THE THEORY OF PRICE 4

By M. Northrup Buechner

February 13, 2013

Another in a series of essays elaborating Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by the author.

 

My theory of price is a theory of objective prices, in which price measures the objective economic value of a good or service. The concept of “objective” I use is based on Ayn Rand’s concept of objective—the concept after which she named her philosophy. She discussed this concept in writing in her article “What Is Capitalism,” the opening essay of Capitalism: The Unknown Ideal (CUI). Her defining statement is:

The objective theory holds that the good is . . . an evaluation of the facts of reality by man’s consciousness according to a rational standard of value. (Rational, in this context means: derived from the facts of reality and validated by a process of reason.) The objective theory holds that the good is an aspect of reality in relation to man” (1966, p. 14; her italics)

The objective theory of the good defined in this paragraph posits a standard that is wider than the standard of the Objectivist ethics. The standard of value for her ethics is man’s life, that is “the terms, methods, conditions and goals required for the survival of a rational being through the whole of his lifespan—in all those aspects of existence which are open to his choice.” [VOS, 18].

There are other standards of value that satisfy the objective theory of the good, standards that are common among the participants of a free economy—for example, the accumulation of wealth, the welfare of my family, the advancement of my career, my children’s preparation for life, my enjoyment of life, my family’s happiness, and many others. These are all rational standards according to her definition of rational in this context: “derived from the facts of reality and validated by a process of reason.”

Ayn Rand stated the theme of “What Is Capitalism?” in this sentence: “Of all the social systems in mankind’s history, capitalism is the only system based on an objective theory of values” (her italics). To establish this, she had to overturn the foundational viewpoint of all of modern economics (including the Austrians), that the root of the economy is subjective feelings. (To soften and obscure their actual position, economists often call these feelings “preferences.”).

Her answer was: “The free market represents the social application of an objective theory of values.” To prove that, she carved out two new categories of economic value, philosophically objective value (POV) and socially objective value (SOV).

She defined philosophically objective value as:

a value estimated from the standpoint of the best possible to man, i.e., by the criterion of the most rational mind possessing the greatest knowledge, in a given category, in a given period, and in a defined context (nothing can be estimated in an undefined context) (1966, 16; her italics).

She defined socially objective value as “the sum of the individual judgments of all the men involved in trade at a given time, the sum of what they valued, each in the context of his own life (1966, 17, her italics).

What are these “individual judgments”? They are the judgment of each individual buyer that the product is worth the price he has to pay. If this were not his judgment, he would not pay it. When we sum up the prices paid by all the buyers of a product, we get the socially objective value.

The standard term for this total in economics is “total revenue” or, less often, total sales receipts. This sum is the socially objective value because the buyers purchase each good and service based on an evaluation of the facts of reality by each man’s mind according to a rational standard of value (see the opening paragraph).

Now we can answer the common objection to capitalism that the market is irrational because the manufacturer of lipstick makes a greater fortune than the manufacturer of microscopes, “even though it can be rationally demonstrated that microscopes are scientifically more valuable than lipstick” (p. 17). The greater fortune of the lipstick manufacturer is the product of millions and millions of lipstick sales, while the microscope manufacturer sells a few thousand. The result is that the socially objective value of lipstick greatly exceeds the socially objective value of microscopes.

But, Ayn Rand says, “this does not mean that the values ruling a free market are subjective.” There follows a brilliant analysis, that could only have been penned by Ayn Rand, of how and why objectivity and rationality rule the market—even though the socially objective value of lipstick exceeds that of microscopes. I leave it to my reader to read or reread that paragraph (Capitalism: The Unknown Ideal, 1966, p.17).

Next time, I will explain how and why I misinterpreted this material in my book.