Marginalism III

By M. Northrup Buechner

May 5, 2013

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

Last time, I defined Marginalism as the principle that people value things at the margin; they value one more or one less; they do not value an entire quantity unless the entire quantity is at stake. This insight resolved the diamond/water paradox and opened the door to the idea that the prices of goods are not independent of the value people place on them—which is true.

What is not true is the alternative conclusion that was drawn—that the value people place on goods determines their prices. It is alleged to work like this: The value placed on a good by consumers is reflected back to the labor that produces that good. Workers who produce highly valued goods, such as jewelry, are paid a high wage, while workers who produce goods on which people place a relatively low value, such as McDonald’s hamburgers, are paid a low wage.

The prices of things tend to equal their cost of production (the classical economists were right about that), but that is because businessmen bid the wages of various workers up or down depending on what consumers are willing to pay for the things those workers produce. The result is that, according to modern economics, everything in the economy, all its prices, interest rates, wage rates, contracts, output, costs, employment, jobs, etc., is caused by the subjective preferences of consumers.

This is where the economy begins: with what consumers want and how much they want it—and over time, the whole economic system automatically falls in line with those desires. If consumers’ desires change, if they want more chicken and less beef, the whole economic system shifts to accommodate their desires.

This is what modern economists call “consumer sovereignty.” The consumer is king; the consumer rules the economy. When they feel like defending the free economy, this is modern economists’ defense.

This also is the subjectivism of modern economics. Economic thought has gone from the view that consumer desires are irrelevant to understanding the economy to the idea that consumer desires determine everything about the economy. Modern economic subjectivism holds that the whole economic system is an expression of the subjective preferences of consumers.

In other words, the modern idea is that consumer desires create the economy. This is a minor variation on philosophical subjectivism—the idea that man’s mind determines the facts, that what people think creates reality.

In its original form, economic subjectivism was relatively benign. It was wrong, but it arose as an answer to economic intrinsicism, which was even more wrong and needed to be answered. The early economic subjectivists had no concept of objectivism (small “o”) as an alternative and made no distinction between objectivism and subjectivism. As a result, their implicit philosophical perspective was a hodgepodge of both concepts. Sometimes they made valid points, but when they did, those points depended on the objective part of the hodgepodge. But this is important: sometimes they made valid points. That could not save them or economics.

In the realm of ideas, you cannot get away with just a little poison. The implications of an idea eventually will out. The rise of philosophical subjectivism throughout all fields of knowledge in the twentieth century was duplicated in economics, resulting in a completely subjective economic theory. Its signpost is the premise that facts are relevant only insofar as consumer preferences make them relevant.

For an Objectivist, there is obviously something wrong here. It cannot be true that the subjective desires of consumers are the basis for the whole economy. At the same time, the above description of how consumer desires determine wages has a certain plausibility to it. What is wrong with it? The short answer is “everything.” That answer is actually true, but it is hardly illuminating.

Next time, I will bring the light.