The notion of value is one of the aspects of economic thinking that gets a lot of discussion and is often misunderstood. How is it derived? Who determines what something is worth? A lot of public policy is based around altering prices that “seem too high.” Who determines whether a price is too high, too low, or just right? The simple answer is: you do, your spouse does, neighbor, teacher, friend, mother, etc. In economics, we call this methodological individualism.
The concept of methodological individualism is important for understanding how we value things. I often joke that economists don’t have a lot of friends because they use terms like this. But really, all this phrase means is that only individuals can make a choice. If we were able to add up all of those individual choices we could understand how a group chooses over certain options.
Firms don’t choose, governments don’t choose and churches don’t choose. Individuals choose and groups of individuals make up these larger institutions. The influential Austrian economist, Ludwig von Mises writes,
For a social collective has no existence and reality outside of the individual members’ actions.
In our post on marginal analysis, we discuss how choices are relative (you choose between things), and I shared a story about a choice my friend and I once had to make about the value of our time. It works the same for the value of goods or services; only you can decide how much a good or service is worth to you. We call this concept subjective value.
In a fallen world dominated by scarcity, all value that we place on items (from toothpaste to life insurance) can only be assessed by the person doing the choosing. You say “potato,” I say “po-tah-toe.” You may spend your money at one store, I at another.
Have you ever purchased anything on eBay? I have done a lot of shopping on eBay and find that the prices I am willing to pay for items I am interested in (usually children’s clothing for my son) depend on my current situation and priorities. For example, I may be willing to pay more for an outfit if I think it would be perfect for an upcoming family picture than I would for that same outfit if we had no picture scheduled.
One of our questions is, how do we know if a firm has set a price that is “too high”? One way we can know is if people stop purchasing that good and switch to some alternative good or substitute good. For example, if there is a freeze in Florida in the middle of the growing season, oranges are likely to get more expensive. As their price rises, you might decide to purchase fewer oranges and eat another fruit instead. If the price rises too far, you will eventually stop buying oranges all together.
Economic value is in the eye of the beholder; but the beholder’s eye can be fickle. If you’re taking a cross-country road trip, find yourself desperately hungry, and come to a gas station with the sign out front that says, LAST FOOD AND GAS FOR 120 MILES, you’ll be glad to see a Subway store attached to it. You will value that toasted, foot-long, double-meat club on honey wheat a lot more in that situation than if you were walking around downtown Seattle, where there is a Subway on every third corner. (pg 217)
All of this means that value is assessed externally by purchasers, so it has nothing to do with how much it cost to make the item. This misconception is called the “Labor Theory of Value.” I would love to be able to charge $500 an hour for each economics class that I teach. I spent a lot of time in school and have lots of student loans, but that is not relevant to the customer. As it turns out, there is more than one person who can teach economics (a good thing!) and this competition in supply drives prices down. What matters is the value of my teaching. Only when I serve my customers by providing quality teaching will I be able to charge a price that they feel is appropriate.
Subjective value implies that the way we value things can and will change over time. This does not imply that we should be reckless, but rather that we must understand how and why we value one thing over another so that we can make the most intentional and informed choices possible. In this way, we can be effective stewards of the resources God has given us.
Question: How has the value of certain items changed to you as your circumstances change? Leave a comment here.
- Part 1: Economics: A Tool for Navigating a Fallen World
- Part 2: No Free Lunch: Why Understanding ‘Opportunity Cost’ Matters
- Part 3: Understanding Economics as Stewardship
- Part 4: Decision-Making on the Margin
- Part 5: People Value Different Things
- Part 6: The Knowledge Problem Triple-Whammy
- Part 7: How Prices Harness Knowledge
- Part 8: The Miracle of the Market Process
- Part 9: What is Your Advantage?
- Part 10: How Trade Allows Us to Serve Others
- Part 11: Is the Economy a Pie?
- Part 12: How to “See” the Unintended Consequences
- Part 13: We Need to Consider Consequences
- Part 14: Four Lessons of Economics: A Case Study of JP Morgan
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