Let us forget about money for a moment. Producers own their tools and exchange directly in a barter economy.
I go to a baker. I have a few wooden boats I made. I want bread. I ask the baker if I can get some bread in exchange for wooden boats. We reach an agreement and exchange:
So 20 is the exchange ratio of a wooden boat for bread. You get 20 loaves of bread for a wooden boat.
Every exchange has a ratio. The question is what determines it. Maybe you say scarcity determines it.
Scarcity and surplus move the ratio
If wooden boats are scarce, buyers outbid each other in bread. The ratio rises. More suppliers join in to make wooden boats, and at some point there are too many wooden boats.
If wooden boats are plentiful, sellers compete with each other, bring down prices to grab the market share.
At some point production adjusts exactly to demand, the movement stops and the ratio settles.
Scarcity and plenty explain why the ratio moves. They do not explain why it stops where it does. That is the question.
When production adjusts exactly to demand, what explains the ratio?
Suppose production adjusts exactly to demand. There are 100 wooden boats for 100 people and 100 loaves for 100 people. No scarcity, no plenty.
I go to the baker again. The exchange has changed:
Scarcity and plenty explained the movement, and now the movement has stopped. They explain nothing. Something else is holding the ratio at 3 rather than 5.
Could it be culture or preference?
You say society values wooden boats in one town, bread more in another.
Lets say culture can move the ratio. Take two towns, A and B. In A, wooden boats are prized. The ratio starts high. But a producer in A lowers his ratio to undercut the others, buyers flock to him, and the others must follow. Competition pulls the ratio down. Over time the ratio in A drifts toward the same point as in B, if the conditions of production are the same.
So culture moves the ratio. But something pulls it back when it drifts.
The question is what.
What did they give up?
At this point a useful question that can be asked would be - what did they give up to make their products? The boat maker gave up hours cutting, joining and finishing. The baker gave up hours kneading, waiting for dough to rise and baking.
What each brings to the exchange is time already spent. So when they agree on a ratio, they are agreeing on how much of one person’s time trades for how much of another’s.
The tools count too. The boat maker built his own plane, and the hours spent building it are part of what the boat costs.
It is labour time
It is the ratio of the labour times needed to make the two goods. But in a society it is important to understand that it is it is the labour time required under average tools and average skill at a given time, not the time any one slow carpenter happens to spend.