Fact 2: Our Subjective Values
Upon leaving Scarcity Stan's Bakery Shoppe and Confectionery Palace our pedestrian's excursion drops into Mega-Mart Discount Warehouse Super Center. A quick tour of this mecca of mass production -- lasting no more than three days -- is likely to reveal within the 20 gadzillion square feet of floor space a number of sales racks, shelves, and tables filled with merchandise marked down for clearance. A prominently displayed sign on one sales rack boldly declares that the regular $24.99 price has been drastically reduced, for this week only, to $3.98. What a bargain! What a sale! We have the chance -- "for a limited time only" -- to get stuff valued at $24.99 for only $3.98! With a bargain like this, how can we lose?
It's easy to lose, if you don't understand the concept of value. Most of us have several "bargains" stored away in the attic, closet, or garage that never have seen, and probably never will see, anything resembling use. What seemed like a great "bargain" at the store, does nothing but occupy space at home. (By the way, does anyone have use for a distributor cap for a 1949 Ford?)
The posted price of any product is only the first step in understanding this notion of value. To see why, consider the second basic fact of economic life:
FACT 2 VALUE IS IN THE EYE OF THE BEHOLDER -- The value of a good, service, or resource is subjectively determined by the satisfaction of wants and needs that it provides to consumers.
The operational term here is subjective. As far as you are concerned, the value of a good depends exclusively on how much satisfaction it provides to you. If a good is worth $24.99 to you, then it has a value of $24.99. If, however, you are willing to pay only $3.98, then that its value to you is only $3.98.
Scarcity and Exchange Can Be Bloody
Let's return for a moment to that nasty scarcity problem from Fact 1, Our Limited Pie. It tells us that society doesn't have enough of everything for everyone -- a problem if ever there was one. What can you do about a predicament like this?
For example, suppose that you and I are browsing around Steroid Steve's Athletic Footwear For The Physically Adept in search of a pair of size 10 Steroid Steve cross trainers. At precisely the same instant we both spy the very last pair of size 10 Steroid Steve cross trainers on a display rack. We both want the shoes. We both have the cash on hand to make the purchase. We both reach for the shoes and make contact at exactly the same time. What do we do?
We have three options. All three have been tried by society at various times, but only two are generally deemed acceptable in civilized society. (By civilized, I'm excluding, of course, rush-hour traffic, rock concerts, and professional hockey matches.)
- To the death. One of us could extract the cross trainers from the grip of the other, using whatever force is available -- a good old fashion free-for-all. Taken to the extreme, this will result in one death -- an unappealing alternative for the shoe store, not to mention one of us. This is also the alternative that's generally not acceptable in civilized society.
- Parental coercion. Much like a parent who settles a backseat territorial argument between siblings on a cross-country car trip, an all-powerful Steroid Steve clerk could take charge of the situation to determine who receives the cross trainers. This can be done arbitrarily or through some predetermined rule, such as height, weight, sex, previous purchases, country club membership, etc. Wait just a second! Who does this Steroid Steve clerk think he (or she) is -- the government? In a word -- yes! More on this when we get to Fact 5, Our Necessary Evil.
- Voluntary exchange. Both of us could peacefully and voluntarily negotiate over who best deserves the right to buy the cross trainers. We could start a bidding process in which each of us determines the price we would be willing to pay for the shoes. This alternative illustrates the common method of voluntary market exchange that occurs millions of times each day in our economy (and it's less painful than a battle to the death).
Although survival of the fittest does surface occasionally, most exchanges are conducted either voluntarily through markets or involuntarily by the government. Fact 5 considers the government's role in involuntary exchanges, here we explore voluntary market exchanges and what this means for value.
All Those In Favor Say "Buy"
Market is the term economists use for voluntary negotiations that exchange commodities, resources, goods, services, and other such items. You've undoubtedly come across this term many times. For example, you run to the supermarket for a loaf of bread and gallon of milk, note that the stock market has dropped 600 points since yesterday, or browse through the want ads of the labor market because your boss is a jerk and you want a new job.
These are but a few of the common uses of the term. What they all have in common, although some are more obvious than others, is that buyers and sellers are exchanging stuff. Because buyers want stuff and sellers have stuff, it seems natural that they would somehow get together and work out an exchange. That's what a market does.
The key, however, is that markets are voluntary. As a seller, you sell stuff that you want to sell. If you don't want to sell, then you don't sell. As a buyer, you buy the stuff that you want. If you don't want to buy, then you don't buy. The end result of these negotiations -- the consequence of this buying and selling -- is that the price of the stuff exchanged is agreed on by both buyers and sellers.
- Because the price is agreed on by both buyers and sellers, it reflects their preferences. This is the price that they voluntarily accept.
- Because the price is agreed on by both buyers and sellers, the value placed on the good by buyers is the same as that of the sellers.
The Two Sides of Value
The value of any commodity, whether it's retail merchandise, military weapons, national parks, or inane television programming, ultimately depends on how well it tickles the fancy of those willing and able to pay the price. The road to value, however, can be a long one filled with many twists and turns because the prices of goods depend not only on the buyers, but also on the sellers. The paths of demand and supply go in seemingly opposite directions, but ultimately end at the same source -- subjective values. Let's consider these two sides of a market.
- Demand, the buyers' side of the market, depends directly on the consumer satisfaction generated in the course of consumption.
- Supply, the sellers's side of the market, depends on the opportunity cost of production, which as we see shortly, is also dependent on the satisfaction obtained from consuming stuff.
Demand Begins With Consumer Satisfaction
Here's the scene. You've just entered your local Master Sprocket's convenience store, where you notice a counter display for Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop. You don't personally own a Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop, but know several people who do and they speak highly of them -- usually with a glint in their eyes. Do you buy it? The first order of business is to check the asking price. It's scrawled on the cardboard display -- $4.99 (plus tax).
A series of additional questions are likely to switch the neurons in your brain off and on like the lights in Times Square on New Years Eve.
- Income. Can you afford the $4.99 (plus tax) with your available income? Moreover, if you wanted to buy two or three, perhaps as gifts for family and close friends, can you afford the expense? Checking your purse or wallet, you note that income is not a constraint at this time. Several Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoops could be purchased without exhausting your available cash.
- Substitutes. You recall, though, that Captain Car Hop a mile or so up the highway has its own brand of spark plug tool and ice cream scoop (which also doubles as a dog whistle) but has an asking price of $5.50 (plus tax). Should you buy the Master Sprocket's or pick up the Captain Car Hop version? Is the addition of a dog whistle worth the extra 51 cents (plus tax)?
- Satisfaction. Do you really want to spend your cash on the Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop? This might require a little soul searching. On the one hand, you already have a spark plug tool hiding somewhere near the spare tire in your trunk. And your ice cream scoop is still in working condition, although slightly bent from that half-gallon of very frozen tin roof sundae you bought last month. On the other hand, you don't have anything that can serve as both a spark plug tool and ice cream scoop. Through this deep introspection, you might even begin to wonder if you want a do-it-yourself all-purpose spark plug tool and ice cream scoop at all. Although you have the cash, hundreds of other items could be purchased for $4.99 (plus tax) that could be more useful, pleasurable, enjoyable, or desirable.
This last introspection is perhaps the most important. Your decision to purchase the Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop ultimately depends on the degree to which it's expected to fulfill one or more unrequited need. You buy the instrument because you want it, need it, or expect that it will somehow make you better off. Let's ponder the heart of what motivates buyers -- wants and needs.
Wants and Needs
It's occasionally useful to distinguish needs from wants.
- Needs. A need is generally thought of as a biological requirement to sustain existence. Some of the most basic needs include water, oxygen, food, and protection from temperature extremes. Needs, therefore, come with the basic biological package we call life.
- Wants. A want, in contrast to a biological need, is usually considered a psychological desire. You really don't need it to continue your existence, but having it would make you a little happier. Wants, thus, depend on psychological conditioning and can vary widely from one person to the next depending on culture, childhood experiences, or whatever.
Both wants or needs provide us with the motivation to demand products. Goods that do a better job of satisfying our wants and needs have a greater demand. But (and this is an important "but"), no two people are likely to have the same wants and needs, nor derive the same satisfaction of wants and needs from a given product. The value that you derive from a good need not be equal to the value I derive from the same good. Pretty subjective, eh?
Supply Also Begins with Satisfaction
Let's return to our Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop. Instead of buying this wonderful utensil, we're now talking supply. If you want we'll even make you the Chief Executive Officer (CEO) of Master Sprocket, Inc. (which also means that you are a card-carrying member of the second estate.) In fact, let's go back a few years, when Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop was nothing but a idea in the mind of a junior (hoping-to-be-vice-president) executive. The junior executive, CEO (that's you), and other members of the management team are exploring the possibility of producing and selling the Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop. What do you need to consider?
- Technology. You might consider if producing this instrument is possible. Does the technology needed currently exist or can it be readily developed? If production of a do-it-yourself all-purpose spark plug tool and ice cream scoop is not technologically feasible, then you'd better direct your attention to something else -- like a combination pizza slicer-paint scraper.
- Competitors. You need to evaluate the competition. Industry scuttlebutt says that Captain Car Hop is planning to develop a spark plug tool and ice cream scoop that can serve as a dog whistle. You'd better keep a close eye on them.
- Production cost. And last, you certainly need to consider the cost of producing this wonderful instrument. For example, you have the cost of the factory, equipment, electricity, workers, and raw materials (a titanium alloy developed by NASA scientists) just to fabricate the utensil. Then there's packaging, distribution, and marketing expenses. You also need to add administrative salaries, overhead, and dividends to appease your shareholders.
After evaluating all production cost, you establish your retail price, which in this case is $4.99 (plus tax). If buyers are willing to pay this price, then the junior executive becomes vice president. If not, then the junior executive becomes a mail clerk.
But, let's not leave production cost just yet. Because in conjunction with the willingness of buyers to pay for the instrument, production cost helps determine the market exchange price, and value.
The Opportunity Cost of Foregone Satisfaction
As the CEO of Master Sprocket, you calculate the retail price of $4.99 (plus tax) to cover production cost for all parties concerned, plus to generate an acceptable profit. Let's consider production cost more carefully? Wages to workers is an easy one. Others follow a similar logic.
Suppose that Master Sprocket hires 50 workers, paying each one $10 per hour. Why is Master Sprocket willing to pay each worker $10 per hour and, equally important, why is each worker willing to produce the combination spark plug tool and ice cream scoop for $10 per hour?
- Contribution to production. As Master Sprocket's CEO, you're willing to pay each worker $10 per hour because you've determined that each worker contributes at least $10 per hour to the production of the combination spark plug tool and ice cream scoop. Any business that pays workers more than what they add to production is losing profit.
- Value of foregone production. Each of your workers is willing to produce the combination spark plug tool and ice cream scoop for $10 per hour because this is equal to, or greater than, the wage they could receive in another job. But, note that the other job, whatever it may be, also sets the wage base on what their workers' contribute to production.
Aha! Here is where satisfaction enters supply. To produce one good, a worker isn't producing another good. The cost of production is nothing more than the value of goods that are not produced. When you make the spark plug tool and ice cream scoop, your workers and other resources are not making other stuff. Consumers are therefore losing satisfaction equal to their subjective value of those other goods.
The bottom line, literally, is that value is totally subjective. We might like to think that price and cost are hard and fast numbers with a rigorous, quantifiable, objective dimension, like height and weight. But they're not.
If Master Sprocket's Universal do-it-yourself all-purpose spark plug tool and ice cream scoop is traded for $4.99 (plus tax), then some buyers are willing to pay $4.99 (plus tax) because that's the amount of satisfaction this indispensible utensil generates for them. And Master Sprocket is willing to sell it for $4.99 because that's the amount of satisfaction the buyers of other products give up so that the resources can be used to produce the do-it-yourself all-purpose spark plug tool and ice cream scoop.
Most importantly, the price can change because some of the parties involved change their mind. If buyers don't get as much satisfaction now as they did earlier, then the price will drop from $4.99 (plus tax). If workers, other resource owners, or consumers decide that the goods not produced are more valuable, then the price of the do-it-yourself all-purpose spark plug tool and ice cream scoop will rise from $4.99 (plus tax).
This provides us with a few useful shopping tips:
Three Tips on Value
- Value is what YOU think it is. Don't let advertising fool you into thinking that a product is more valuable that it really is -- to YOU.
- Because someone else places a high value on a product does not mean it's equally valuable to you. Their value is, well, their value, not yours.
- Because a product is costly to produce doesn't mean it's valuable to buyers. Cost is only part of value. The ultimate source of value is your own satisfaction.
This notion of subjective valuation might put your mind to rest the next time you're forced to catch a glimpse of some really stupid, inane, or otherwise idiotic television show because your remote control battery is too weak for a rapid channel scan.
Unfortunately, many of those shows, as "bad" as they may be, are "valuable" to someone. Sure, your tastes may run more in line of hard-hitting dramas like Brace Brickhead, Medical Detective, but you can't stand the sickening sweetness of the Cutsey Kids Sit-Com Hour. Meanwhile you do (or do not) like the continuing saga of Lustful, Tormented Lovers In Madeup Town, USA, while your significant other can't stand (goes crazy over) the live primetime coverage of Big Guys Hitting Each Other Over A Ball. And of course you've never met anyone who enjoys The Egotistical Comedian Show, although it's been rated in the top ten for the past five years.
What applies to television programs applies to every other good that's voluntarily exchanged in markets. You may not understand how anyone, and I mean anyone, could possible drive that model of car, wear that brand of perfume, or live in that style of house, but they do.
Is the world crazy? No, people simply have different wants and needs and place a different value on goods. The next time you see (a) someone younger than you wearing really ugly clothing or (b) someone older than you wearing really ugly clothing, and you start to say "I don't know why they make clothes like that," feel free to slap yourself in the face as a reminder that value is in the eye of the beholder. Then be thankful that voluntary exchanges allow you the choice of wearing your own really ugly clothing.
What Does It All Mean?
Market exchanges help society address the problem of scarcity head on. While they can't eliminate the problem, market exchanges help improve our lives by getting us stuff that we wouldn't otherwise have. A few points follow from this:
- Negotiation and competition. The exchange process works best if a lot -- gadzillions -- of potential buyers and sellers are able to voluntarily negotiate prices and exchanges. As we see in Fact 4, Our Monopolized Markets, control of the market exchange by a few participants can really screw up the process. However, if this doesn't happen, market exchanges let us get the most satisfaction from our available, limited resources.
- Consumer sovereignty. Buyers generally get what they want because sellers are out to make a profit. If buyers value one good more than another, then sellers are prone to accommodate the buyers and supply more.
- Advertising. Because value is subjective and depends on buyers' tastes and preferences, tons of profit can be made by anticipating or controlling buyers' wants and needs. That's one reason you see so much advertising around. It's also why you need to be on guard for any would be "mind controllers."
- Incentives. Ample opportunity exists for behind-the-scenes manipulation. Government, for example, can restrict the exchange of goods like tobacco and alcohol with taxes. This raise the prices to buyers and lowers the prices to sellers. Alternatively, something like education can be encouraged by lowering the price to buyers and raising the price to sellers.
While we could spend a more time in the Mega-Mart Discount Warehouse Super Center, three days is all we can spare for now. Our shopping bags are filled with valuable bargains, every one of which was priced just right. I think it's time that we made a (hopefully) briefer stop across the interstate at the Shady Valley Central Town Sprawling Hills Shopping Mall. Yes, yes, I know that we'll have to fight the overflowing crowds that populate this self-contained suburban city. But, without the crowds, we wouldn't have much to talk about over the next several pages.