7.3 Review: Prices and the market order

This resource contains a summary of some of the key concepts discussed in unit 7. Don't skip ahead - the information on this page is easier to understand if you have watched the video lecture and discussion seminar video in their entirety. Bookmark this resource to keep it handy during studying.

Lecture 7: Prices and the market order
  • An important implication of the use of money is that all prices are expressed in terms of one good. In an economy with money, money is one half of every transaction.
  • A barter economy with 10 goods would require 45 different prices, each expressing each good in terms of the other. But a money economy with 10 goods would require only 9 prices. (number of individual prices =n(n−1)/2).
  • A barter economy with 100 goods would require 4,450 different prices. But a money economy with 100 goods only has 99 prices.
  • A barter economy with 1,000,000 goods would require 500 billion different prices. But a money economy with 1,000,000 goods would requires 999,999 prices.
  • Expressing all prices in terms of one commodity leads to easier calculation. Individuals can compare all goods using one measure: the price in terms of money.
  • Individuals are able to produce a value scale: a ranking of goods in terms of individual preference.
  • Individual value scales determine individual quantity demanded at each price level. The quantities demanded by all individuals aggregate to the market demand at each price level.
  • Producer value scales determine the quantity supplied at each price level. The quantities supplied by all individuals aggregate to the market supply at each price level.



  • Law of demand: As price increases, the quantity demanded decreases.
  • Law of supply: As price increases, the quantity supplied increases.
  • The price point at which the quantity supplied equals the quantity demanded is the equilibrium price.
  • If prices were set at a price higher than the equilibrium price, the quantity supplied would be larger than the quantity demanded, i.e. there would be a surplus. This would lead to the price dropping, until it reaches the equilibrium price.
  • If prices were set at a price lower than the equilibrium price, the quantity demanded would be smaller than the quantity supplied, i.e. there would be a shortage. This would lead to the price rising until it reaches the equilibrium price.
  • It's better to think of the 'equilibrating process' instead of a fixed equilibrium. The world is not fixed, it isconstantly evolving and changing, and changes are constantly affecting the market. Equilibrium is, in a sense, never reached. But the drive to equilibrium is constantly altering prices. When QS > QD we get a surplus and a tendency for prices to fall. When QD > QS, we get a shortage and a tendency for prices to rise.
  • Speculation is what ensures that the prices clear and equilibrium is reached.
  • Prices of factors of production are also determined based on consumer demand.
  • The discounted marginal value product (DMVP) of a factor of production is the additional revenue this factor contributes to the business employing it, discounted to its present value.
  • Entrepreneurs will pay for an additional unit of labor, capital, or land as long as it costs less than its DMVP.
  • If hiring an additional worker for a day will add $10 of revenue to a business, that business will hire an additional worker if their wage demand is less than $10 per day.
  • If an entrepreneur is considering buying a machine that costs $1,000, he will buy it if the discounted marginal value product it produces over its lifetime is greater than $1,000.
  • Ultimately, it is the consumers' valuation of final goods that gives value to factors of production. The function of the entrepreneur is to pay for the factors of production before production has taken place, taking on the risk that consumers won't value it enough.
  • The value of factors of production, including labor, is only determined through the subjective valuation of consumers. It is futile to complain about wages or returns on capital. These are vital signals from the market telling individuals how valuable their labor, land, and capital are.
  • Entrepreneurs simply cannot decide wages for themselves and are slaves of the subjective valuations of consumers. If they decide to overpay for wages, they will lose their profitability and be replaced by entrepreneurs who pay the correct price.
  • If the entrepreneur decides to pay a lower wage, he would lose his workers to others who will pay them more.
  • Entrepreneurs and capitalists cannot oppress workers in a free market system, because workers can always leave to a competitor, or start their own businesses.
  • The consumer is king. Individuals are only sovereign in a market economy in their capacity as consumers. Producers are subordinate to the desires of consumers.
  • The market economy has steadily increased the real wages of workers, because the market economy is constantly finding new ways of increasing the value of human time.
  • Is the market a democracy? No. It's much better!
Last modified: Tuesday, July 27, 2021, 10:26 AM