Money and the Market Process

Money is the crucial institution that underpins the market process. To the extent that commerce is orderly, it is due to the coordinating features of markets. Quantities supplied tend to match quantities demanded over time. This in turn is due to the communication between producers and consumers that money enables. Consumers can rank their consumption preferences, but this preference is purely subjective and cannot be extended beyond the mind that performs the ranking process. But consumers can communicate their preferences through the medium of money. What was purely subjective now becomes “intersubjective”: consumers can give producers information for adjusting production plans to meet consumer demand because money prices provide a mutually intelligible metric for how the adjustment process should proceed.

Producers use money prices to compute profits and losses. The prices of their inputs are used to ascertain cost; the prices of their outputs are used to ascertain revenue; profits are the latter less the former. Money thus allows producers to reduce incredibly complex production choices to a comparatively parsimonious metric that helps them know whether they’re doing things consumers like. Profits are consumers’ way of telling producers they like what producers are doing and would like to see more of it. Losses are the opposite: consumers’ way of telling producers they dislike what producers are doing and would like to see less of it. Because money prices in market economies reflect opportunity cost, profits (or losses) for firms also reflect the creation (or destruction) of wealth not just for private parties, but for society as a whole.

Of particular importance is the role of money prices in helping producers choose least-cost production methods. As Ludwig von Mises argued, the use of money and profit-and-loss accounting helps firms cope with the intricacies of heterogeneous production plans. For any given product, there are multiple ways that product can be produced. Which should firms choose? If you are a railroad executive tasked with building a new branch line, and you can use steel or titanium for your rails, which should you pick? The obvious answer is steel: although titanium’s metallurgical properties are such that titanium will make tougher, more durable rails, the additional benefits gained by using titanium are almost certainly not worth the additional costs incurred. Railroad passengers simply won’t pay ticket prices high enough to cover the costs of titanium rails. The ticket price for a titanium-using railroad is higher than the value consumers place on the next-best use of the resources used to buy tickets. But you could not know this in the absence of a money-using market economy, which enables comparative forecasts of the profitability of different production methods. Money not only helps producers get consumers the things consumers want; it helps producers get consumers those things as cheaply as possible.

These are all familiar arguments for the power of markets, but the point is rarely made that money is just as necessary in these arguments as are markets. A market economy without money would simply not be able to achieve a sufficient division of labor to make questions of steel vs. titanium rails a live issue. Not even the most rudimentary calculations concerning the profitability of labor-intensive vs. capital-intensive production processes would be feasible without money. When expressing gratitude for the economic bounty of liberalism, don’t just thank exchange. Thank the medium of exchange as well.

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Alexander W. Salter

Alexander W. Salter is an Assistant Professor of Economics in the Rawls College of Business and the Comparative Economics Research Fellow with the Free Market Institute at Texas Tech University. His research interests include the political economy of central banking, NGDP targeting, and free (laissez-faire) banking. He has published articles in leading scholarly journals, including the Journal of Money, Credit and Banking, Journal of Economic Dynamics and Control, Journal of Financial Services Research, and Quarterly Review of Economics and Finance. His popular work have appeared in RealClearPolitics and U.S. News and World Report.

Salter earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Occidental College. He was an AIER Summer Fellowship Program participant in 2011.