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Wednesday, September 12, 2012

Price Interrelationships

Up to now we have considered the formation of prices only on a limited market, as if each time we had to do only with a particular market and a particular good. In truth, however, the several markets are more or less closely interconnected and to this fact we must now give a moment’s attention.
Markets are related to one another first in the general sense that supply and demand on one market are somehow affected by total demand and total supply on all other markets. If more of one good is suddenly demanded, less of some other good will be demanded. If small plane flying should become a popular sport, it is probable that the demand for baby carriages and baby clothes would decline since the incomes of most people would be insufficient for the upkeep both of an aeroplane and a numerous family. If bread and butter are expensive, the demand for books or furniture will suffer—one could give endless examples of this.
But besides this general interdependence of all markets, we find also a special and narrower interdependence of those markets which, in one way or another are directly “joined.”
The first example of such a joint relationship is the case of commodities which are substitutes for one another: margarine for butter, artificial for real silk, tea for coffee. It is clear that movements in the prices of such substitute goods will show a marked parallelism. These market relationships have an additional importance in that the possibility of substituting one commodity for another provides consumers with alternatives that tend to limit excessive price fluctuations.
Consider now a second and still closer interrelationship resulting from the so-called joint production of goods. This concept is taken to mean goods which are produced simultaneously by the same productive act, such as gas, coke, and tar in gas (or coke) production, or as iron and slag in foundry operations, or as wool and meat in sheep-raising. All these cases—and they are surprisingly numerous—of joint production present a most interesting variation from the usual type of price formation. Goods of this type are the Siamese twins of the economy, each of whom has its own life and would like to follow its own way but is nevertheless linked inseparably to the other. The salient point is that one of the linked goods cannot be produced without the other; their costs of production are joint and indivisible. It is of course true in this case as elsewhere that total receipts must cover the combined costs of production if production is to be maintained in the long run. The proportion in which the costs of production are shared by the jointly produced commodities (as reflected in their prices) is determined by the intensity of demand for the one and for the other commodity. If there is a greater demand for one of the products than for the other, the one for which there is the lesser demand must be sold at a price low enough to assure the disposal of what amounts to a “waste product.” Thus, if the demand for the principal commodity increases without a corresponding increase in demand for the by-product, there may result, by reason of the unavoidable joint production relationship, a marked fall in the price of the by-product. Consequently, those producers who are concerned solely with the by-product, may find themselves in a most vexing situation. A good example of this is silver which, in recent times, has been supplied largely as a by-product of copper and zinc production. Since the demand for copper and zinc has increased much more than for silver, a fall in the price of silver has ensued which—until the rise in silver prices in 1961-62—severely affected operations of mines engaged in the production of silver only.7
Consider next, as a final example of market interrelationships, commodities which are complementary to each other and which arc consequently jointly demanded. There are many such goods: ink, pens and paper; trout and white wine; collars and ties, etc. The understanding of this market relationship can be of real importance for those responsible for economic policy. If, for instance, it is desired to better the position of a given industry, an efficacious course of action might be to lower the price of a complementary good. One could, for example, bring about a preceptible improvement in the position of the dairy industry in many countries by lowering the tariff on coffee imports.

Economics of the Free Society

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