One of the axioms or premises of economics is that values are subjective. As the Austrian economist Carl Menger said in his 1871 book Principles of Economics, there is no value inherent in things. Objects have value only because persons have an interest in them. Value is entirely in the mind.
Economics is the science of utility. Related to value, utility is the importance that people place on goods. Goods have importance because they satisfy desires. The utility of goods depends on how much we already have. Another axiom of economics is diminishing marginal utility. The marginal utility of a good is the extra utility from using one more unit of a good, or the preference for another unit of a good relative to another unit of something else.
One reason marginal utility diminishes is because extra units become used for less important purposes. For example, water would most importantly be used for drinking, then for bathing and cleaning, and then for gardening. When one has already gotten water for drinking and bathing, an extra gallon for watering a lawn has low marginal utility, so one would not pay much for that next gallon. The market price of a good depends on its marginal utility, not the total utility.
Subjective values create objective market prices. The “market value” is the price the good sells for. For example, the market value of an ounce of gold today is $1100. If one’s subjective value for gold is greater than that of the dollars and greater than the subjective value of other things one could buy for that money, one buys the gold.
You get the most for your money when the marginal utility of each dollar spent is equal for all goods. Thus the consumer optimum is the quantities for which the marginal utilities of all goods, relative to their prices, are equal.
In the past, economists thought that value came from the cost of production, or the amount of labor need to produce a good. Some socialists still believe this fallacy. If people do not value a good, it does not matter how much labor went into it; it will have no market value. Or, a good such as a painting may have much more subjective value than what was paid to the artist.
Another fallacy is the belief that economic value comes from labor saved. For example, an apple might sell for a dollar because if one worked as an apple picker and seller, one would earn a dollar, so buying the apple saves you from being an apple man. This is a roundabout way of stating the cost-of-production fallacy.
Those who get all their income from land rent save no labor when they buy goods. And even those who get their income from labor have no way of knowing how much labor it would take them to grow an apple. They might pay more than the cost of labor for a fancy apple, or less if the apple is not so appealing. Thus the labor-saved proposition makes no sense.
We can think of market prices as being determined similar to auctions. Suppose a cup of coffee is being sold at auction. There will be bids to buy based on the subjective value of the coffee. The bids could be $3, $2, and $1. The highest bidder wins the coffee, and his bid becomes the market price at that moment.
Rather than the cost of production or labor saved determining market prices, Menger showed how the reverse happens. The value of the land rent and labor used in production comes from the market value of the product, which comes from the subjective values of the buyers. You will be paid $50 for your labor in building a chair only because a buyer’s subjective value for the chair was greater than $50. You will provide the labor only if the subjective value of the goods you can buy with your wages is greater than the subjective value of the leisure alternative.
Given the price of goods, if the worker does not get sufficient wages to make it worth while to provide the labor, it will not be provided. Thus in the long run, goods do not sell for less than the cost of production, since in that case, they will not be made. But if goods in competitive markets sell for more than the costs of the labor and capital goods, then firms will enter the industry and expand the production, driving down the price until the firms only make a normal profit.
Thus in competitive industries, goods do normally sell at the cost of production, but that is not because the cost of production determines the price, but rather because profit and loss will drive the market price to that level where firms make normal returns to labor and capital, unless there is some monopoly power.
Because values are purely subjective, attempts by governments to control prices or to push prices up or down with taxes and subsidies reduce social wellbeing. The prices set by pure free markets maximize social welfare. Any intervention that changes this will make folks less well off.
Those who impose their values on others are tyrants and thieves. Yet this imposition is what most folks want to do, either directly or via the power of government. The universal ethic is based on subjective values. The universal ethic recognizes the equal moral status of subjective values, and makes it morally evil to deny to individuals the peaceful and honest exercise of their subjective values. Thus what is economically bad is also what is morally bad. Social peace and prosperity depend on honoring the equal status of our subjective values.
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FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.
Foldvary is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.
Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.