As regards the question of definition, Mill starts with the distinction somewhat loosely drawn by Adam Smith between value in use and value in exchange. When we say that a thing possesses a certain value in use, we say in more words than are necessary that it is useful: that is to say, value in use is an awkward phrase for utility. The conception of utility (see Wealth) is the most fundamental in economics. It is held by Mill to mean the capacity to satisfy a desire or serve a purpose, and thus “useful,” the corresponding adjective, is as fitly applied to ices as to steam-engines. But utility is obviously much wider than value, and Mill proceeds to say that by value in political economy we should always understand exchange value. This language seems familiar and definite, but on analysis it is clear that exchange implies two terms at least. If we say that a thing can be exchanged, we imply that it can be exchanged for something else, and when we speak of the exchange value of a thing we must directly or indirectly refer to the value of some other thing or things. In practice in modern societies this other thing is standard money: an Englishman who talks of the exchange value of anything means the number of pounds sterling (or parts thereof) which it will fetch in the market or be appraised at by a fair arbitrator. On this view then the value of a thing is its price; but a very little experience in the theory or history of economics will show that it is often desirable, and sometimes necessary, to contrast value with price. “At the same time and place,” says Adam Smith, “money is the exact measure of the real exchangeable value of all commodities. It is so, however, at the same time and place only.” If, however, the exchange value of a thing is not its price, what is it? According to Mill, “The value of a thing is its general power of purchasing, the command which its possession gives over purchasable commodities in general.” But what, we may well ask with Mill, is meant by command over commodities in general? Are we to understand the complete national inventory of wealth, or the total of things consumed in a given time by a nation? Obviously such conceptions are extremely vague and possibly unworkable. If, however, we make a selection on any representative principle, this selection will be more or less arbitrary. Mill is to some extent aware of these difficulties, although he never subjected them to a rigorous analysis; and he points to the obvious fact that a coat, for example, may exchange for less bread this year than last, but for more glass or iron, and so on through the whole range of commodities it may obtain more of some and less of others. But in this case are we to say that the value of the coat has risen or fallen? On what principles are we to strike an average? The attempt to answer these questions in a satisfactory manner is at present engaging the attention of economists more than any other problem in the pure theory. Mill, however, instead of attempting to solve the problem, frankly assumed that it is impossible to say except in one simple case. If, owing to some improvement in manufacture, the coat exchanges for less of all other things, we should certainly say that its value had fallen. This line of argument leads to the position: “The idea of general exchange value originates in the fact that there really are causes which tend to alter the value of a thing in exchange for things generally, that is, for all things that are not themselves acted upon by causes of similar tendency.” There can be no doubt as to the truth of the latter part of this statement, especially if we substitute for one commodity groups of commodities. But it is doubtful if the idea of general exchange value arises from a consideration of the causes of value; and recent writers have constantly emphasized the distinction between any change and the causes of the change. Following out the idea in the last sentence quoted, Mill goes on to say that any change in the value of one thing compared with things in general may be due either to causes affecting the one thing or the large group of all other things, and that in order to investigate the former it is convenient to assume that all commodities but the one in question remain invariable in their relative values. On this assumption any one of them may be taken as representing all the rest, and thus the money value of the thing will represent its general purchasing power. That is to say, if for the sake of simplicity we assume that the prices of all other things remain constant, but that one thing falls or rises in price, the fall or rise in price in this thing will indicate the extent of the change in its value compared with things in general. There can be no doubt that, in discussing any practical problem as to the changes in the relative value of any particular thing, it is desirable to take the changes in price as the basis, and much confusion and cumbrousness of expression would have been avoided in the theory of the subject if, to adapt a phrase of Cournot’s, money had by Mill and others been used to oil the wheels of thought, just as in practice it is used to oil the wheels of trade.

By this method of abstraction the treatment of the theory of value becomes essentially an examination of the causes which determine the values of particular commodities relatively to a standard which is assumed to be fixed. Now in order that anything may possess value in this sense, that it may exchange for any portion of standard money or its representatives, it is evident on the first analysis that two conditions must be satisfied. First, the thing must have some utility; and secondly, there must be some difficulty in its attainment. As regards utility, Mill apparently regards it simply as a kind of entrance examination which every commodity must pass to enter the list of valuables, whilst the place in the list is determined by variations in the degree of the difficulty of attainment. Later writers, however (more particularly Jevons), have given much more prominence to utility, and have drawn a careful distinction between final and total utility. This distinction is useful in throwing light on the advantages of, and motives for, exchanging commodities. Suppose that on a desert island A possesses all the food, so many measures—(say) pecks—of corn, and B all the drinking water, so many measures—(say) pints. Then A, taking into account present and future needs, might ascribe to the possession of each portion of his stock so much utility. The utility of the first few pecks of corn might be regarded as practically infinite; but, if his stock were abundant, and a speedy rescue probable, the utility ascribed to successive portions would be less and less. In the same way B might make an estimate of the utility of successive measures of the drinking water. Now, if we regard only total utilities from the point of view of each, both are infinite. If an exchange were made of the total stocks of both men, the position of neither would be improved. But, if A sets aside (say) half his stock, then it may well happen that he could advantageously exchange the rest against part of B’s drinking water. In precisely the same way B might set aside so much of his stock for his own consumption, and then the utility of the remaining portion would be much less than the utility he would gain if he obtained in exchange A’s surplus. Thus, if the two men exchange their remainders, both will gain in utility; in the case supposed they will make an enormous gain. For simplicity we have supposed each stock to be divided into two portions, but nothing has been said of the principles of the division. It is, however, clear that A can advantageously go on exchanging a measure of corn for a measure of water so long as by doing so he makes a gain of utility. Conversely B can advantageously offer water so long as he gains greater utility from the corn received in exchange. The utility of the last portion of corn retained by A (or of water by B) is the final utility of the stock retained, and similarly the utility of the last measure obtained in exchange may be called the final utility of the stock purchased. A will have done his best if these utilities are just equal. For at this point, if he were to offer (at the same rate of exchange) more corn, it is clear that he would lose more utility than he would gain. Mutatis mutandis, the same reasoning applies to B; and thus the rate of exchange will be so adjusted as to bring about this equality of final utilities on both sides. It follows that, if A gains on the last portion received just as much utility as he loses on the portion parted with, on all the other portions received he will have gained more than he lost. The total of these gains over successive portions has been called by Prof. Marshall consumer's rent.

However useful this theory of final utility may be in throwing light on the fundamental nature of value, and on the advantages of exchange, it is obviously too abstract to be applied to the explanation of the relative values of the endless series of commodities and services which constitute a nation’s stock of valuables at any time. For this purpose we must resort to the law of supply and demand, which requires a very careful statement owing to the ambiguities of popular language. Mill has succeeded in getting rid of most of these ambiguities, but he has hardly given due emphasis to the fundamental character of the law. He argues, after the brief consideration allotted to the element of utility, that the other preliminary condition necessary for value—difficulty of attainment—is not always the same kind of difficulty, and he arrives at three distinct laws of value, according to three forms or degrees of this difficulty. (1) In the first place the difficulty may consist in an absolute limitation of the supply, and in this case the corresponding law is said to be the law of supply and demand. Even on Mill’s view the class of commodities which comes under this heading is both large and important, for it includes not only the favourite examples of old pictures, china, &c., but also land, and especially building sites in large cities. Again, it is pointed out that, although comparatively few commodities may be absolutely limited, almost all commodities may be so locally and temporarily, which is really only another way of saying that the law of supply and demand governs all market values; for it is obvious that the supply actually forthcoming or obtainable in a specified time in any market is limited,—a point which may be well illustrated by the extreme case of a “corner.” Again, under certain circumstances the supply may be artificially limited, as in the case of monopolies, a typical example being the destruction by the Dutch of some of their spice, in order that the limited quantity might sell for a total higher price. Besides all these important instances of the operation of the law of supply and demand, Mill is compelled also to bring under the same law the wages of labour, the values of the staples of international trade, and some other peculiar cases of value. In fact, step by step he is almost forced to the conclusion, now generally accepted, that the law of supply and demand is the fundamental law of value, of which the other laws are only particular cases. At the outset, however, he appears to consider the two others as of co-ordinate importance. (2) When the difficulty of attainment consists not in the absolute limitation but simply in the fact that the article requires labour and capital to produce it, the normal or natural value is said to be determined by the cost of production. (3) In the last case taken by Mill it is supposed that an article can be increased in quantity, but only at an increasing cost, and in this case the corresponding law of value is the cost of production of that portion which is obtained under the most unfavourable circumstances. These three laws of value may now be examined critically and their mutual relations discussed, for the last two, if not properly of coordinate importance with the first, are at any rate wide generalizations.

In order to understand the law of supply and demand, it is best to take separately the general law of demand and the general law of supply, and then effect a combination. Demand must be defined as the quantity of any article demanded at some particular price, it being assumed of course that the bidder of the price can meet his engagements, or, as is sometimes said, that the demand is an effectual demand. It is quite clear that by demand we cannot simply mean desire to possess, because in a sense every one desires everything, and the less the means of payment so much greater in general is the desire. Again, it is obviously necessary to insert the qualifying clause “at some particular price,” because, as a rule, with a change in price a different quantity will be demanded. It is, indeed, this variation of quantity demanded, according to variation in price, which gives rise to the statement of the general law of demand, namely: As the price of any article falls, other things remaining the same, the quantity demanded increases, and, conversely, as the price rises the quantity demanded decreases. A very good example of this law is found in the effects of the remission of taxes. The repeal of a tax leads to a fall in price and the fall in price is accompanied by increased consumption. Conversely, it has often been found that to increase the amount of a tax does not increase the revenue from it, because the demand for the article falls off. The precise connexion between the price and the quantity demanded differs in different cases, and, strictly speaking, is probably never the same for any two commodities. At the same time, however, commodities may be placed in large classes according to the general character of the variation. The variation of quantity demanded according to price will ultimately rest on the principle of final utility explained above. A person with a limited amount of money to spend will hit the economic mark in the centre if the final utilities of his several purchases are equal. This is a rather technical way of saying that a prudent man will not spend a penny more on any particular thing if the penny spent upon some new object would give him a little greater satisfaction. Reverting to the variations of demand according to price, a contrast will at once be observed between necessaries and luxuries. However much the price rises, so long as people have the means they must consume a certain amount of necessaries, but, however much the price falls, the limit of consumption of bread, for example, must soon be reached. On the other hand, a great fall in price of many luxuries may cause an enormous increase in the demand, whilst a great rise may almost destroy the demand. A great deal of light might be thrown on many interesting problems in the progress of a nation and of its various component classes, if the laws of demand, or the statistics of consumption according to price, were obtainable.

Turning to the element of supply, this term in a similar way may be defined as the quantity offered for sale at some particular price, and the general law of supply may be stated thus: As the price rises, other things remaining the same, the quantity offered tends to increase, and, conversely, as the price falls the quantity offered tends to diminish. Expressed in this manner, supply appears to be exactly analogous to demand, and the analogy seems to hold good even when we push the analysis up to the utility to the seller as compared with the utility to the buyer. For, as the price rises, the seller will obtain greater utility, and will thus retain less for his own use or will be induced to produce more. On closer inspection, however, the law of supply is found to be not so simple as the law of demand. It would only be so if the seller had simply to compare the relative advantages of exchanging his commodity and of retaining it for his own use, without any further reference to the conditions of, or the motives for, production. In most commodities, however, the determining influence is not the comparative utility of consumption by the owner on the one hand or of the consumption of something else obtained by exchange on the other, but it is rather a comparison of the trouble of producing with the advantage of selling the article when produced. Of course, if we are considering finished products in any market the case is more simple; but even here the question of the relative advantages of present sale and reservation for a future market or distant place must be determined, and then the element of cost of production will again be brought back.

Before considering the relation of cost of production to supply, it will be convenient to combine the laws of supply and demand, taking the former in its simplest aspect, and to state the general law of supply and demand as governing value. Excluding the simple case of the barter of two commodities of which the rate of exchange will be determined as explained above in reference to final utility, and meaning by demand the quantity demanded in a market at a certain price, and by supply the quantity there and then offered at a certain price, the general law may be stated thus: In any market the price of any article will be so adjusted that the quantity demanded will exactly equal the quantity offered at that price. The force by which the adjustment is made is, in general, competition. Thus, if the price were above the point indicated by the law, there would be a lessened demand and the competition of sellers would tend to lower the price. Conversely, if the price were lower the competition caused by the increased demand would tend to raise it. The law as thus stated corresponds to what Mill calls the equation between demand and supply. He was induced to adopt this phrase in place of the more popular expression, the ratio of demand to supply, on the ground of its greater accuracy. And, if the term ratio is to be taken strictly, no doubt Mill’s criticism is perfectly just. At the same time the equation must be stated very carefully to avoid falling into the truism suggested by Cairnes, namely, that in any market the quantity bought at any price is equal to the quantity sold at that price. The point is that in accordance with the general principles of supply and demand the quantities offered and demanded vary with the price. And, however inaccurate the literal use of the term ratio may be, it has the advantage...