Saturday, November 22, 2008

The Joy of Inequality

Suppose, while milling around a flea market, I come upon a man selling some old silver coins. Raking through his pile I find a 1939 Walking Liberty half dollar. After inspecting it I offer him $5; of course, he wants $7.50. We haggle a little bit, I let on that I’m about to walk away, and he abruptly cuts his price to $6. I accept his revised offer and stuff the old coin in my pocket.

In the hypothetical example above the selling price is $6. But is this really the value of the coin?

Only God, who made all things, knows the intrinsic value of anything. In exchange, however, human beings assign value to things according to their own perceived needs and desires. This valuation process is highly subjective and has little to do with the intrinsic qualities of a particular item. Only if an item satisfies perceived needs will it be exchanged between two parties.

So now, how much was that silver coin really worth? It was worth more to me than the $6 I paid for it; were it not so I wouldn’t have let my cash go for it. On the flip side of the exchange, the $6 of folding money was worth more to the seller than holding the silver coin. If this were not the case he would not have let the coin go. What we have here is (not a failure to communicate but) a double inequality. I valued the coin more than my folding money; he valued my cash more than the coin. The double inequality of the exchange assures that we, buyer and seller, have mutually benefited from the sale. Apart from such an outcome we would not have carried out the transaction.

Therefore, one cannot say that the 1939 Walking Liberty half was worth $6. It was actually worth more than that to me, and less than that amount to the seller. Value is subjective, at least on the human level.

Moreover, the transaction reveals another difference between the seller and me. Because he wanted my cash, at that particular moment he had a higher time preference than me. In other words, he needed the immediacy offered by the cash, probably in order to make the purchase of some other good (maybe he had mouths to feed that very evening). In my case, I was willing to hold a commodity for a perceived future benefit – I reckoned I could sell that coin for a higher price at a later time. Because I invested in the coin and deferred to a potential future income from it, my time preference was lower.

Children, teenagers and elderly folk typically have high time preferences; people in their prime working years tend to have lower time preferences.

Down here in the South the terms value, price and cost are interchanged carelessly. Riding by a palatial home a friend might ask, “Wonder how much that house cost?” Oh, do you really want to know? The cost of any commodity is the sum of charges made for land (if applicable), labor, capital and the producer’s profit. No one really knows or cares how much a house actually cost. The real question being asked is at what price would it most likely exchange. Real estate appraisers define “market value” as the most probable price a property would exchange for in an open market between a typically motivated buyer and seller (that is, assuming no duress or derangement on the part of either party). But, as we demonstrated above, the true value is, in the mind of the buyer, actually greater than the exchange price; to the seller, it is less. Were it not so they would not engage in a sale.

Inequality in the assignment of value is what causes free exchange to occur. The marketplace is where value-assigning actions are carried out by many individuals, each seeking to improve his lot in life.