Free Liberal

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One Man's Weed is Another Person's Flower

Values are Subjective

by Fred E. Foldvary

One of the axioms or premises of economics is that values are subjective. As the Austrian economist Carl Menger said in his 1871 book Principles of Economics, there is no value inherent in things. Objects have value only because persons have an interest in them. Value is entirely in the mind.

Economics is the science of utility. Related to value, utility is the importance that people place on goods. Goods have importance because they satisfy desires. The utility of goods depends on how much we already have. Another axiom of economics is diminishing marginal utility. The marginal utility of a good is the extra utility from using one more unit of a good, or the preference for another unit of a good relative to another unit of something else.

One reason marginal utility diminishes is because extra units become used for less important purposes. For example, water would most importantly be used for drinking, then for bathing and cleaning, and then for gardening. When one has already gotten water for drinking and bathing, an extra gallon for watering a lawn has low marginal utility, so one would not pay much for that next gallon. The market price of a good depends on its marginal utility, not the total utility.

Subjective values create objective market prices. The “market value” is the price the good sells for. For example, the market value of an ounce of gold today is $1100. If one’s subjective value for gold is greater than that of the dollars and greater than the subjective value of other things one could buy for that money, one buys the gold.

You get the most for your money when the marginal utility of each dollar spent is equal for all goods. Thus the consumer optimum is the quantities for which the marginal utilities of all goods, relative to their prices, are equal.

In the past, economists thought that value came from the cost of production, or the amount of labor need to produce a good. Some socialists still believe this fallacy. If people do not value a good, it does not matter how much labor went into it; it will have no market value. Or, a good such as a painting may have much more subjective value than what was paid to the artist.

Another fallacy is the belief that economic value comes from labor saved. For example, an apple might sell for a dollar because if one worked as an apple picker and seller, one would earn a dollar, so buying the apple saves you from being an apple man. This is a roundabout way of stating the cost-of-production fallacy.

Those who get all their income from land rent save no labor when they buy goods. And even those who get their income from labor have no way of knowing how much labor it would take them to grow an apple. They might pay more than the cost of labor for a fancy apple, or less if the apple is not so appealing. Thus the labor-saved proposition makes no sense.

We can think of market prices as being determined similar to auctions. Suppose a cup of coffee is being sold at auction. There will be bids to buy based on the subjective value of the coffee. The bids could be $3, $2, and $1. The highest bidder wins the coffee, and his bid becomes the market price at that moment.

Rather than the cost of production or labor saved determining market prices, Menger showed how the reverse happens. The value of the land rent and labor used in production comes from the market value of the product, which comes from the subjective values of the buyers. You will be paid $50 for your labor in building a chair only because a buyer’s subjective value for the chair was greater than $50. You will provide the labor only if the subjective value of the goods you can buy with your wages is greater than the subjective value of the leisure alternative.

Given the price of goods, if the worker does not get sufficient wages to make it worth while to provide the labor, it will not be provided. Thus in the long run, goods do not sell for less than the cost of production, since in that case, they will not be made. But if goods in competitive markets sell for more than the costs of the labor and capital goods, then firms will enter the industry and expand the production, driving down the price until the firms only make a normal profit.

Thus in competitive industries, goods do normally sell at the cost of production, but that is not because the cost of production determines the price, but rather because profit and loss will drive the market price to that level where firms make normal returns to labor and capital, unless there is some monopoly power.

Because values are purely subjective, attempts by governments to control prices or to push prices up or down with taxes and subsidies reduce social wellbeing. The prices set by pure free markets maximize social welfare. Any intervention that changes this will make folks less well off.

Those who impose their values on others are tyrants and thieves. Yet this imposition is what most folks want to do, either directly or via the power of government. The universal ethic is based on subjective values. The universal ethic recognizes the equal moral status of subjective values, and makes it morally evil to deny to individuals the peaceful and honest exercise of their subjective values. Thus what is economically bad is also what is morally bad. Social peace and prosperity depend on honoring the equal status of our subjective values.

This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.


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Comments

Very nice. The problem arises, however, when there is market power in the product markets, which allows for a less than free labor market - or a monopsony. Additionally, the variable price for labor within a firm also presents a problem, since the market is hierarchical rather than free.

In a free labor market, all bidders would hav perfect information on price and the barriers to entry would be dealt with. One need only go on a few job interviews to know that the market for labor is not free.

Oddly, to get a free market for labor - in other words to overcome the market power of labor buyers - collective action is required. This can come in two forms: labor unions or employee ownership and control - and even then, there are problems to overcome. I write about these in my book. Click on the URL and look at the July 2004 entry for Pay Equity.

To be snarky, I have an unrelated question which will be our quiz for the day.

What provision of the United States Constitution allows for the imposition of a Land Value Tax by the federal government?

Answer: There isn't one. Income from labor can be taxed federally, but not its value.

I'd actually like to see some draft amendment language for those who propose such an amendment. The whole concept is entirely academic until an amendment is drafted and a sponsor is found to introduce it. Prey tell, does Dr. Paul have such an amendment in his quiver?

Let's not get carried away with axioms. The correct number of axioms for understanding the world is zero.

Let's take one as a quick example.
" Another axiom of economics is diminishing marginal utility."

Oh yeah? This is invariably true?
How useful are three automobile tires?

# posted at by Morgan