Why does the price of anything change? Forget the fancy things we trade like currencies, stocks, or commodity futures, but why does anything change in price? In fact, back up one more step: Why does anything even have a price to begin with? If you haven't taken time to devote yourself to learning this topic, you're leaving a giant hole in your knowledge base. It means that you're currently attempting to make a profit from the change in price of something without even knowing why its price is changing.
It will take some time to help explain this concept from the ground up, but it will be well worth your patience. To start, I'm going to take you back in time. It's a time where there are no computers, no phones, no communication devices of any kind. If you need to interact with somebody, you'll have to meet them face-to-face. Because of this lack of technology, any exchange of goods or services (food, clothing, house cleaning, anything) has to be done directly from one individual to another and that has to happen in person.
During this time, there are no such things as stocks, bonds, options, equities, or futures, and the only currency is called a “florp”. Florps are a universal currency used by everybody, everywhere in the entire world (so there is no such thing as a currency exchange). I know this is starting to get a little weird, but bear with me.
Understand that a florp is simply a piece paper with a boring scribbly design, a special mark of authenticity by the government that issued the florp, and a numerical value equal to the number of florps that this piece of paper is worth. Note that this, while very simplified, is essentially what any currency is.
In most cases where a trade takes place, one individual will trade a valuable item (like a classy hand-made shirt or some apples to eat) for any number of florps. Because florps are nothing more than a piece of paper with some ink on them, their actual practical value is limited, other than perhaps blowing one’s nose or helping start a fire. This doesn’t sound like a very smart trade. The only reason anybody would give up their precious possessions for useless pieces of paper is because those pieces of paper can just as easily be traded to somebody else for anything else (perhaps a new blanket or a strong axe for chopping wood).
For example, Aaron Applegrower gives his apples to Frank in exchange for florps, then later Aaron gives his newly-acquired florps to Bob Blanketweaver in exchange for a cozy blanket. This can be very helpful because if Bob doesn’t want or need apples, he won’t be willing to trade his blankets directly to Aaron for Aaron’s apples. Similarly, if Frank really needs apples and doesn’t have anything that Aaron wants, he won’t be able to eat. Not to mention, if Aaron doesn’t trade his apples quickly after picking them, they will spoil and rot; florps won’t.
Florps play the important role of being the “middle man” in the exchange of goods or services, but here comes the important question: “How many florps is an apple worth? What’s the price of a blanket (in terms of florps)?” There is no right or wrong answer. Remember that, because this is an exchange between two people, a “fair price” is simply a price that those two people agree on.
There are A LOT of factors that will influence the number that both people choose, but let’s not worry about that just yet. The end result is that both parties agree on the price, make the exchange, and go on with their lives. Returning to our example, let’s say Frank is willing to give up 2 florps for 1 of Aaron’s apples, meanwhile Bob has made it clear that he will trade 1 of his blankets for 10 florps.
Aaron walks to Frank’s house, exchanges 5 apples with Frank for 10 florps (2 florps per apple), then heads back home. After a long day, he gets a good night of sleep, then wakes up and makes the journey to Bob’s house. He arrives, gives Bob 10 florps, receives a blanket from Bob, then returns home.
Everybody seems to be satisfied, but a serious problem arises. Aaron has to waste a lot of time traveling and has many things he needs to acquire. He needs firewood, a new chair, some fresh eggs and milk, a new outfit, and a hammer; and he’ll have to get all of these things from different people. To make matters worse, they all want to trade their items for florps, not apples. Aaron has the burden of needing to sell his apples to different people to collect enough florps, and then go buy each item he needs from each individual.
Aaron isn’t the only one having problems. Harry Hammerbuilder, Charlie Chairconstructor, Donald Dairyfarmer, Wally Woodcutter, and Claire Clothescrafter all have to travel to sell their items or wait for customers like Aaron to show up at their homes. The planning is difficult (especially without phones or computers to communicate), the travel is hard, and the entire process is slow. Acknowledging this, everyone has a meeting and they devise a brilliant plan.
Instead of traveling from home to home, they will all meet in the town square each Saturday from sunrise to sunset. At this place, everyone can not only sell his or her items, but also buy anything they need from anybody else. Everyone jumps for joy at the thought of this! They think about all of the benefits: planning is specific and straightforward, traveling is cut to a fraction, more customers are available to sell items to, and more people are available to buy from. In contrast to the way they’re doing things now, this is revolutionary.
And they call this wonderful place a market.