individual well-being.
It would be wrong to presume that the principal purpose of economic activity was mainly the multiplication of physical things. Menger emphasizes that the essence of economic activity lies in the pursuit of the maximum satisfaction of desires. Therefore, by facilitating exchange, traders exert a productive activity. At its core, economic development means the extension of the ability to exchange. This happens by way of reducing transaction costs.
Goods for Use and for Exchange
There are numerous goods that have an important use value for certain individuals, while in most cases the same individuals would try in vain to satisfy any need in an indirect, exchange-mediated manner with those goods. There are also goods whose exchange value exceeds their personal use value from the perspective of a specific person. The guiding principle of all economic activity of men—the satisfaction of their needs as completely as possible—applies to both the use value and the exchange value. This means that people would maintain those goods for themselves whose personal use value is higher than the exchange value and offer these goods for exchange against ones with a higher personal use value (p. 219).
The valuation of this tradeoff is not always easy. Correctly recognizing the economic value of goods is one of the most important economic tasks and thus the decision about which goods or which partial quantities to keep in one’s possession and which to sell represents one of the most difficult tasks of practical economic activities. The increase of the quantity of any good which is subject to a person’s disposal reduces the use value of each partial quantity of it. When this happens the exchange value predominates for the owner while, conversely, the reduction in the quantity of a good available to an economic subject usually results in an increase of the use value of this good, causing it to be retained from exchange.
These considerations apply also to commercial goods. The character of a good as a commodity is not something inherent in a good but is a special relationship between this good and a person. A specific good will cease to be a commodity as soon as the economic subject who has it at his disposal gives up his intention to trade but decides to use it himself. The minted metal immediately ceases to be a “commodity” if it is no longer intended by its owner for exchange but for some use purpose.
An important aspect of economic activity is the ease with which goods can be traded. There are limits to commerce in terms of the people to whom a good can be sold. The marketability of a good also depends on the locality in which it can be traded and on its quantity. Finally, goods are limited in their marketability in terms of the time limits within which they can find a market. These aspects are of tremendous importance for the use of money in exchange (p. 238).
At the historic beginning of economic activity, the interest of the people is focused on the use value of goods in terms of immediate satisfaction of needs. Only with economic development does the exchange value of a good enter the horizon of the people. It is hard for persons with opposite estimates of exchange value to find each other such that A has the good X to offer and wants good Y while B has Y to offer and wants X. For exchange to take place, A must esteem the value of the exchange good Y higher than that of the exchange good X, while B must have the opposite estimation and value the good X higher than Y.
Driven by the human urge to improve personal well-being, the economic interest will lead individuals to give their goods in exchange for some other good even if they do not need it for their own immediate purposes if this good is salable in an easy manner. These are goods that are accepted widely in exchange and therefore can also be converted against other commodities. Then, under the powerful influence of habit, a certain number of goods will be used more frequently and more willingly in exchange. Finally, one explicit good or a small number of specific goods will emerge as the general means of exchange. For this to happen, there is no need for legislative compulsion or any consideration for the public interest.
Without a plan or any official guidance, some specific goods emerge as generally accepted means of payment. The origin of money is thus entirely natural. “Money is not a state invention, it is not the product of a legislative act, and its sanction by the state authority is therefore alien to the concept of money in general. The existence of certain commodities as money developed naturally from economic conditions, without the need for state influence” (p. 257). Money is not the product of a formal agreement or something that was introduced by a state legislature. The origin of money is economic and appeared in different locations over time according to the ruling economic situations.
The commodity that becomes money results from its practical usefulness. As Menger points out, it would be an error to presume that the function of money as such is “a measure of value” and serves for the purpose of “preservation of value.” These functions are accidental to the nature of money and not contained in the concept of money (p. 279). In the exchange of goods, there are no equivalents in the objective sense and therefore money cannot serve as a measuring rod of the exchange value.
In a developed economy, not only can the satisfaction of desires be obtained by goods in use, but also by goods in exchange. Value results from satisfying desires. An exchange good represents an indirect kind of satisfaction. Both types of goods reflect the principle of valuation: use value in direct form, exchange value in indirect form. Exchange comes into play because people differ in their estimates of use value and exchange value of a specific good. Most goods have limited marketability. Their exchange would be limited without a general means of payment. However, as there are commodities that find a market almost everywhere, one good or a few of them will emerge to be used as a general means of payment, that is, as money.
This is the fourth part of the series on Menger’s Principles of Economics, which appeared 150 years ago in 1871. The first part treated the concept of a good, the second part presented Menger’s notion of the economy, and the third part treated the concept of value. (The more technical aspects will be treated in the final article of the series, which covers the formation of prices).