While risk may be easy to understand by considering formal organizations and transactions designed primarily to deal with risk, its effects are pervasive far beyond such situations. Anyone who buys an automobile knows (or discovers) that he is not really buying transportation, but is in fact buying a given
The fact that costs differ vastly with respect to individual knowledge and preferences creates an opportunity for people who specialize in bearing particular kinds of risks. A farmer may have considerable knowledge of how to grow a particular crop, but little knowledge of the economic data or complex principles which cause the prospective price that he can expect for his harvest to vary by large amounts as of planting time. Someone else who has specialized in studying the economic facts and principles may have a much narrower range of expectations of future prices for that crop, even if he could not actually grow the crop himself if his life depended on it. Either individual could directly acquire the knowledge that the other possesses by investing the time needed for both the theoretical understanding and the practical experience to apply it. A less costly alternative may be to transact with one another on the basis of their existing knowledge. The farmer can reduce his risk at the cost of selling his crop during the planting season for somewhat less than the average of his range of expectations of prices at harvest time. If he thinks the price of his produce is going to range somewhere between sixty cents apiece and a dollar apiece, he might consider eighty cents apiece as his best guess, but accept seventy-eight cents apiece as a guaranteed price in advance — in effect paying someone else two cents apiece to take the risk off his hands. The buyer may accept this if he has either a more optimistic estimate, or reason to have much more confidence than the farmer in the same estimate of eighty cents apiece, or merely stronger nerves.
Buying for a guaranteed price and selling at whatever price later emerges in the market is a way of earning a residual claim to the difference. This residual claim may be a positive amount or a negative amount, as many a bankrupt speculator has learned. People who are not pure speculators may nevertheless engage in economic speculation as a part of their normal activities. A farmer who plants in the spring without any guaranteed price for his harvest the following fall is working as a speculator as well as a farmer, whether he thinks of it in those terms or not. A student who chooses to study for a particular profession is also speculating on the state of that profession in future years, as well as on what his own values will be in future years, since changing values may make him dissatisfied even if the profession itself is exactly as he foresaw it. Perhaps the greatest speculation of all is bringing a child into the world, where he may become the pride and joy of your life or cloud or destroy whatever happiness you may find from other sources.