Let’s modify our last exercise and move from a one time trade, into an ongoing series of trades. (please note I have no idea about birth rates and growth of baby animals, so correct me if you know)
John still raises chickens and he still wishes to eat steak. Likewise Bill still raises cows and wishes to eat chicken. Every 6 months they make a trade of 1 cow for 1 chicken.
The novelty of having a new type of meal – chicken, lasted a few trades for Bill. In time, however, Bill realized that 1 chicken provided him with only about 3 meals and 1 cow produced about 15 meals! Therefore when it was time for another trade Bill would negotiate based upon meal value - 5 chickens for 1 cow so that each would receive 15 meals.
Of course John did not like this new deal and wanted to stick to the old 1 for 1 trade, but Bill refused to make that deal. The value of John’s chicken’s had dropped 80%. John’s only choices were either to accept the new value or go without a cow. John decides to make the trade.
This new agreement continues for some time, until Bill realizes that every 6 months he produces 1 new cow and trades it away to John while John produces 20 new chickens and only trades 5 to Bill. John is able to build more and more chickens and Bill always stays static. Bill realizes the value of his cows is not just in the product they produce but in the comparative rarity – which is 1 cow to 20 chickens.
Prices and the value of goods can seem like voodoo, but supply and demand are always at the core. We see it clearly by looking at just 2 individuals involved in a trade. But the same simple principle applies to all goods and services. Is there a buyer for x? What are people willing to pay for x? What is involved in producing x? And as we’ve seen there is never a hard and fast value. Product value is a negotiation and a balance of supply and demand.
We can compare what we’ve seen so far to modern day products. Take electronics – upon release the demand is high, often supply low, and novelty is a factor. People will line up and pay high prices. But those prices are never sustained. Eventually the price comes down as the market decides what a product is really worth.