Marginalism VI

By M. Northrup Buechner

June 8, 2013

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

Last time we saw that the law of utility is limited by the fact that most of the things that people acquire are not identical. We went through a standard explanation, seeing how a farmer would value his buckets if one were lost or another was added. But we ignored how the farmer acquired his buckets, which also is standard in explaining the law of utility.

Goods do not magically appear and disappear. They do not fall like manna from heaven only to be snatched away by the devil. In an economy governed by a price system, such as the one in which we live, when people want to possess goods, they BUY them at a PRICE. When they want to dispose of goods, they SELL them at a PRICE. This fact, that prices are almost always involved in both the acquisition and the disposal of goods, is the second fact about the economy that nullifies the law of utility.

In the normal course of events, people value goods at the prices they have to pay for them. This is normal, natural, and unavoidable. The extent to which price automatically affects our evaluations is quite remarkable. For example:

“Girls, girls, look at this ring. I got engaged last night. Billy asked me to marry him and gave me this ring. He paid $20,000 for it.”

“Oh my Gawd! Look at that rock!”

“It is so big. And the sparkle is almost blinding!”

“That is the most beautiful thing I have ever seen.”

“Where did Billy get $20,000?”

“$20,000? Billy? Oh, I was just kidding. He paid $20 for it. It’s just a piece of glass. But he promised to buy me a real ring as soon as he can.”

In the blink of an eye, the ring is transformed from a big, blinding diamond into an uninteresting piece of glass.

What is the point? In an exchange economy, price is value—price measures the value—not to everybody, not all the time, not if you keep your wits about you (as did the girlfriend who asked where Billy got the money)—but as a first impression, and for the things one routinely buys every week or month, people take price as the value.

Price as a measure of value is a variation on, and perhaps an extension of, the principle identified by Böhm-Bawerk, that people value goods that are easily replaced at the price it costs to replace them. This principle applies to all consumer goods that are for sale in the market. It excludes items like photographs, family heirlooms, keepsakes, and other such items, perhaps of enormous value to an individual, which cannot be replaced.

Consider, for example, a standard 26 ounce container of table salt or a five-pound bag of sugar. Both are very inexpensive and no one has reason to think much about them or to consider what their objective value might be. But if salt or sugar were rare and hard to get and each container cost $500 or $1000, people would value both salt and sugar in accordance with their prices. They would be thought of as precious commodities like caviar, saffron, or platinum.

Alternatively, suppose you have one roll of Bounty paper towels left in your kitchen, so you buy a package of fifteen Bounty towels on your next shopping trip. If storage is not a problem, the fact that you now have sixteen rather than one does not change the value to you of an individual roll. This contradicts the law of utility, but it is true nevertheless.

The proof is introspection—that is, each of us can imagine ourselves in these circumstances and grasp that we would still value a roll of Bounty towels the same as before. The reason is that, since we can buy more Bounty towels whenever we need them, we have no reason to value them at anything other than their price.

Evaluation is more variable with some expensive items. Consider a house, for example. Normally, when one buys a house, one values it at the price one paid. But, if the buyer thinks he got a bargain, he will value the house at more than he paid. Over time, as the housing market goes up or down, the value of the house goes up or down, and the owner revises the value in his mind, depending on what may be more or less reliable sources of information. However, a change in circumstances can change the value of a house to its owner, independently of its market value, such as an increase or decrease in the number of occupants or a change in the neighborhood.

In general, people value exchangeable items, that is items that can be bought or sold, at what they can be bought or sold for. For the most part, this includes even the most expensive things. If this is true, the law of utility is irrelevant.

The preceding discussion applies to consumer goods and services in an exchange economy. Things are different with producer goods. However, the law of utility does not apply to producer goods; it has always been applied only to consumption items. In the context of consumer goods, it is hard to think of cases where the law of utility helps us understand what people buy and what they pay. Additional units are not identical, and if they are, such as gasoline, we value them by what they cost, not according to an alleged diminishing utility.

Next time we will take up what I think is the truth about why and how people decide what to buy.