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.

16 comments:

clumsy ox said...

A very cogent, simple, clear explanation. Well done indeed!

I suspect the inaccurate confusions of cost, value, price, worth, etc. are at the root of a lot of financial problems we see. I'm dumbfounded by some of the comments people make about money and economics:and I suspect there is a certain culpability for mainstream media here.

But on the other hand, I recall "consumer education" classes in high school designed to help teenagers navigate the grown-up world of money and personal finance. They made some appalling assumptions about economics, even while offering [good] advice that only makes sense in light of those assumptions being false.

One might almost suspect a conspiracy. Perhaps a vast left-wing conspiracy????

Funny how things work.

Chuck Hicks said...
This comment has been removed by the author.
Chuck Hicks said...

Thank you for the kind words, Mr. Ox.

Though it sounds cursory, I think it's safe to say that gov't education has a clear Marxist bias, and schoolkids are given a certain collectivist slant. That's why even so-called "paleoconservatives" I've been reading lately have capitulated to the notion of bailing out the automakers. "What's good for GM is good for America," and all that.

Anonymous said...

There is an objective, and objectively knowable, dimension to the "value of an item" being exchanged, to wit, what the item really is. This is not relative to perceived needs and desires.

Now, in the "joy of inequality" model you outline, need it be the case that both buyer and seller know what the thing (or service) really is? If so, then it seems to me that there is an objective as well as a subjective dimension to the exchange, qua exchange, insofar as it by definition involves some real, objective item or service that is bought and sold.

If, on the other hand, the "inequality of exchange" model can dispense with consideration of what the item really is, then it would appear to be open to the charge of not only being arbitrary and haphazard (i.e., in cases where both parties do not know what the item really is) but also equivocal (i.e., in cases where one party knows what the item really is, but another party does not).

I take it that no one wants to admit that haphazard and/or equivocal exchanges are desirable and/or permissable?

But if there is at least some obligation to the truth here, then there is an irreducilby objective dimension (ontological, epistemological, and moral) to every economic transaction.

Even so, I suppose that it must be a matter of debate as to what degree one party in a transaction is obligated to enlighten the other party as to the actual nature (note: I do not say "value") of the item being transacted.

In other words, however we measure value, if objectivitity is deemed part and parcel of an economic exchange, i.e., what an item is, the parties' knowledge thereof, specifically the relatively superior knowledge of one party concerning a thing to be bought and sold, and what kinds or amounts of such knowledge must be divulged by the more knowing party to the other in order that the exchange, even if unequal, not be equivocal.

Anonymous said...

To conclude my last (run-on) sentence:

... then must we conclude that certain kinds or amounts of unequality, vis-a-vis subjective valuations, are unjust?

Chuck Hicks said...

The Spanish scholastic Luis Saravia de la Calle wrote in 1544:

"...those who measure the just price by the labor, costs and risk incurred by the person who deals in the merchandise are greatly in error. The just price is found not by counting the cost but by
common estimation."


There is no necessary equivalence between the price at which something exchanges and its intrinsic qualities. To use an extreme illustration, in a country where no one plays the piano a Steinway would transfer for an obscenely low price. The difference in valuation between the buyer and seller determines whether it will sell at all. To stress the nature of an item is to appeal to the labor theory or cost theory of value, which de la Calle refutes above.

I think the objective dimension in the transaction involves mine and the seller's sense of well-being. God had Adam to name the animals; it seems He allows us to name the price for items in exchange, as well.

You bring up an important point about the moral obligation of disclosure between buyer & seller. An exchange of goods involving imperfect knowledge on the part of one or both parties violates the definition of market value.

Chuck Hicks said...

My fourth paragraph above was poorly thought out and helped nothing. What I was getting at is that, as a result of mutually beneficial exchange, the seller and I have discovered the utility of the item, which is near as one can get to its objectivity. He found its exchange value; I found its value in use.

I should add: the silver coin example was cast in the vacuum of a single exchange to demonstrate the principle of double inequality. What brought the seller and I into the $6 ballpark was bigger than both of us -- the market. The actions of innumerable silver coin buyers and sellers set the price range within which we negotiated.

Anonymous said...

The nearest one can get to an item's objectivity is knowledge of what the item actually is, which identity and knowledge is presupposed by, and therefore relevant to, its economic use.

Chuck Hicks said...
This comment has been removed by the author.
Chuck Hicks said...

Agreed. A thing is what it is. But it's value can change.

Menger (Principles of Economics) employs the example of a man who trades a pound of gold for a pound of bread to feed his starving family. But chiefly Menger is more concerned with marginal utility and prices of final goods and the production goods. Tough sledding for a worn-out mind, but I'm getting there.

Anonymous said...

Some things, say, a piece of bread, are easier to identify than others, say, mortgage-backed securities. So the observation that "a thing is what it is" is more than trivally relevant to the economic exchange of things.

The most obviously applicable rule is don't buy (or sell) something if you don't know what it is. However, it is not difficult to conceive of mitigating circumstances in which one or both parties to an exchange might be lead to misconceive the nature of thing without any culpability of their own, and so be lead to engage in irrational/unjust transactions.

I belabor the point because certain statements you make(e.g., This valuation process is highly subjective and has little to do with the intrinsic qualities of a particular item) seems
(1) to be false since the "intrinsic qualities of a thing" are of the essence of any transaction/valuation regarding that thing, and (2) to invite abuse, to wit, a haphazard or equivocal estimation of value (which is always the estimated value of the thing itself, i.e., in its objective reality), equivocal with respect to the nature of the item bought and sold, that is, (a) as it actually is versus (b) as it is mis-perceived to be by the buyer and/or seller.

It seems obvious to me that some items/services in the marketplace, i.e., those whose nature is less apt to be generally understood, might in certain circumstances be subjectively evaluated in a grossly inappropriate manner by a (relatively) unknowing party in a transaction. I do not see anything in your theory of completely subjective valuation that allows for this possibility; hence, the theory appears to be unsound.

In short, it seems obvious to me that a proper subjective valuation of an item is predicated upon objective knowledge of the item itself, and that where such knowledge is lacking (through ignorance, culpable or not, or deceit, to whatever degree) then the inequalities of subjective valuation, no matter how free the exchange, render the transaction either absurd (haphazard) or unjust.

Chuck Hicks said...

"Value is subjective" is an observable fact. The marginalist economist does not reach for an ideal definition of value; he notes what human behavior actually is, right, wrong or indifferent. Menger would readily agree with you that people make horrible mistakes in valuing things, especially nebulous objects like MBS's. This does not change the fact that we assign values to things in diminishing order, based on needs and desires at different points in time.

The Phoenician sailors, caught in a storm brought upon their vessel by the disobedient prophet (Jonah), tossed all their trade goods overboard in an attempt to save themselves. In that moment their "valuables" became value-less, i.e. not worth holding on to for future trade.

Subjective valuation and marginal utility are important because they explain phenomena that classical economics (Smith, Ricardo) could not explain, e.g., why diamonds are valuable and water (except in a desert) is not. Both God and we know that water is essential to the sustenance of life, but its super-abundance in most populated areas renders it a non-economic good. People assign value to things that are 1) scarce and 2) used to meet needs.

I began with an illustration of double inequality to set up a definition of money; for I wish to demonstrate in the near future that money is not wealth.

It will take time to develop the point, but, free markets quickly reveal errors and bring swift resolution to irresponsible behavior. By contrast, command economies where value is defined externally by some authority actually prolong, deepen, and spread diminished living standards across entire populations, even punishing those who seek to act prudently.

Chuck Hicks said...

For the sake of anyone peeking in on this conversation, I should further clarify that subjectivity with regard to value does not mean randomness or arbitrariness. There is a method to the madness, created by needs and available resources.

Another example -- suppose I need to buy a new lawnmower. Cub Cadet is known to be the best there is in mowing machinery. But I don't have the resources to exchange for a Cub Cadet. So I buy a lesser-quality model (a Sears Craftsman) that will nonetheless get the job done. People make decisions like this one everyday.

Now, what I have effectively done in this case is assign less value to the Cub Cadet than to the Craftsman -- illogical from a qualitiative (intrinsic) standpoint, but perfectly rational in terms of prudent resource allocation. The Cadet is intrinsically better, but I value it less in light of a range of other needs (this is similar to the functional super-adequacy applied to over-improved homes I described in an earlier post). Said another way, the Cadet is "more mower than I need," so its additional attributes are beyond the margin of my satisfaction, and thus discounted. Note, it's not the price of the Cadet I discount, but its value.

Now, out there in the mower marketplace are those for whom the Cadet exactly fits their needs -- bigger lawns, steeper inclines, etc. which its design features would better address. But for me to reckon that I must have a Cadet because it's the best out there, and to go into debt to have one, is not economically prudent.

Anonymous said...

Agreed, subjective valuation is a fact, insofar as it is the valuation of subjects. I want to ensure that the object being exchanged is not excluded from consideration. I am also concerned about the potentially evil effects of market activity predicated upon the supposed autonomy of subjective valuations.

For example: Usury is evil. An economic theory which grants autonomy to subjective valuation seems to permit and even encourage this evil in practice. Therefore, a theory of subjective valuation (as autonomous) is inadequate as a basis of economic exchange.

This does not mean that the insights gained by consideration of this phenomena (as in the examples you cite) can be dispensed with. But they do not seem to clearly establish the fact of subjective valuation as in principle a sufficient condition for a reasonable and just economic exchange.

Now the "seems to" qualifies my remarks as exploratory and open to any defense or clarification of your theory as my be offered. Such clarification may already be present in what you have said, and I am simply overlooking it.

Final thought: Although prudence, in many circumstances, may require that certain evils be permitted, it is never the case that evil should be encouraged. It "seems to me" that your theory is permissive of the evil of usury (for example), but does it also, in practice, encourage that evil?

Chuck Hicks said...

"Autonomy" is limited by the marketplace. For all the men like me who won't buy a Cub Cadet, there is someone who can and will. I do not set the value of the Cadet for others; only for myself.

One does not have to be Mengerian to recognize that, given a particular crisis, the market price for Cub Cadets can plummet as it has for many commodities. That would follow the de-valuation of the product by the its typical buyers, irrespective of its superior characteristics. Consider the prices of SUV's these days...

Citing usury you open another field of discussion outside the scope of this simple microeconomic example. The Torah (Deuteronomy 23:20-21) forbade usury between Hebrews, but allowed it to be charged to foreigners. Interest is the price of time preference -- my willingness to let someone use my money now while I forego its use.

I don't charge interest to anyone; in fact, I don't loan money at all but simply give it if I have it to give. I personally don't know many individuals, Christian or otherwise, who charge interest to their creditors.

Banks, credit unions, etc. are business enterprises that earn income through interest. I'll put off the topic for now (Happy Thanksgiving!), but note (with a grin) that Jefferson & Taylor, et. al. hated banking cartels.

Anonymous said...

Fair enough. I will simply note that charging interest may in certain cases be an example of, but is not by definition the same thing as, usury. I am using the term as defined by Belloc in "On Usury."