In a Market with Many Buyers and Sellers, the Price Reflects the Valuations of the Buyer Least Willing to Buy and the Seller Least Willing to Sell (the “Marginal Pairs”)

Menger sought to explain prices as the outcome of the purposeful, voluntary interactions of buyers and sellers, each guided by their own subjective evaluations of the usefulness of various goods and services (what we now call marginal utility, a term later coined by Friedrich von Wieser). Trade is thus the result of people’s deliberate attempts to improve their well-being, not an innate “propensity to truck, barter, and exchange,” as suggested by Adam Smith. The exact quantities of goods exchanged—their prices, in other words—are determined by the values individuals attach to marginal units of these goods. With a single buyer and seller, goods are exchanged as long as participants can agree on an exchange ratio that leaves each better off than he was before. In a market with many buyers and sellers, the price reflects the valuations of the buyer least willing to buy and the seller least willing to sell, what Böhm-Bawerk would call the “marginal pairs.” Regardless of the exact structure of the market, then, voluntary exchange takes place until the gains from trade are momentarily exhausted. Menger’s highly general explanation of price formation continues to form the core of Austrian microeconomics.

--Peter G. Klein, foreword to Principles of Economics, by Carl Menger (1976; repr., Auburn, AL: Ludwig von Mises Institute, 2007), 7-8.