The Economic Way of Thinking, Part 7

Economic Value Is a Function of Subjective Value

Dr. Ronald Nash is a contributing editor of The Freeman. He is professor of philosophy and theology at Reformed Theological Seminary in Orlando, Florida. His many books include The Closing of the American Heart: What’s Really Wrong with America’s Schools and Poverty and Wealth: Why Socialism Doesn’t Work, both published by Probe Books in Richardson, Texas.

In previous parts of this series, I explained the importance of becoming familiar with a number of commonsense principles that make up what is often called the economic way of thinking. Principles already examined include the importance of incentives and the fact that everything has a cost. This month’s principle introduces us to the unavoidable fact of economic uncertainty.

The Reason for Economic Uncertainty

We seldom know enough about individual persons, even people especially close to us, to predict with any certainty what choices they will make among the various options open to them. We may know that a particular friend ranks tickets to Chicago Cubs baseball games very high in his personal scale of values. But we may not know how smitten he has become with the young lady he met yesterday and how suddenly the prospect of a picnic with his new friend has become more important than watching the Cubs play the Cardinals.

The major reason why certainty in economics, indeed, why certainty with regard to human action, is impossible is the fact that all economic value is subjective. The value that different people place upon different economic goods, upon various choices open to them, varies from person to person. It also changes for the same person at different times. People’s value scales are personal and different.

People value things differently for a variety of reasons which include: (1) different tastes; (2) different perceptions of available opportunities; (3) different interpretations of other people’s actions; (4) different interpretations of current events; (5) different expectations about future events and people’s future actions; and (6) different degrees of alertness to previously unrecognized opportunities.

Because economic value is subjective or imputed value, it follows that economic knowledge is always incomplete, limited, and fallible. None of us can ever know all that we need to know about the subjective value that other people impute to their options. Indeed, we have enough problems attaining this kind of knowledge about ourselves. None of us can attain perfect knowledge about the future. While it is often possible to make some estimates of what will happen, certain knowledge about the future is unattainable. Long-time investors in the stock market will vouch for this, as will anyone who has ever tried to start a business.

One corollary of our limited knowledge about the future is the possibility that the economic value of things will change in unpredictable ways. Natural catastrophes may make some resource more or less valuable. Human tastes, customs, and fashions may change. New highways may change traffic flows. Huge new shopping malls may lead people to develop new shopping habits. Inner cities may decay as people move to the suburbs.

In all such changes, some people will win and others will lose. The scarcity of information means that economic decisions must always be made with some caution and tentativeness. No one, not even the largest and previously most successful businesses, can be completely sure what the future holds for them. Each morning, when the owners of any enterprise open for business, they can never be certain what the market will do to them that day. After what is often a huge investment of money, time, and labor, it is always possible that the business person might discover on a certain day that no one was interested in what he had to offer. The frightening prospect is that the Maytag repairman of the familiar television commercials could be any one of us.

But isn’t everything said thus far just plain old common sense? It is, save for all the people who seem to forget the lessons in this month’s principle, usually at the worst possible time. What is most interesting about the fact of economic uncertainty is its contemporary relevance for several theoretical issues in economics.

Economic Uncertainty and Entrepreneurship

An entrepreneur is someone who believes he sees an opportunity that others have not yet recognized. The key to understanding economic competition is recognizing that no one knows everything, different people have different information. One thing the market process does is gather and communicate information about the most important wants of buyers and sellers. As astute entrepreneurs pay attention to information provided by changing market prices, they often come to recognize new opportunities. These new opportunities may take the form of new products or services that consumers want or of new ways of using scarce resources. As entrepreneurs recognize hitherto unseen opportunities and assume risks in an effort to maximize their own well-being by taking advantage of those opportunities, their actions result in significant benefits to large numbers of people through the creation of new jobs along with the provision of new goods or services.

Economic Uncertainty and Socialism

Without question, the most significant consequences of economic uncertainty affect socialism. Socialism is an economic system in which commands flow downward from the small number of economic planners at the top. In order for such a system to work, the planners at the top must have knowledge about what goods exist and in what quantity and location, and also about what economic goods consumers want and at what price.

The big problem for socialist planners is the fact that it is the market that supplies this information and socialism is incompatible with markets. The most important way in which people can acquire knowledge about the subjective value that individuals place upon various economic goods is to study changing prices. Prices are determined as prospective participants in economic exchanges buy or refuse to buy in response to their personal assessment of their opportunities. As countless individuals, each acting in line with their subjective value scales, exchange units of goods, services, and money, market prices evolve.

The degree to which an individual wants some good or service will have an obvious effect on the price he will pay to acquire it. The more he wants something, the higher price he will be willing to pay. Since the key to understanding the wants and preferences of consumers is market prices and since market prices are unavailable in a system like socialism that abolishes markets, the socialist planners are in obvious trouble when it comes to supplying the wants and needs of consumers. Of course, when economic socialism is married to political tyranny, the desires of the individuals forced to live under such a system do not matter.

But economic planners in a socialist system have other problems. They are cut off from the information required to set rational prices for the goods they sell. Imagine that you’re the manager of a factory operating under a socialist system. Suppose your factory produces 1,000 widgets a day. One of your problems is to decide what price to charge for your widgets. But to do this rationally, in a non-arbitrary manner, you must first have access to various kinds of information. You can hardly know what selling price to place on each widget until you first know how much it cost to make it. But under socialism, such information is not available since the government owns the land, the raw materials, the machinery, the factory, the utilities, and everything else. Under such a system, it is impossible to know the cost of producing economic goods. And if you cannot know the cost, then you cannot know what price to offer the good at. What industries located in socialist states typically do is investigate what similar products are selling for in non-socialist economies.

Economic Uncertainty and Capitalism

Rational economic activity is impossible without certain kinds of information. Access to that information is hindered by the fact that economic value is a function of the subjective value that individual people impute to economic goods. One of the more important functions of a market system is the steady supply of information it provides about these subjective preferences by means of rising and falling prices. One of the ironies of socialism is the fact that socialists need capitalism to survive. Once we recognize all this, we can more easily understand not only why socialism does not work, but also why it cannot work.