Trade is a skill available to players and NPCs. Ranks in this skill reduce the difference in price between what you can purchase goods for and what you can sell goods for by 5% per rank. As a party skill, if your character has 10 ranks in Trade, you can have a maximum effective skill level of 14, worth a 70% reduction in the trade penalty.
In any given settlement, there will be the base value assigned to specific goods which can be influenced by a buy price (what you pay), a sell price (what they pay), and a market supply modifier (based upon local abundance or scarcity of that type of commodity).
With no skill in trade, you purchase commodities for 110% of their base value multiplied by their market supply modifier, and sell commodities for 90% of their base value multiplied by their market supply modifier. With the maximum trade skill, you can change these to purchasing at 103% and selling at 97%, giving you an edge in expanding your profit margins, although exploiting market supply, even with no skill, will always yield far more profit than simply reducing the penalty you have in trade alone will.
Weapons and armor (which you can acquire in abundance from fallen enemies), however, have a radically different trade penalty, with you purchasing arms and armor at around 200% of their base value, and selling at around 20% of their value before trade skill comes into play. This is to ensure that simply looting the corpses of enemies isn't far more profitable than any other way of making money in the game.
Trade skill will also affect how long it takes to collect taxes.
Every town and village in the game will produce several different kinds of goods. Generally, villages only produce "raw material" goods like wool, grapes, or chicken, while towns have the industry to create "finished product" goods like wool cloth or wine.
Villages produce raw materials based upon the village prosperity, with more prosperous villages producing more goods.
Towns, meanwhile, consume raw materials when they produce finished product goods. Producing a unit of wool cloth consumes a unit of wool, and since towns do not produce their own raw materials, they are dependent upon their villages supplying them (and by extension, their peasants not being attacked on the road to the town when they go to trade).
Some goods are neither raw materials for other products generated at villages, nor finished products produced from an associated raw material item generated in towns. These goods can be produced either by villages or towns, although it is worth noting that most of these goods are foods only produced in villages. If towns produce these products, however, such as spice being produced at Tulga, they are produced directly at the town itself, and do not require any trade or any villages to produce that item, and production is based solely upon that town's productivity score, bypassing the need for villages for that one type of product.
Players can also own a Productive Enterprise at a town, which will produce finished goods from raw materials just like towns will, but where the productivity of the facility is fixed. A player-owned ironworks will turn 2 iron into 2 tools regardless of town productivity, which may be a lot or a little depending on the relative prosperity of the town.
The villages attached to castles will send their peasants to the nearest town of their own faction, supplying that town with their raw materials. In the event that a castle is taken far from the rest of the faction (such as Vaegirs taking a Rhodok castle), this can result in a long and vulnerable trade route for the peasants to follow, but occasionally providing towns with access to goods they normally would not have, and potentially upsetting normal town supplies of certain goods if they rely upon a castle village whose castle was taken by an enemy faction.
Villages and towns also consume certain commodities at a given rate. Food items, for example, tend to be consumed fairly quickly and regularly. Raw material items are consumed only in the production of finished goods unless they are also food items (like grapes). Some items, like Velvet, are rarely used, so almost no town will actually have shortages of that product.
Supply and DemandEdit
The entire model of "supply and demand" is based around a "market supply modifier", which is a number that multiplies the value of a given type of good. This is ultimately just a simple number for each type of trade good for each town and village in the game that tries to abstract the complex concept of Supply and Demand without having to track how many of each village has of which goods. While the items in the market are the "Supply" of a given market, the presence or absence of these items ultimately doesn't matter to the price of goods or productivity in a town or village, only the market supply multiplier does. This is probably to represent a supply that is simply not for sale, but the mechanics of the system are sometimes off. Even while this is just a single simple value, however, the sheer number of these simple values, and the way in which they interact with one another, ultimately creates a complex and difficult-to-predict market.
Talking to the Guild Master about trade in a town will let you see all of the goods whose market supply multipliers are over 1100, with the format of saying something like, "We have shortages of Trade Good (1234), and other commodities," where the (1234) is the market supply modifier, representing, in this case, prices that are 123.4% of that product's true price. (There is no way to directly see the market supply modifier of a village, you can only infer through the prices they will trade at). A market supply modifier of 1000 is an "average" price, where goods are worth exactly their base value (plus or minus your trade penalty when you actually buy or sell). When the market supply modifier goes up, goods are bought and sold for more, and "shortages" occur when the value is over 1100 (which means 110% normal prices), and villagers from other towns will start to tell you that you can get "very high prices" of a good at a market supply modifier of 1300 or more (when they buy and sell for 130% or more of the normal value). Market supply multiplier values below 1100 are never directly displayed, although they can be inferred through understanding the other mechanics of pricing.
Over time, as towns and villages consume products, the supply multiplier rises, and when goods are produced, that lowers the supply multiplier. Likewise, purchasing goods raises the supply multiplier of a good, and selling lowers the supply modifier of a good.
It is important to note that every time you buy or sell a good, the market supply modifier for that good changes at the moment that you have transferred the good. The magnitude of the impact of each unit you buy or sell varies depending upon the type of good and size of the market you are buying and selling from, but generally, you can expect the price to change by about 2% or 3% of the base value (the market supply modifier will go up or down about 20 to 30 points) each time you make a purchase or sale. This applies before you can sell the next item in your inventory, meaning that if you purchase and sell 6 units of a single type of good at a time, the price of the sixth unit will be 10% to 15% higher or lower than the price of the first unit. Hence, buying and selling in bulk ultimately winds up diminishing your overall per-unit profit margins.
Although one should not generally purchase and sell the same good from the same market, it is worth noting that purchasing a unit of a trade good and then selling it back to the same market will not result in the town having the same market supply modifier as before you purchased and sold that unit. For example, selling a unit of Ale at 140 denars, leaving the menu, returning, purchasing it back, leaving the menu, then returning again, will show the price of that same unit of Ale to now be selling at 138 denars. In other words, selling goods to a town in a "shortage" of a certain good will cause that good's market supply modifier to go down by a greater amount than buying that good back will cause it to go back up. The cause of this discrepancy is currently unknown, but may have to do with a quadratic change in the market supply modifier as the modifier becomes higher (reflecting more desperate shortages of a good), or may have to do with the overall impact that a purchase or sale to a market will have on the market supply modifier is at least partially based upon the overall number of goods that are in the market at that time.
Furthermore, you can "exchange" goods like a 1/30 unit of cheese for a 30/30 unit of cheese, but while the game pays less for a mostly-eaten unit of food, it actually still counts exactly the same as a full unit of food. Doing that exchange of 1/30 cheese for 30/30 cheese while there is a minor shortage will actually wind up dropping the price of cheese by 1%, as if there were more cheese in the market after buying a full wheel of cheese, and selling back only crumbs, rather than there being less cheese (and higher prices) that one would rationally expect.
To get around this issue, it may be advisable to purchase items in bulk where they are cheap, and then sell them only one or two at a time at each town or village you come across until you have sold them all to prevent the price of the goods from dropping too far.
Unlike real life, the "supply and demand" system of Mount&Blade only seems to demonstrate the "supply" portion of the economics picture. When prices for beef get too high, townspeople will not just eat more pork instead (this principle of economics being called a "substitute good"), nor will low beef prices drive down demand (and hence prices) for pork.
Likewise, what is called the "elasticity of demand" (which explains how much price impacts whether or not customers will consume a product) has only rudimentary implementation. Towns that produce bread, for example, but cannot import enough grain, will continue to make bread even after the supply multiplier has been pushed to the point where the grain is more valuable than the bread they are turning it into. (This is especially obvious with Dhirim's bread/grain supply and Ichamur's wool cloth/wool supply). While this is unconfirmed, the only function of a shortage seems to be that the greater the shortages of goods become, the more impaired productivity becomes in general, meaning that they will still be turning wool into wool cloth even after they have "run out of wool", just at a lower rate.
This ultimately means that the largest "shortages" (and hence, the largest swings between how low you can purchase the product and how high you can sell the product) will occur only on "raw material" goods, like iron or flax, between towns and villages where much of that material is produced, but none of the related "finished product" goods are produced (and hence, with nobody consuming them, the market supply multiplier only goes down over time), and selling them to the towns where that raw material is not produced, but the finished product for that raw material is produced (and hence, supply is continually exhausted, but never renewed without trade).
It is important to note, however, that there are no cities where prices for some goods are automatically very low or high - prices fluctuate solely upon the rates of production and consumption in the market. Because each village and town tends to keep producing the same goods, and tends to have voids in their production in the same goods, however, (outside of player-owned facilities which can drastically change local supply,) there are some very predictable patterns for where prices for one good will be cheap, and another will be expensive.
For example, in Warband, the town of Halmar produces Bread, Ale, Wine, Leatherwork, Tools, Wool Cloth, Pottery, and Oil. Its only directly attached village is Peshmi, which produces Pork, Chicken, Bread, Grain, Sausages, Hides, and Wool.
Without the support of castle villages, and assuming Peshmi is not continually looted and raided, this means that four of the eight products of Halmar (Bread, Ale, Leatherwork, and Wool Cloth) are produced from raw materials produced by Peshmi, and as such, prices will generally be dependant upon how much Peshmi is raided, but usually fairly low for these finished goods. One of the eight products of Halmar (Pottery) is a direct product of Halmar, and needs no supply from trade to produce, although they produce more than they need, causing Pottery to typically be inexpensive in Halmar so long as it maintains high productivity. Wine, Tools, and Oil, meanwhile, are produced in Halmar, but the raw materials (Grapes, Iron, and Olives) are not, causing the prices for these raw material goods to become unusually high when Halmar has high productivity.
Meanwhile, neither Halmar, nor its villages produce or use as raw materials Velvet, Raw Silk, Dyes, Linen, Flax, Furs, Date Fruit, Honey, Dried Meat, Smoked Fish, and other food items. The raw materials Raw Silk, Dyes, and Flax, therefore, will only have average or low prices, even though they are not produced there, because they are never consumed in the production of finished products. The food items and goods like spices and furs may have higher or lower prices, depending on how much of those products that particular market likes to consume, although consumption of these types of goods tends to be much slower than consumption of raw materials, so places where prices were once high can be brought down low if you try to exploit a trade route too frequently.
Halmar is a town that is frequently visited by caravans by virtue of its central location, however, which means that its lack of supply from its villages can often be mitigated by caravans trading at Halmar. A town further on the edges of the map will often have more extreme variations between the market supply modifiers of the goods it produces itself and the ones it must import than a town near the center of the map.
The nearby castle village of Ehlerdah, attached to Reindi Castle (initially owned by Swadia) will also provide Pork, Chicken, Bread, Grain, Fruit, Cabbages, Iron, Wool, and Pottery to Halmar if Reindi Castle is in the possession of the same faction as the one that holds Halmar. If this is the case, Iron will no longer fetch such a high price at Halmar's market, as Iron can be supplied to Halmar through one of its villages. Likewise, Fruit and Cabbages will become available, and Pork, Chicken, Bread, Grain, Wool, and Pottery will all become less expensive for as long as Ehlerdah can produce and supply Halmar with its goods.
In this way, the tides of battle can have an indirect impact on the layout of the most profitable trade routes.
Also, some of the most drastically cheap goods occur when villages produce a raw material, but towns do not make their finished products. Rivacheg and Jelkala are the only two towns that usually have villages that produce Raw Silk in their area, but Jelkala produces Velvet from that Raw Silk, and as such, Raw Silk can sometimes be more expensive in Jelkala than even in towns which do not produce Raw Silk at all (since they do not consume any of it, either). Rivacheg, meanwhile, will almost always have the cheapest Raw Silk prices in the game, as they produce quite a bit, but use none of the product.
Because you can purchase land for your own industries to turn raw materials into finished products for your own profit, the locations where raw materials are produced, but not the finished products, are the ideal locations to set up facilities that make those finished products, as your raw materials will be as cheap as they possibly can be, and you face the least competition for the products you sell. Rivacheg, then, is a great place to set up an extremely profitable velvet weavery and dyeworks (which can often produce as much as 1300 denars a week all by itself). Other towns featuring these opportunities are Dhirim, which has plenty of cheap grain, but no breweries of its own, and Curaw, whose villages produce iron but where there is no production of tools.
Some goods are very heavy and thus slow down your party. The weight penalty can be partially offset by keeping horses in your inventory (rule of thumb is to keep one horse per five units of *heavy* inventory, but experiment to find optimal level). The quality of the horses is irrelevant to their ability to act as pack mules; a Lame Sumpter Horse will give you the same bonus to carry weight/speed ratio as a Spirited Courser, so stock up on Lame and Stubborn horses (or better yet, just keep the horses that you take from Steppe Bandits for free) to save money.
As a final note, selling goods to the Book Merchant means that the book merchant will buy goods at the price that those goods trade for in that town. While it is perhaps a bug, he will continue to carry those goods in his own inventory to other towns, where the prices will change, potentially giving you a chance to sell goods to the book merchant and then buy those exact same goods back from him in a different town at a lower price, only to sell them back to him again in another town for even more profit. This also affects the local market supply modifiers, even though the "actual goods" you have traded never hits those markets, and the goods will leave town along with him.
In the actual trade screen, it is possible to make transactions with few Denars changing hands. Because transactions only occur once you click "return," you can first select items you want from the merchant's inventory, and then pick items to sell him back. In the middle of the screen, it shows who will have to pay who how many Denars once "return" is selected. In this way, you can in effect purchase goods with goods. This method is also helpful if the merchant doesn't have enough Denars to buy all of your loot, you can simply trade your loot for something of his that you like.