lnc2prime - Notes 2 Value Trade creates value Middlemen A...

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Notes 2’. Value; Trade creates value; Middlemen A. Value 1 A pound of tin is worth more than a pound of turnips. How come? That question, i.e., what determines the value of a good, is one economic thinkers have spent a lot of time and effort attempting to answer. The issue is pretty well settled today, but it’s instructive to take a brief look at the history of the theory of value. Adam Smith and David Ricardo, and practically all the early classical economists, ascribed to some form of the labor theory of value, which holds that the value of a good is determined by the amount of labor required to produce it, that is, the amount of labor that the good “contains.” Now, if you don’t take this too far, it works as a nice approximation of the real world. Writing in 1776, Smith put it in Wealth of Nations, If among a nation of hunters . . . it usually costs twice the labour to kill a beaver which it costs to kill a deer, one beaver should naturally exchange for or be worth two deer. Now, assuming that the hunters are rational, utility-maximizing individuals, who won’t waste their time hunting animals that won’t bring a price high enough to justify the effort—which also assumes that these guys have a pretty good idea of the relative market prices of different animals and other goods, too—this makes sense. A beaver pelt must be worth two deer skins because it trades for two of them. I won’t mind spending twice as much time for each beaver I trap if I know that each beaver pelt will sell for as much as two deer skins. But a big problem with the labor theory of value arose when economists reversed the causality: If I spend twice as much time hunting a beaver as you do hunting a deer, then my beaver pelt must be worth two of your deer skins. Wrong! Say that it also takes twice as much time to kill a rat as a deer. (Rats make a small target and can be pretty hard to shoot. Try it some time.) Does that mean that one rat pelt will trade for two deer skins? Not likely. But doesn’t the rat pelt “contain” twice as much labor as the deer skin! Yes, but who cares? It’s still a rat pelt. Who wants it? That gets to the heart of modern value theory, which is based on something developed in the 1870s called marginal utility theory, which you’ll get familiar with in Economics II. The basic idea is that the value of a good depends on the usefulness, or utility, it produces for the consumer. The modern concept was best stated by the American (University of Chicago) economist Frank Knight in 1928: [C]ost must be measured in terms of products, and not of pains or outlays. 2 That is, I don’t care how much trouble it was for you to make that widget, I’m only going to pay you what I think it’s worth. So in modern thinking, value is subjective , that is, it is determined by the person (subject) doing the valuation, not by any quality of the good (object) itself. In contrast, the labor theory of value is objective ; the value rests in the object itself. A simple test shows the problem of the labor theory of value and the wisdom of the modern subjective theory. Consider a box of crackers that you have
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