Austrian Economics - Value

Value

The concept of value can be a little challenging to fully grasp but for our purposes let's keep it as simple as possible and again work from the ground up. Our first step has to be the understanding that value is far more than just getting a 'cheap price' on something. In many cases, the cheap price does not represent value at all, at least not in the 'good' sense. Can that low priced computer that subsequently blew up be considered good value? Let's do our best for the time being to disconnect the idea of price tag and value entirely.


We'll start our trek into value with a definition. From a dictionary standpoint:

wiktionary.org said

  1. The quality (positive or negative) that renders something desirable or valuable.
  2. The degree of importance given to something.
  3. That which is valued or highly esteemed, such as one's morals, morality, or belief system.
        He does not share his parents' values.
        family values
  4. The amount (of money or goods or services) that is considered to be a fair equivalent for something else.
  5. Any definite numerical quantity or other mathematical object, determined by being measured, computed, or otherwise defined.
value - Wiktionary
Great, now we're back to a whole bunch of stuff to consider and getting further away from simple. Let's put it all in the metaphorical blender and condense the lot into something meaningful and easy to digest.

Carl Menger said

"Value is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men."

Principles of Economics, chapter 3.
In other words: given the limited supply (scarcity) of all goods available to a person, a person who, by their very nature, would like to get the most for the least (economize), will place a judgement of importance of these goods, a ranking, a scale of valuation. This value scale exists only in the minds of humans therefore the concept of value does not exist outside of our conciousness.

Value is the relationship between two choices. Generally we can't have our cake and eat it too, so we choose one end over another, the cost being the end given up. This happens at a specific point in time. Further, a value scale is a dynamic thing, very often changing due to circumstances, environment and mood. Generally I prefer (value) pizza higher than a hamburger but sometimes, even if a pizza joint is situated right beside the burger joint, or perhaps the burger joint further away from the pizza place, I'll choose a burger over pizza. Two things here:
  • at this point in time my value scale has modified to elevate a burger over both a pizza and the monetary representation of the market price: I value chowing down on the burger more than the $x.xx I paid for it)
  • the cost of this choice is the end forgone, in this case the pizza
Poking around a little deeper: when a person purchases a newspaper at a sidewalk vendor for $1, this means that at that point in time, the person valued the newspaper more than they valued the $1 and conversely the vendor valued the $1 more than they valued the newspaper. This can easily change however: you have already read a newspaper found on the subway so when passing the street vendor, the $1 most likely now ranks higher than the newspaper in your value scale and you probably won't purchase one. Additionally, it might be the end of the day, the vendor has sold most of his newspapers and has a pressing engagement to attend to. He now values the engagement more than the $1 and will close up shop for the day despite any left over newspapers subsequently being valued by consumers at $0 the next day when the vendor reopens.

Water for example would have a higher importance or value to you than a doughnut on any given day, but that doesn't mean that you don't value a doughnut pretty high from time to time. If you have a belly full of water, now the doughnut may have a higher ranking despite the fact that it is not a life giving requirement. As a side note, water is often used in conjunction with diamonds to outline a paradox, see the utility section below for further info.

Finally, water sitting in a puddle with no humans around has no value, value exists only in our minds.

Some examples to further understanding and show the subjective and changing nature of value:
  • we all value food, without it we cease to exist, so it's safe to say we have a built in value for food. But I for example don't value coconut at all, I don't like it: it's gross, disgusting, yucky, gruesome, but I digress. It's food to be sure, but it has no value to me unless it was the last thing to eat on the planet, then its value to me changes considerably. So note here the subjectivity of value but also note how value can change based on circumstances.
  • how much value does a snow blower have to a person who lives in the tropics? Conversely, how much value does that same snow blower have to someone in a northern climate. One step further: how much value does that same snow blower have to the northern climate person if no fuel is available?
  • assume two identical objects: one object you obtained via 40 hrs of hard work, the next day the other was given to you. Which one do you value more? Does the value you place on the items themselves, regardless of how they were obtained, change now that you have two instead of just one?
Generally speaking, value has two sides: use value and trade value. Using the snowblower example from above, while the snowblower will have little to no use value in the tropics, that is, there is no snow to blow and that is the device's only function, if there is a ready market to exchange snowblowers for other goods/services/money, then there is value in the tropical snowblower: trade value or potentially a store of value until a trade opportunity presents itself.

One further important item with regards to value: as mentioned above, value is a ranking, a scale, but it can only be considered
ordinal ordinal: :
of or relating to order, rank, or position in a series. (dictionary.com)

because it is subjective. In other words, saying that one values coffee by a unit of X over tea has no meaning. Pizza makes me 20% happier than a burger: this cannot be measured. Mary cannot say she values an item of clothing by X units more than Betty, only that she likes it more or values it more based on her observation of, and/or statements by, Betty. Instead it is coffee valued higher than tea, pizza valued higher than a burger, clothing valued higher by one person over another.

The concept of value is a human construct, part of which is formulated by our human ability to choose, unlike most animal species which we currently know to rely in large part on instinct thus rendering the idea of value irrelevant. Locke stated his belief, in his Second Treatise, that nature on its own provides little of value to society, implying that the labour expended in the creation of goods gives them their value. 'Intrinsic value’ does not really apply to the human experience. Value is instead ascribed by the beholder based on need, want, availability and consequence of obtaining:
  • how badly do I need something or is it just a want
    • each case (need/want) has degrees as well
  • what is the supply, present and future
    • what are my alternative choices
  • what is/are the impacts of the action of obtaining the item
  • what effort is involved in obtaining the end

Ludwig von Mises said

Value is not intrinsic, it is not in things. It is within us; it is the way in which man reacts to the conditions of his environment. Neither is value in words and doctrines, it is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act.

Cost & Price

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Cost
  • the total amount of (measurable) means employed to create an item; producer's expenses
  • the end forgone to obtain the highest ranked one: my top two eat out foods are pizza and fish 'n chips, normally in that order of ranking. When I go out and have pizza, the cost is fish 'n chips (and whatever psychic revenue I obtain from consuming it) and vice versa.
Price
  • the exchange rate of the good on a market. This exchange rate is most often quoted in monetary terms: $8 for the pizza

Marginal Utility

[underline mrgnt="-20px" width="80%"][/underline]There are some important concepts here but I'll try to keep things at a high level as the nitty gritty is not necessary for our purposes. In terms of the context and goal with this site, if you don't grasp this part well, I'm still working at it myself, no worries, you will definitely not be left out of the overall message.

Margin

To begin with, a dictionary definition of margin:

Term: margin (noun) Definition:  1 : the part of a page or sheet outside the main body of printed or written matter
 2 : the outside limit and adjoining surface of something : edge
Source Reference: Margin | Definition of Margin by Merriam-Webster Note: Mises: "Acting man is not in a position in which he must choose between all the gold and all the iron. He chooses at a definite time and place under definite conditions between a strictly limited quantity of gold and a strictly limited quantity of iron."
In the context of economics, it is the edge part that is the winner which translates into: specific amounts, not the all of it. People make decisions "on the margin", for example: no one chooses between "diamonds" or "water", but between a definite amount of diamonds and a definite amount of water.

Utility

Robert Murphy: "All action aims at exchanging a less satisfactory state of affairs for a more satisfactory state. We can say that individuals rank outcomes in terms of happiness, utility, satisfaction, contentment, etc. Value rankings are always ordinal, never cardinal. There is no unit of happiness or utility, and hence we can only say that a man preferred A to B; we can never say he preferred A 'three times as much.'"


The Law of Marginal Utility/The Law of Diminishing Utility

Two examples to start with from Robert Murphy's 2004 article What Does Marginality Mean?:

The Water-Diamond Paradox

The most famous application of marginalism is the solution to the so-called water-diamond paradox, which seemed to stump Adam Smith in his Wealth of Nations.1  The problem is this:  Why do diamonds have a higher exchange value than water, when diamonds are a mere frippery while water is essential to life?  Shouldn't people be willing to offer more in exchange for a unit of water than for a unit of diamonds?

The solution, of course, is that no individual is ever in the position of choosing between all of the diamonds in the world and all of the water in the world. A given choice is made on the margin. If offered a choice between a cup of water and a handful of diamonds, most people would pick the latter because the marginal utility of those particular diamonds is higher than the marginal utility of that particular cup of water.

Some economists would describe this situation by saying that diamonds are scarcer than water, because the demand for diamonds relative to their supply is so much higher. Yes, water is more important for human welfare than diamonds, but there is so much water to go around that even if ten trillion gallons were to disappear, no one would care. On the other hand, if only a few pounds of diamonds were to vanish, some people would be very upset.

Teachers versus Athletes

The classical confusion over use and exchange value resurfaces in modern times whenever someone laments:  "Teachers make only a fraction of what professional athletes make!  Doesn't this country care about education more than sports?!?"

Again, such statements do not take into account the fact that decisions are made on the margin. The fact that a teacher makes $25,000 while a baseball player makes $250,000 does not imply that anyone thinks baseball is more important than education (though some may indeed believe this!). All it really means is that the first employer believes that the services of that particular teacher are worth (at least) $25,000, while the second employer believes that the services of that particular baseball player are worth (at least) $250,000.

As with water and diamonds, the issue is one of relative scarcity. The aptitude and skills necessary to be a teacher are in much greater abundance (relative to the uses others have of teaching services) than the aptitude and skills necessary to become a professional athlete (relative to the quantity of professional sports that consumers wish to see). If fifty random US high school teachers were to suddenly quit, the impact on education would be negligible; replacements could be found almost immediately, and within a short while no one would notice the change. But if suddenly fifty random NBA players were to quit, the league would take years to fully recover from the loss.

Before leaving the issue of teacher versus athlete pay, let me point out one subtle contradiction by the critics of capitalism:  The very same people who remind us over and over that a person's income is no measure of his or her intrinsic worth, are the ones who complain the loudest over this country's "priorities" when it comes to salaries. But if we are already agreed that a person's salary has no relation to moral worth or social importance, then why is the teacher (or nurse, fire fighter, etc.) entitled to more money than the professional athlete?

Murray Rothbard said

This process of valuation according to the specific units involved provides the solution for the famous “value paradox” which puzzled writers for centuries. The question was: How can men value bread less than platinum, when “bread” is obviously more useful than “platinum”? The answer is that acting man does not evaluate the goods open to him by abstract classes, but in terms of the specific units available. He does not wonder whether “bread-in-general” is more or less valuable to him than “platinum-in-general,” but whether, given the present available stock of bread and platinum, a “loaf of bread” is more or less valuable to him than “an ounce of platinum.” That, in most cases, men prefer the latter is no longer surprising.

Here is where we get a little divergence on the idea of marginal utility between Austrian economists and mainstream economic thinking regarding marginal utility and 'The Law of Diminishing Utility'.

Mainstream thinking has marginal utility akin to "too much of a good thing", that is, the more one has of an item, the less utility, the less happiness, satisfaction one gets from it and in that manner utility is diminishing with each unit beyond 1. Snack food makes for a perfect example: pick a treat item that you absolutely love and you are hungry enough to eat. I'll pick bags of Miss Vickies Sea Salt & Malt Vinegar chips, yum.  The first one goes down and the utility is usually as close to maximum as possible. Then the next, somewhat less utility. Then the third, forth and I approach the point where I couldn't care less if I never saw one of these chips again even if I was still hungry enough to eat more.

Austrians look at it somewhat differently. I'll use Rothbard's egg example adapted from Art Carden's article Diminishing Marginal Utility: It's a Law:

Looking at Joe and his value scale:
  1. Feed his family with cake
  2. Feed his daughter with a scrambled egg
  3. Feed his wife with a scrambled egg
  4. Feed himself with a scrambled egg
  5. Feed his dog with a scrambled egg
We're also going to assume Joe requires 4 eggs to fulfill his cake recipe but at this point he has only three. With his first egg, he's going to feed his daughter, that being the highest priority he has with one egg. His second egg will be used to feed his wife and the third himself. After attending the local market, Bob has purchased a 4th egg which on the surface looks like it's cake for all, that the 4th egg has a higher marginal utility instead of lower meaning marginal utility is increasing not decreasing/diminishing. The key point missed in this assumption: the 4th egg can only be used to bake a cake if the other three eggs are present. This means we are no longer looking at this example through the lens of individual eggs being the unit but rather groups of 4 eggs now being the unit. This means Joe's value scale may now look something like this:
  1. Feed his family with cake
  2. Feed his family with scrambled eggs
He will choose to feed his family with cake and if he were to obtain another set of 4 eggs, scrambled eggs as well, even the dog wins :)

Important point from the article (emphasis mine): "… the value scales listed above were listed according to the wants satisfied by the marginal unit of a given good, not by the good itself…Our hero Joe didn't prefer the first egg to the second in and of itself; he preferred feeding his daughter to feeding his wife. If only one egg is available, he must choose between competing ends, and the end that satisfies him most is feeding his daughter."

Term: Marginal Utility Definition: People make decisions on the margin. No one chooses between "guns" or "butter", but between a definite amount of guns and a definite amount of butter.

As an actor acquires more and more units of a good, he devotes them to successively less and less urgent ends (i.e. ends that are lower on his scale of values). Therefore the marginal utility of a good declines as its supply increases. This is the law of diminishing marginal utility.
Source Reference: Marginal utility - Mises Wiki, the global repository of classical-liberal thought