§ 3. —As illustrated by trade in cloth and linen between England and Germany.

Mr. Mill still further illustrates the operation of the law of reciprocal demand by the case of a trade between England and Germany in cloth and linen, as follows:

“Suppose that ten yards of broadcloth cost in England as much labor as fifteen yards of linen, and in Germany as much as twenty.” This supposition then being made, it would be the interest of England to import linen from Germany, and of Germany to import cloth from England. “When each country produced both commodities for itself, ten yards of cloth exchanged for fifteen yards of linen in England, and for twenty in Germany. They will now exchange for the same number of yards of linen in both. For what number? If for fifteen yards, England will be just as she was, and Germany will gain all. If for twenty yards, Germany will be as before, and England will derive the whole of the benefit. If for any number intermediate between fifteen and twenty, the advantage will be shared between the two countries. If, for example, ten yards of cloth exchange for eighteen of linen, England will gain an advantage of three yards on every fifteen, Germany will save two out of every twenty. The problem is, what are the causes which determine the proportion in which the cloth of England and the linen of Germany will exchange for each other? Let us suppose, then, that by the effect of what Adam Smith [pg 397] calls the higgling of the market, ten yards of cloth, in both countries, exchange for seventeen yards of linen.

“The demand for a commodity, that is, the quantity of it which can find a purchaser, varies, as we have before remarked, according to the price. In Germany the price of ten yards of cloth is now seventeen yards of linen, or whatever quantity of money is equivalent in Germany to seventeen yards of linen. Now, that being the price, there is some particular number of yards of cloth, which will be in demand, or will find purchasers, at that price. There is some given quantity of cloth, more than which could not be disposed of at that price; less than which, at that price, would not fully satisfy the demand. Let us suppose this quantity to be 1,000 times ten yards.

“Let us now turn our attention to England. There the price of seventeen yards of linen is ten yards of cloth, or whatever quantity of money is equivalent in England to ten yards of cloth. There is some particular number of yards of linen which, at that price, will exactly satisfy the demand, and no more. Let us suppose that this number is 1,000 times seventeen yards.

“As seventeen yards of linen are to ten yards of cloth, so are 1,000 times seventeen yards to 1,000 times ten yards. At the existing exchange value, the linen which England requires will exactly pay for the quantity of cloth which, on the same terms of interchange, Germany requires. The demand on each side is precisely sufficient to carry off the supply on the other. The conditions required by the principle of demand and supply are fulfilled, and the two commodities will continue to be interchanged, as we supposed them to be, in the ratio of seventeen yards of linen for ten yards of cloth.

“But our suppositions might have been different. Suppose that, at the assumed rate of interchange, England had been disposed to consume no greater quantity of linen than 800 times seventeen yards; it is evident that, at the rate supposed, this would not have sufficed to pay for the 1,000 times [pg 398] ten yards of cloth which we have supposed Germany to require at the assumed value. Germany would be able to procure no more than 800 times ten yards at that price. To procure the remaining 200, which she would have no means of doing but by bidding higher for them, she would offer more than seventeen yards of linen in exchange for ten yards of cloth; let us suppose her to offer eighteen. At this price, perhaps, England would be inclined to purchase a greater quantity of linen. She would consume, possibly, at that price, 900 times eighteen yards. On the other hand, cloth having risen in price, the demand of Germany for it would probably have diminished. If, instead of 1,000 times ten yards, she is now contented with 900 times ten yards, these will exactly pay for the 900 times eighteen yards of linen which England is willing to take at the altered price; the demand on each side will again exactly suffice to take off the corresponding supply; and ten yards for eighteen will be the rate at which, in both countries, cloth will exchange for linen.

“The converse of all this would have happened if, instead of 800 times seventeen yards, we had supposed that England, at the rate of ten for seventeen, would have taken 1,200 times seventeen yards of linen. In this case, it is England whose demand is not fully supplied; it is England who, by bidding for more linen, will alter the rate of interchange to her own disadvantage; and ten yards of cloth will fall, in both countries, below the value of seventeen yards of linen. By this fall of cloth, or, what is the same thing, this rise of linen, the demand of Germany for cloth will increase, and the demand of England for linen will diminish, till the rate of interchange has so adjusted itself that the cloth and the linen will exactly pay for one another; and, when once this point is attained, values will remain without further alteration.”