David Ricardo (1817)

On The Principles of Political Economy and Taxation

Chapter 30: On the Influence of Demand and Supply on Prices

It is the cost of production which must ultimately regulate the price of commodities, and not, as has been often said, the proportion between the supply and demand: the proportion between supply and demand may, indeed,for a time, affect the market value of a commodity, until it is supplied in greater or less abundance, according as the demand may have increased or diminished; but this effect will be only of temporary duration.

Diminish the cost of production of hats, and their price will ultimately fall to their new natural price, although the demand should be doubled, trebled, or quadrupled. Diminish the cost of subsistence of men, by diminishing the natural price of the food and clothing, by which life is sustained, and wages will ultimately fall, notwithstanding that the demand for labourers may very greatly increase.

The opinion that the price of commodities depends solely on the proportion of supply to demand, or demand to supply, has become almost an axiom in political economy, and has been the source of much error in that science. It is this opinion which has made Mr Buchanan maintain that wages are not influenced by a rise or fall in the price of provisions, but solely by the demand and supply of labour; and that a tax on the wages of labour would not raise wages, because it would not alter the proportion of the demand of labourers to the supply.

The demand for a commodity cannot be said to increase, if no additional quantity of it be purchased or consumed; and yet, under such circumstances, its money value may rise. Thus, if the value of money were to fall, the price of every commodity would rise, for each of the competitors would be willing to spend more money than before on its purchase; but though its price rose 10 or 20 per cent if no more were bought than before, it would not, I apprehend, be admissible to say, that the variation in the price of the commodity was caused by the increased demand for it. Its natural price, its money cost of production, would be really altered by the altered value of money; and without any increase of demand, the price of the commodity would be naturally adjusted to that new value.

'We have seen,' says M. Say, 'that the cost of production determines the lowest price to which things can fall: the price below which they cannot remain for any length of time, because production would then be either entirely stopped or diminished.' Vol. ii. p. 26.

He afterwards says, that the demand for gold having increased in a still greater proportion than the supply, since the discovery of the mines, 'its price in goods, instead of falling in the proportion of ten to one, fell only in the proportion of four to one;' that is to say, instead of falling in proportion as its natural price had fallen, fell in proportion as the supply exceeded the demand.(66*) - 'The value of every commodity rises always in a direct ratio to the demand, and in an inverse ratio to the supply.'

The same opinion is expressed by the Earl of Lauderdale.

'With respect to the variations in value, of which every thing valuable is susceptible, if we could for a moment suppose that any substance possessed intrinsic and fixed value, so as to render an assumed quantity of it constantly, under all circumstances, of an equal value, then the degree of value of all things, ascertained by such a fixed standard, would vary according to the proportion betwixt the quantity of them, and the demand for them, and every commodity would, of course, be subject to a variation in its value, from four different circumstances:

1. 'It would be subject to an increase of its value, from a diminution of its quantity.

2. 'To a diminution of its value, from an augmentation of its quantity.

3. 'It might suffer an augmentation in its value, from the circumstance of an increased demand.

4. 'Its value might be diminished by a failure of demand.

'As it will, however, clearly appear that no commodity can possess fixed and intrinsic value, so as to qualify it for a measure of the value of other commodities, mankind are induced to select, as a practical measure of value, that which appears the least liable to any of these four sources of variations, which are the sole causes of alteration of value.

'When, in common language, therefore, we express the value of any commodity, it may vary at one period from what it is at another, in consequence of eight different contingencies:

1. 'From the four circumstances above stated, in relation to the commodity of which we mean to express the value.

2. 'From the same four circumstances, in relation to the commodity we have adopted as a measure of value.'(67*)

This is true of monopolized commodities, and indeed of the market price of all other commodities for a limited period. If the demand for hats should be doubled, the price would immediately rise, but that rise would be only temporary, unless the cost of production of hats, or their natural price, were raised. If the natural price of bread should fall 50 per cent from some great discovery in the science of agriculture, the demand would not greatly increase, for no man would desire more than would satisfy his wants, and as the demand would not increase, neither would the supply; for a commodity is not supplied merely because it can be produced, but because there is a demand for it. Here, then, we have a case where the supply and demand have scarcely varied, or if they have increased, they have increased in the same proportion; and yet the price of bread will have fallen 50 per cent at a time, too, when the value of money had continued invariable.

Commodities which are monopolized, either by an individual, or by a company, vary according to the law which Lord Lauderdale has laid down: they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production.

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