A major question throughout economic history has been the question of what determines the value of an item. Most economists throughout history (and many today) believed in an intrinsic theory of value; that an item has an innate value that can be measured and calculated.
Common intrinsic value theories include the labor theory of value (supported by both Karl Marx and classical economist David Ricardo), the exchange theory of value (proposed by Marxist economist I. I. Rubin), the monetary theory of value (proposed by Marxist economist John Milios), and the power theory of value (proposed by institutional economists Jonathan Nitzan and Shimshon Bichler).
In the late 19th century, William Stanley Jevons, Léon Walras, and Carl Menger (founder of the Austrian school) separately developed the subjective theory of value. This theory argues that the value of a product is not intrinsic to the product itself but instead is determined by a consumer’s desire for that product.
Since individuals have different wants, needs, and possessions, the value an individual places on goodwill differ from person to person.
Time plays a role in the value of an product. A cup of coffee provides a very clear example of subjective value and time preference.
Let’s say I offer you a cup of coffee in the morning. If you enjoy the taste of coffee, and it’s part of your morning routine, you’ll likely be grateful because you value a cup of coffee. If you don’t like the taste of coffee, you won’t want to accept it because you don’t value it.
Let’s say I offer you a cup of coffee in the evening. If you work the night shift and enjoy coffee, you’ll value it and be grateful to receive it. If you’re about to go to sleep, you’re going to reject my offer whether you enjoy coffee or not, because coffee is significantly less valuable when you’re trying to sleep.
So not only is a cup of coffee valued differently between people that like coffee and people that don’t, but its value differs throughout the day. Coffee is more valuable when you first wake up and less valuable when you’re about to sleep.
In addition, people have different preferences for taste. Some people value coffee more with the addition of sugar, while others will see the added sugar as a negative.
Certain items are greatly affected by time preference. If someone is severely dehydrated, they place a high value on water now and couldn’t care less about receiving water in the distant future. Likewise, if a smoker hasn’t had a cigarette in some time, he would be willing to pay more for a new box if he can get it sooner rather than later.
Why is it that when shopping, we decide it’s worthwhile to buy one or two (or maybe a few more), but we eventually stop, even when there is more of that item for sale?
We might find a shirt we like, and then buy it, and we might even buy more than one, but rarely do we buy out the entire stock. After all, if someone likes pasta, and decides it’s worthwhile to buy a box, wouldn’t it be worthwhile to buy the second, and third, and fourth box, since they’re all the same price?
Marginal utility is the added satisfaction gained from each additional item. What we find is that each additional item is valued less than the item before it.
Take currency, for example. A homeless man will value an additional ten dollars far more than Jeff Bezos will. The Jeff Bezos of 1996 would value an additional ten dollars (inflation-adjusted) far more than the Jeff Bezos of 2019 would.
Part of diminishing marginal utility is based on the concept that we tend to use our available resources on the most valuable things first. For instance, if one only has enough money to cover basic needs, that money will fund their basic needs. After that, any additional wealth will cover one’s greatest wants. After these are covered, any additional wealth will cover less desirable wants.
This applies to any good, not just money. If one has $10 of spending money and they buy a box of pasta for $1, they’re declaring dollar number 10 to be worth less than box of pasta number 1. If they buy a second box, they’re declaring dollar number 9 to be worth less than box of pasta number 2. If they decide not to buy a third box, they’re declaring dollar number 8 to be worth more to them than box of pasta number 3.
This is (subconsciously) how value is compared. We cannot calculate exactly what dollar number 8 is worth to that individual person, but we can say it’s worth less than dollar number 7, more than dollar number 9, and more than a box of pasta number 3.
It is this theory of value that solved the troublesome diamond-water paradox (why are diamonds more valuable than water when water has more use than diamonds?). Because water is so plentiful while diamonds are more scarce, each additional diamond has a much higher marginal utility than each additional unit of water.
With this kept in mind, we see thousands of examples of the subjective theory of value every single day. Intrinsic value theories kept running into exceptions, but the subjective value theory covers everything. One can criticize it for declaring value too abstract to easily calculate, but this is only saying it’s inconvenient for central planners, not that it’s untrue.
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