Myths of Economics: Value

There are a few beliefs about value which are false yet commonly held: value is objective and value is quantifiable. While neither of these is true, both are believed in general and presented as fact by those who should, and possibly do, know better.

When we speak of value, we often confuse this term with cost or price. We speak of the “cost of living” or the “price per ounce” as though either or both of these things denote value. In fact, value is something which can only represent a verifiable thing to a single individual at a particular point in time. For example, a warm coat has certain value to a person in Alaska which is not likely shared by a similar person in Hawaii. Similarly, that same warm coat to the person in Alaska has certain value on a cold day which is absent on a mild day. While the price of the coat is almost certainly too high to the Hawaiian on any day, the price assigned by those interested in selling it is either too high or too low to our Alaskan based on the temperature at the time we ask. As a result, the value of an item is both subjective and constantly in flux.

Similarly, the value of an item cannot be quantified. When our Alaskan talks of the value of their warm coat, they refer to this item in relation to other items available. When offered the option of a warm room or the warm coat, our Alaskan will choose based largely on their tasks and goals: work to be done outside will increase the value of the coat while leisure or work to be performed inside will decrease the value of the coat. In the case of work to be done outside, several other attributes like external temperature, coat comfort, coat serviceability, and coat effectiveness will come to play in the coat’s value at the time our Alaskan reaches into their coat closet.

In all cases of value, it should be understood that the ranking of our warm coat can only be done ordinally; our warm coat is only considered in order of value above or below alternatives. For example, to complete tasks outside in Alaska, the warm coat is compared against other protective clothing available at the time. Each available alternative is ranked in order of perceived benefit to achieve the goal based on the temperature at the time. Our Alaskan might value a lighter coat ahead of our warm coat because the task is sufficiently brief, the temperature is sufficiently low, or flexibility is sufficiently greater than the warm coat. In the end, the alternative chosen cannot be measured quantitatively against the alternatives because no common measure is possible; there are too many factors or methods of measurement to isolate a value common  to all the potential alternatives.

In the final analysis, it is impossible to for an actor to understand or communicate all of the reasons for a given valuation. Choices involve myriad alternatives with incomparable attributes pertinent only in subjective evaluation. Value is ever changing based on available alternatives and a continuously changing landscape of attributes and alternatives.

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Building Arguments

The Austrian school of economics is unique in the field largely due to its reliance on deductive reasoning over empiricism. This doesn’t mean that empirical evidence has no value, only that it is used to confirm rather than develop hypotheses. The use of deductive reasoning led the early leaders of the Austrian school to develop theories in marginal utility, time preference, and the business cycle.

The advantage to such an approach is consistent, logic based argumentation; it is difficult to counter a contention when it is built on soundly applied logic. With sound reasoning, policy decisions can be prescribed with confidence not in their predictive nature but in the certainty that they are pointed in the correct direction.

Since Ludwig von Mises, Austrian economic theory has been grounded in what he termed “praxeology,” the science of human action. With the individual as the starting point, the tendencies of individual action lead the Austrian economist to develop broader economic theory. The fact that an item possessed today is of greater value than the same item possessed tomorrow, for example, enabled Austrian economists to develop theories of interest as it relates to time. These theories could then further be extrapolated, logically, to show how interference with interest rates creates false signals regarding individual time preferences and ultimately leads to mistakes in investment. These mistakes cause the business cycle. The most complex theories put forth by economists of the Austrian school can all be traced back, logically, to the actions of individuals.

The Natural Tendency

The Federal Reserve has a dual mandate: maintain acceptable levels of employment and regulate prices. While the former might appear valid, the latter betrays a lack of understanding regarding economics.

In the free market economy, the natural tendency of all products and services is to decline in price. This is due to both the Law of Demand and free competition. Demand tends to increase as the price of a product decreases. As demand increases, competition increases to supply that demand. Competition results in still lower prices as improvements in production and delivery further increase supply.

When a product is first developed, it’s cost of production is virtually infinite. This cost means that the price to be charged on the market is also virtually infinite. As a result, demand is nearly non-existent. For example, there was nearly no demand for the personal computer when it was first developed. As production of the product is improved, lower costs are realized by the producer and lower prices can be sought on the market. When the price of the personal computer dropped to a level within reach of many businesses, demand increased. As competition emerged, prices continued to fall further spurring demand. Today, the personal computer is ubiquitous.

This is not to say that prices perpetually fall, only that they naturally fall. When, for example, an oil well dries up, it potentially impacts the price of oil; curtailed supply tends to increase the price. In the case of the personal computer, the tendency for price to decline has slowed as competitive products like tablets and smart phones crowd out demand. These natural price fluctuations result from market demands and competition as well as cost of resources.

This brings us back to the Federal Reserve. The purpose of this particular institution was to lessen the impact of the business cycle; periodic drops in economic growth known as depressions were claimed to be inherent in free market capitalism. A central bank, it was argued, was necessary to intervene in markets as a means of avoiding depressions. This goal was to be achieved by fighting the natural tendency of prices to decline. Since the founding of the Federal Reserve, multiple global depressions have occurred, showing how fruitless and counterproductive it is to fight the natural tendency of prices to decline.