Subjective Value and Trade

Howard Baetjer: All right, in this first lecture the topics are that people respond to incentives. These are basic concepts of economics. Now the first things we’re to be going through, people respond to incentives, value is subjective, trade creates wealth, the invisible hand principle, the fact that wealth is not fixed but can be increased [00:00:30] even without limit. I’ll take a moment to talk about what Julian Simon calls the ultimate resource. The last point in this lecture is that money is not wealth. We need to be careful not to think of money and wealth as being the same.

The first point, a fundamental principle of economics is that people respond to incentives. Sometimes I’m tempted at the beginning of my courses to say, “People respond to incentives, any questions? All right, I’ll see you at the final exam,” [00:01:00] because almost everything we do in economics is a tracing out the fact that people respond to incentives, how incentives change and how people respond to them. For example, an increase in the minimum wage, it’s been pretty large in Seattle recently, gives workers more of an incentive to go find a job at a higher wage, but it also gives employers an incentive [00:01:30] to find something other than human workers that they can use in their production process. When stores want to clean out the shelves of their summer clothing, what they do to give you all an incentive to buy some of that clothing and make space for the winter clothing?

Student: A sale?

Howard Baetjer: Put it on sale. Lower prices give people an incentive to buy more of a good. When a pro football team [00:02:00] wants to get a player to join up, they’ll often give the guy a signing bonus as an incentive to sign up and so. We won’t spend much more time on that but it should be in the background of everything we talk about, people respond to incentives. We look at how the incentives change with different situations.

Next main topic, value is subjective. Value is in [00:02:30] the eye of the beholder. Value is in the person doing the valuing not in the object being valued. These reading glasses that I’m holding, for example, that are so useful to me, these are valuable to me because I need them, not because of anything inherent in the glasses themselves. Would any of you like to have my reading glasses? Do you need reading glasses at this point? No, you’re too young. You don’t need them, so they don’t have much value to you because your eyes [00:03:00] aren’t aging as mine are. The distinction here is with the labor theory of value. The current modern theory of value is that value is subjective. It’s in the opinions, the tastes of the person doing the valuing. The older theory was the labor theory of value.

This was presented very well and incorrectly in Adam Smith’s The Wealth of Nations. It was picked up by Karl Marx [00:03:30] and used in the theory of Marxism. That is the idea that what determines the value of a good on the market is the amount of labor that went into producing it. Now there is a relationship, but it’s not a causal relationship. If labor theory of value were true, then if an apple pie took four hours to bake and a mud pie took four hours of labor to bake, then they should be of equal value. [00:04:00] After all, it took the same amount of labor to produce it, but that’s not the way it is because people generally don’t like to eat mud pies so they are not as valuable to people as apple pie so value is subjective.

The third point is that trade, exchange can create wealth and that’s a consequence of people valuing things differently. When two people value things differently … Suppose you and I are going to make an exchange, you have the reading glasses [00:04:30] and I have the cup. I want the reading glasses more than I want the cup, you want the cup more than the reading glasses, we can make an exchange and both of us feel better off from the standpoint of our own individual values. Trade can create wealth. Now this is an important point because they’re so much misunderstanding in the general talk that goes on [00:05:00] in society about wealth. People have the idea that trade is zero sum. We hear the expression that’s, “One man’s loss is another man’s gain. The rich get richer and the poor get poorer,” but that’s not necessarily true. One man’s loss is not another man’s gain, if each is trading away what he values less for what he values more. One man’s gain is a consequence [00:05:30] of the other man’s gain at the same time.

We have mutual exchange to mutual benefit. Is it really true that the rich get richer and the poor get poorer? Think about Steve Jobs, for example, who died a very rich man. Did he get rich by making us worse off with all those Apple products? Does any of you own an Apple product, have an iPhone or an iPad or whatever? Were you exploited, [00:06:00] were you taken advantage of, when you bought this? No, you gave up what you valued less for what you value more. It was worth more to you to have the iPhone or the iPad then the money you gave up, so you became better off by the exchange and so did Steve Jobs. Because value is subjective, because trade can create wealth, people in a market economy make themselves better off by making others better. [00:06:30] In that sense trade, just by itself, can create wealth.

Let’s have a quick quiz here to review these last couple of comments. Suppose you and some friends go late one night and you’re hungry and you go to Pizza Hut and get a Cheese Lover’s pizza, spend say, I don’t know what they cost now, suppose it’s $11. What do [00:07:00] we know about them? You the pizza for $11. What do we know about the value of the pizza? I’m looking for two things. If you bought a pizza for $11, what do we know about the value of the pizza?

Student: Pizza Hut valued it at $11 or less and you valued you it at $11 or more.

Howard Baetjer: Nicely done. Nicely done. We value things differently. The reason the trade occurred is that you valued the pizza more than the $11. Pizza Hut valued the $11 [00:07:30] more than the pizza. That’s why the trade occurred. Of course, I’m trying to trap my students when I ask this. They will say, “Well, if it sold for $11, than it’s worth $11. That’s the value.” No, because value is subject. The price is $11 but that’s different from the value and we’ll come back to that in a moment.

All right next, and along these lines the invisible hand principle. The term invisible hand comes from Adam Smith’s the Wealth of Nations [00:08:00] and he asserted there that when there is protection of private property and freedom of exchange, then people are led as if by an invisible hand to produce a result that was no part of their intention, that is benefiting other people. The invisible hand principle, as I think of it, is that in a market economy people who want to benefit themselves, even if they’re just selfish, are led [00:08:30] as if by an invisible hand to benefit other people. Because after all, if people aren’t required to deal with them, the only way they can get from other people what they want is to offer those others a corresponding benefit in exchange, so they have to think, “What do other people want?” The car companies now, presumably, they don’t love you and me, but they’re constantly thinking, how many cup holders do we want, what kind of stereo equipment, do we want side airbags. Constantly focused on what [00:09:00] other people want. They’re being led by an invisible hand to consider the well-​being of others.

One key there that we always need to keep in mind is that assumes that the underlying principles of a free economy are there. That is protection of private ownership, protection of private property and freedom of exchange. As long as people are free to exchange or not, the only reason they will is if [00:09:30] they think it makes them better off. People who want more for themselves must pay attention to the wants of others. My professor at George Mason, Walter Williams, says this in his usual colorful way. He says, “In a free economy to get more for yourself serve your fellow man. You don’t have to care about him, but serve him.” That’s the invisible hand principle. Whether or not you really care, you must pay attention to somebody else’s wants if you want more for yourself [00:10:00] in an exchange economy.

All right, a little bit more on wealth. We said that trade creates wealth. The next point I’d like to make is that wealth isn’t fixed. Wealth isn’t fixed. People created it. Often, I find people seem to assume there’s only a certain amount of wealth in the world so if some people have more, others must have less. Well no, that’s not going to be true over time. If that were true, why then [00:10:30] who was that gazillionaire caveman who had all the wealth years and years ago? Well no, everyone was poor in the caveman time and gradually human beings have become wealthier. How did they become more wealthy? In part, it’s by trading with one another, but also it’s by transforming natural resources into the goods and services that we want. Human beings are creative, they find ways to use natural resources in ways that [00:11:00] can create what Adam Smith called the necessaries and conveniences of life.

I don’t see any limit to this because human beings create wealth there’s no reason that we should always have poor people with us. If by poor, we mean people who don’t have enough food and clothing and shelter to support life. Human beings are creative enough that given the right institutions, [00:11:30] given time, we should be able to produce enough wealth. Human beings should be able to produce enough wealth, create enough wealth, to sustain everybody at a high standard of living.

Along these lines to get to the next main topic, the ultimate resource. This is the title of the book by economist Julian Simon. What do you suppose he had in mind? Those of you know don’t say so that others can guess. What do you suppose [00:12:00] Julian Simon said was the ultimate resource? As a little background, this is in the context of a book in which he considers the possible depletion of resources, like chromium and cobalt and petroleum and so on. He said, “That’s not really a problem because the ultimate resource is something different.” What’s the ultimate resource according to Julian Simon? None of you knows, not even those of you … ? Want to guess?

Student: According to me, it would be time, but I’m not [00:12:30] sure it’s that.

Howard Baetjer: That’s not what he had in mind. I can see where you’re getting at there but that’s close. He had something else in mind. What’s happening in time? What’s being used in time? The ultimate resource.

Student: Is it human ingenuity?

Howard Baetjer: That a girl, yes. Human ingenuity. Human beings, the human intellect, the human ingenuity attached to the human spirit, that’s the ultimate resource. [00:13:00] There doesn’t seem to be any limit on that. As long as human beings are creative, we should be able to transform natural resources into more and more good stuff to take care of people’s medical needs, their food needs, their housing needs and so. There’s no necessity in the long run for the human race, for anyone, to be poor. I hope that in your lifetime you will see the poorest people in the world living at the standard of living you live at now. I think that’s a very real possibility and it’s because of the [00:13:30] ultimate resource.

To illustrate this a little bit, I remember, I guess, when I was around your age, some people were worried that we would run out of vinyl for long-​playing records. We had our music on these long-​playing records made out of vinyl and vinyl was running short. Before were wondering, “Well, what will we do?” Has that been a problem for recording music? No, we don’t use vinyl any longer because the ultimate resource, human ingenuity, [00:14:00] has figured out a way to put gazillions of songs on these tiny, tiny little chips using far less of the physical resource of vinyl or whatever it might be. There’s a good illustration of the ultimate resource at work.

Petroleum is another resource people are worried about running out of, but with petroleum we have a good opportunity to think about what we mean by a resource. What Simon argued [00:14:30] was that, “It’s human creativity and intelligence that creates resources of physical stuff.” There was a time when petroleum, oil, use to gunk up streams in Oklahoma and Pennsylvania. It was just a nuisance, but some intelligent human beings figured out that it could be refined into kerosene and make a good fuel. Then the petroleum became a resource [00:15:00] when people figured out a way to use it.

All right, last point is that money is not wealth. Last point for this lecture, money is not wealth. Sometimes when I say, as I did a few moments ago, that wealth is not limited, human beings could create wealth. I can see a quizzical look over my student’s face and they say, “There’s only a certain amount of money.” They’re thinking of money as well, but money [00:15:30] … Can you eat money? No. Can you wear money? Can you shelter yourself from the rain with money? Money isn’t really useful in and of itself. It’s useful instead as a?

Student: A medium of exchange.

Howard Baetjer: As a medium of exchange. We say money is a medium of exchange. It’s useful as my friend, Anthony Davies of Duquesne University, says “As a conveyor belt.” [00:16:00] Ultimately, he says that “It’s goods and services that trade against goods and services. Money is just a conveyor belt.” We don’t really want money for itself. We want it to spend it on something else. Keep that in mind that distinction between money and wealth. Can you have more money without more wealth?

Student: You can print it.

Student: Yeah.

Howard Baetjer: You can print it. When you print more money, do you have more wealth?

Student: No.

Howard Baetjer: No, that’s inflation. If we [00:16:30] could imagine a happy situation where there was not excessive printing of money, you could have a fixed or relatively fixed quantity of money and the quantity of wealth, of goods and services, could outstrip that. What would that mean about the value of each monetary unit if the amount of goods and services increased more rapidly than the quantity of money? What would happen to the value of each money unit?

Student: Increase.

Student: Deflate.

Howard Baetjer: It would increase. Each money unit would be able to buy more and more and that would be a positive, [00:17:00] a desirable, kind of deflation.

Student: Yeah.

Howard Baetjer: All right then just for quick review, people respond to incentives, value is subjective. Because value is subjective, trade can create wealth. Remember the invisible hand principle? People, when they’re not allowed to steal from one another, they want more for themselves or lead as if by an invisible hand to consider the well-​being of others. Wealth is not fixed. People create it. The ultimate resource is the human [00:17:30] imagination coupled to the human spirit. Money is not wealth. Money is the conveyor belt, the medium of exchange. That’s it for the first lecture. Questions? Here’s a question I think?

Student: I just want to ask that you said, “Trade doesn’t make poor people poorer and rick people richer.” I just want to ask you that. [00:18:00] What makes the distinction or the gap between poor people and rich people more stronger or more deeper?

Howard Baetjer: What makes the gap between rich and poor larger?

Student: Yeah.

Howard Baetjer: An insight that’s useful to me on that question is an insight that was stressed by the great trade economist, Peter Bauer. He was once in [00:18:30] a debate with a man about what causes poverty. His debating opponent gave a long speech and Bauer sat there sort of characteristically glowering and he got his chance at the podium. Again, the topic is what causes poverty. As I understand the story, he came to the podium and he looked out over the audience and he said, “Poverty doesn’t have causes. Wealth has causes,” and he sat [00:19:00] down. Poverty is easy. It’s easy to be poor. We don’t do anything. We don’t make any effort to sustain ourselves. We’re going to be poor. What needs the explanation is the wealth. Why do some people in some parts of the world and sometimes of history do better? Well, it’s because we have the institutions we’ll talk about, private ownership, freedom of exchange, a reliable money. In those settings, people get richer. [00:19:30] If you think about the world now, the poor people of the world are concentrated in areas where there are not free markets or there are markets that are less free. There’s less security of private ownership, less freedom of exchange, more predatory governments. I would answer that, what explains the difference between rich and poor, is that some people have more economic liberty and so they get better off. [00:20:00] People who don’t have economic liberty, stay poor.

Student: If money doesn’t equal wealth, which I believe, why the Fed, the ECB, still print money?

Howard Baetjer: Oh boy, that’s a big, big question. I would love to have you come take my money and banking class. Why do central banks print money? There are undoubtedly many reasons. [00:20:30] One main reason I believe must be that there are short-​term political benefits to printing money and those benefits tend to win in the political process of a politicized central bank over the longer-​term benefits of not printing too much money. It’s always a temptation to goose up the economy with printing of new money so as to [00:21:00] reduce unemployment, to generate better returns in the stock market. One answer to your question is, it’s a difference between seeing the long run, the benefits of being restrained, and trying to create just the right amount of money versus the temptation to inflate to produce more money. Is that an answer to your question?

Student: I guess so.

Howard Baetjer: Now part of it also is that there are people who believe, and [00:21:30] I think they’re mistaken, that more rapid production of money really is a good thing overall, but that’s a macroeconomic issue and, boy, there’s differences of opinion on that among very, very bright people. That’s maybe too big a question for us to get into more [00:22:00] deeply now.