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Saturday

At the first mention of "Economics", most people's eyes glaze over. That's no surprise, as "the Dismal Science" as it is called is so overwrought with arcane equations and contrived concepts that I sometimes wonder if even economists really understand it.

A big part of that obscurity does one thing: it hides one simple, basic fact of economics that any 8-year old boy who has ever traded baseball cards could understand. It doesn't require complicated proof, or ideological agreement, and it won't require any math beyond 2+2. All it requires is an explanation that integrates facts you already know, and simple, nearly self-evident logic. And no, it's not the law of supply and demand. It's not nearly that complicated.

These equations and charts and hifalutin' ideas seem to have little bearing on real life, and to a large extent, they don't. This one fact does, however. It is so fundamental to real life, and so simple, that if you really understand it, if you accept it, it will change everything about how you see economics. It may even turn you into a capitalist.

So if you've made it this far, read on. If you're one of those people who says "I will never become an evil capitalist, no matter what evidence and facts I see", then go ahead and move on to the next blog.

That simple fact is this:
Everything that has a value has a different value for each person, and a different value at different times and in different circumstances for the same person.


The entirety of economics, including the law of supply and demand, is just a working out of the ramifications of this fact. There's an old joke about a guy who comes home with his trunk full of dog food. His wife demands to know why he bought it, since they don't have a dog. He replies "But it was on sale!". If you get this joke, you get economics.

You might say that it's funny because he doesn't need dog food. That the "value" of the dog food is the retail price, and if it was on sale, he still got a good deal, but that it doesn't do him any good without a dog. One mistake in that would be failing to understand what value really means. You'd be right in saying that he doesn't need the dog food, or that it doesn't do him any good, but what does "need" or "do him any good" mean other than as indication of the dog food's value to him?

Value is always a subjective thing. It is always related to an individual's needs and wants at any given time. That the man does not need the dog food, or that it does him no good is another way of saying that it is of little or no value to him. To another person who does have a dog, the dog food would be very valuable. To this same man, at a later time when he gets a dog, it would be of greater value to him.

An 8-year old boy knows that if he has two Sammy Sosa cards, that the second one is far less valuable to him than the first one. If his friend has two Barry Bonds cards, then that second one is less valuable to the friend. And that Barry Bonds card is a lot more valuable to the first boy, since he doesn't have one, than his own duplicate Sammy Sosa card. Even to an 8-year old boy, the next step is obvious, but we'll come back to that later.

Value changes continually based on the circumstances of the moment, and everyone's circumstances are unique. There cannot ever be a single, universal value for anything.

This brings up a corollary to the first fact:

The price paid for something is never the value of the item to either party to the purchase.


It's easy in these days of casual use to equate "value" with "price". How often do you hear some gadget advertised as on sale for $14.99 along with the claim that it is a "$25.00 value"? Do you always buy these things because you think you will make $10.00 profit on the purchase? No, you know that if the thing is useless to you, or that it is of a quality or condition that it is not worth even the $14.99, that it is not and never was a $25.00 value to you.

Price is what we must give up to acquire something we value. It is not the measure of value, it is the measure of the value of something we already have - or that we could buy - that we have to weigh against the value we place on the item we're contemplating buying. If the shill on the TV commercial thought that the item was worth $25.00 to him, or even $14.99, why would he be trying to sell it to you? Wouldn't he just buy it himself and save the advertising costs? No, he probably already has one, and he doesn't need two. Another way of putting that is that the warehouse full of them he has are worth less than $14.99 each to him.

If you buy his product, it is because you value it higher than you value $14.99. If he sells it to you, it is because he values it less than $14.99. $14.99 represents neither the value of the item to him, nor it's value to you. You value it higher than $14.99, and he values it lower. $14.99 is somewhere in the middle.

This leads us to the next corollary:
In any voluntary exchange, both parties receive more value than they give up.


If both of our 8-year old boys have one Sammy Sosa card, exactly the same in condition, maker, year, etc., would it be a good idea for them to trade them? If price is the same as value, then of course it would. And then it would be a good idea to immediately trade back, and back again, endlessly. If a gadget has a value of $25.00 because its retail price is $25.00, then it would behoove you to buy it. And then to immediately sell it back, and back again. It would also be in the interests of the seller to do so. You could both spend the rest of your lives endlessly trading the same $25.00 for the same gadget, and pretend that you are engaging in productive economic activity.

But price is not value. Assuming you really need or want this gadget, you trade your $14.99 for the gadget because the gadget is worth more to you than $14.99 is. He sells it to you because $14.99 is of more value to him than the gadget is. The baseball card traders trade one's duplicate Barry Bonds for the other's duplicate Sammy Sosa, because each is more valuable to the boy that doesn't have one than to the boy that has duplicates.

And the trading stops there. They don't go back and forth, because the card they now have is more valuable than the one they gave up. Both have increased the value of their collection. This brings us to the final conclusion:
Voluntary exchange increases the overall value in the system

Only voluntary exchange can make 2+2 equal 5. Only voluntary exchange produces value just by virtue of the exchange. The value, and therefore the wealth, in a society is produced, not found, inherited, or stolen. Value may be acquired by an individual in all of those ways, but only if it was there - produced by somebody - for it to be found, stolen, or inherited. No matter how hard you work, any values you achieve above those you produce and use yourself, are achieved by voluntarily trading the result of that work.

Anything else is just shuffling value around, like the two boys endlessly swapping Sammy Sosa cards back and forth.

That it is voluntary means that both parties have weighed the value of the items in question against each other, and decided that they would end up with the more valuable item if they make the trade. No one else can know all of the multitude of factors that go into how a person values something. It can depend on the basic needs of the people involved (you need groceries for the next week, and don't want to take the time to get to a lower-priced grocery store), it can depend on the immediate circumstances (if you're out of gas and stranded, a gallon of gas might be worth $20.00 to you right then), it could depend on the time of day (is the cover charge at that club worth it only 1/2 hour before close?). And since it can change rapidly, that evaluation may change by the time a third party can render his verdict.

All of this applies equally to "As seen on TV!" gadgets and baseball cards as it does to your exchange with your boss of you time and effort for your salary, and just as well to multi-billion dollar corporate buyouts. The principle is the same. Forcing one side or the other to trade involuntarily means that value is not increased. If it was, then the exchange would not have to be forced.

All the fretting over GDP and unemployment rates and inflation and taxes boils down to the one simple point made above. But they aren't necessary to understanding the economic principle you need to know to function in any society based on trade. The value you place on things is yours alone. You can always find somebody that values something you have more than you do, and has something to trade that you value more than they do. We start out in life with nothing but time. Once you reach adulthood - in mind if not in years - you find that you can get anything you want in life by using your time to produce and trade values for ever greater values.

Comments

OK, I get it. Actually, I intrinsically got it before, but never read it in words.

Interesting post.

(*)>

Posted by birdwoman at Tuesday, May 17, 2005 02:03 PM

birdwoman,

That's an excellent point. The purpose of my writing that (which I hadn't quite gotten clear enough to put into words) was to take something that everybody already knew implicitly, and make it explicit. There's some very important reasons, both intellectually and politically, to do that. So important, in fact, I think I'll make an article out of it. Watch for that in the next few days. Thanks for the insight.

Posted by kylben at Tuesday, May 17, 2005 08:33 PM

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