Some people, thinking economics merely a matter of opinions, question the "value" of economists. When people are sick or have trouble with their bodies, they consult a
We are addressing ourselves tonight to a phase of economics that is responsible for many of our problems. Most people do not understand the full importance and significance of value in human action. This ignorance goes back many centuries. We must first deal with some popular fallacies, before presenting the positive theory that must become more popular if our civilization is to be saved. But let's go back to where we left off in the last lecture.
All life is change. For men, life is a series of choices by which we seek to exchange something we have for something we prefer. We know what we prefer. No other man or bureaucrat is capable of telling us what we prefer. Our preferences are our values. They provide us with a compass by which we steer all our purposeful actions. Because few people fully understand this, we have some serious economic problems.
Aristotle Misunderstood ExchangePart of our trouble goes back all the way to Aristotle (384–322 BC), who in some asides in his books suggested a fallacious idea which many people now accept as gospel truth — the idea that the only fair exchange is an equal exchange, or, stated the other way around, that an equal exchange is the only fair exchange. This sounds reasonable but it contains the seeds of many fallacies concerning value, trade, and exchange.
Nonetheless, this idea has been held by many people over the years. It is still held by millions today. It is responsible for a
This is, of course, a very basic error. It goes back at least to Montaigne. My great teacher, Mises, calls it "the Montaigne dogma." Montaigne, who lived in the 16th century, once wrote in his famous essays, "Le profit de l'on est le dommage de l'autres." Translated, this says, "The gain of one is the loss of another." This thought was and is very popular.
It was even promoted by Voltaire. In 1764, Voltaire wrote,
To be a good patriot means to wish that one's community shall acquire riches through trade and power through its arms.… It is obvious that a country cannot profit but by the disadvantage of another country, and cannot be victorious but by making other people miserable.That is a terrible thought to have to live by or with: the idea that all gains in life must come from the suffering of other people. But this is what many people think about the success of others. In the times of the Scholastics, even good Christians held the idea of a "just price" and a "just wage" that never changed. Saint Thomas Aquinas held such ideas. He thought that if it took one hour to produce "A" and two hours to produce "B," then two units of "A" should always be equal to and always exchange for one unit of "B." According to this idea, any other exchange rate was "unfair."
Classical Economists Misunderstood ValueThe early classical economists did little to clear up this fallacy. Even Adam Smith, the founder of the Classical School of English economics, has this to say in his great work of 1776: "Labour is the real measure of the exchangeable value of all commodities." By this he was trying to say, as were those who earlier favored the "just price," that there is a basis for calculating equal exchange rates, and this basis is the labor time it takes to produce what is being exchanged. Any other exchange rate favors one party at the expense of the other.
This, of course, agreed with the Montaigne dogma: If someone is rich, he must have become so at the expense of others. This is still the attitude of many toward businessmen who become rich in the service of the many. Unfortunately this was also the thinking of many of the early economists.
Adam Smith was followed by David Ricardo, who lived from 1772 to 1823. In his Principles of Political Economy and Taxation (1817), he wrote, "The natural price" — I stress here the word "natural," because this was a time in history when everyone believed there were both natural laws and natural prices that men could not alter —
The natural price of labour is that price which is necessary to enable the labourers to subsist and to perpetuate their race, without either increase or diminution.… The natural price of labour, therefore, depends on the price of food, necessaries and conveniences required for the support of the labourer and his family.This was merely a specific application of the general rule that the cost of anything was the amount of labor that went into its production. Ricardo thought this meant that the cost of labor itself must be the cost of the amount of labor needed for the production of the goods needed to produce and support a constant labor supply. This is what Ricardo called the natural price of labor — the price toward which he thought wage rates would always tend to be set.
Then, he went on in the next few pages to define the market price. He wrote,
The market price of labour is the price which is really paid for it, from the natural operation of the proportion of the supply to the demand; labour is dear when it is scarce and cheap when it is plentiful. However much the market price of labour may deviate from its natural price, it has, like commodities, a tendency to conform to it.… When, however, by the encouragement which high wages give to the increase of the population, the number of labourers is increased, wages again fall to their natural price, and indeed from a reaction sometimes fall below it.This was in accordance with the thought that whenever there was too much production of something, competition would send its price below the cost of production. Then, businessmen would reduce production and the price would tend to rise to its "natural price." Ricardo thought these same principles applied to labor. When employers paid higher wages than workers needed to live and reproduce another generation of workers, workers would only raise more children to the working age. Then when these additional children became workers, their competition against each other would drive their wages down toward the "natural wage," and sometimes even below the "natural wage." As a result, some workers would somehow have to be eliminated, probably by war, famine, or epidemics.
This was the philosophy of the Classical School. This was the essence of their ideas about labor, wages, and value. In those days, millions of infants and children never lived to become adults. In fact, one of England's nobles is reported to have named six or seven of his sons after himself, all with the same name, hoping that one of them might live to become an adult and carry on his name.
It was capitalism that reduced the infant mortality rate.
But getting back to this early 19th-century period, this concept of the classical economists presented a very, very gloomy outlook. It meant, according to the doctrines of Malthus too, that any increase in population would only produce great distress. It meant that under the market system of capitalism, it was hopeless to try to raise the real wages, or living standards, of labor. If you raised their wages, they would only have to be lowered eventually, resulting in great suffering and many deaths. This was the thinking of the best economists all through the first half of the 19th century.
They had other problems they couldn't solve. There was, of course, the great paradox of value. Iron and its products were much more useful to men than gold, yet gold was more valuable in the market place. This fact was a paradox the economists of those days could not understand or solve. They couldn't see why gold sold at a higher price than iron, when iron was the more useful metal. Their writings did not solve this problem of value. Instead, they struggled with the labor theory of value, the idea that the value of anything was the value of the hours of labor that went into its production.
Marx's Value TheoryThis was the status of economic thought when Karl Marx appeared on the scene. His Das Kapital was based entirely on this labor theory of value. In the first volume of Das Kapital, he wrote,
The value of labour power, like that of every other commodity, is determined by the working-time necessary for its production, consequently also for its reproduction. Labour power exists solely as an attribute of a live individual, and hence it presupposes the latter's existence. A live individual needs a certain amount of necessaries in order to sustain himself. The working-time necessary for the production of labour power resolves itself, therefore, into the working-time required for the production of such necessaries of life, in other words, the value of labour power is the value of the necessaries required to sustain its proprietor.This was completely consistent with the economic theory taught by the better known economists of that time. Perhaps we tend to blame Marx too much for this. He later had his troubles trying to defend this labor theory of values. However, when he published the first volume, he was merely adopting the value theory which leading economists then held. Under this labor theory of value, there was no hope that workers could improve their conditions in a market society. Marx thought that under capitalism the rich would become richer and fewer while the poor would become poorer and more numerous. With such fallacious ideas, it was only natural for Marx and his followers to oppose the market society. He sought its overthrow as the only way to improve the conditions of the masses. These ideas, including the labor theory of value, are part of the problem we face today in the United States, and they are also popular in other countries, including Argentina.
If labor is the sole source of value, then when there is an increase in wealth, all the increase must rightfully belong to labor. When any wealth or value is created, it is created by labor. Any businessman or investor who takes or receives an increased income is appropriating an unearned income. According to the Marxian theory, he is getting what really belongs to the workers.
When economists speak of indirect exchange, they mean exchange with the use of money. Direct exchange is barter, an exchange of goods for goods, or goods for services, directly, without the use of a medium of exchange. When you exchange goods for money and then exchange the money for other goods or services, it is an indirect exchange.
Marx said that a fair exchange existed when people took a commodity to the market, exchanged it for an equal value of money, and then exchanged this money for an equal value of another commodity they wanted. This, he considered, was a fair indirect exchange. This is what Marx and his followers thought the situation had been and should continue to be.
But those terrible capitalists came along and changed the system. What did they do? They changed the system by starting out with a definite quantity of money. They first bought commodities at market prices and hired workers at market wages. Then what did they do? They sold the finished products for more money than they had paid for the labor and commodities that went into their production. This was an unequal exchange. This was an "unfair" exchange. The capitalists got more back than they paid out.
Marx Opposed ProfitMarx wrote in volume 1 of Das Kapital,
But how can profit derive "spontaneously" from capital? For the production of any commodity the capitalist needs a certain sum, say $25. In this sum are included all the costs of the production.… He subsequently sells the finished commodity for $27.50.… The idea of something being thus created out of nothing is unacceptable to human reason.… When this process is finished the capitalist has only in his possession an object of the same value as previously.Later, he wrote in volume 3, "It is inexplicable that more value should come out of production than went into it, for something cannot come out of nothing." In other words, it's nonsense to say that goods are sold for a higher price than they are worth. So if they are sold for $27.50 they must have been worth $27.50 in the beginning, and that $27.50, except for the cost of raw materials and depreciation, should all be paid to labor.
So, according to Marx, the capitalists cheated the workers. This was supposedly done in this manner: Under the market system, the workers earned enough to buy the food and other essentials needed to sustain themselves, their wives, and their children, in so many hours. Let us assume this was nine hours. Then the businessmen worked them ten or 11 hours and kept the full value of what was produced in the overtime. This was all in harmony with the idea that all value was created by labor only. According to this view, there is no other way to create values. This, of course, brought forth the idea that so many people hold today, the idea that anyone who gets rich from trade or business is doing so at the expense of the workers. This feeling is very, very common in the world today. It is the underlying official doctrine of most labor unions and political parties.
We do not have time to discuss all of the faults of this labor theory of value. However, let me say that Marx wrote his three volumes of Das Kapital in the 1860s. Volume 1 appeared in 1867, based on this labor theory of value. Volumes II and III were also based on it. But Marx was wise enough not to publish Volumes II and III during his lifetime. It was not until after his death that Engels found and edited Marx's original manuscripts. Volume 2 appeared in 1885, two years after Marx's death. The third volume appeared in 1894, 11 years after Marx's death. Economists then studied these last two volumes to see if Marx had been able to defend the labor theory of value, because in the early 1870s economists had come out with a new theory of value, which superseded the labor theory. We shall be speaking of this new theory in a moment.
Böhm Bawerk, one of the greatest economists of all times, and the teacher of my great teacher, Mises, pointed out in 1896 the principal error in the Classical School's labor theory of value, which is the basis of all Marxian thinking, and which is still popular today. Table 1 gives an example illustrating the main error involved in the labor theory of value. This example, of course, is oversimplified, but it should help you to understand the fallacy in the Marxian thinking so prevalent today in the ideas of labor union leaders, the masses of unskilled workers, and even university professors, as well as the political leaders of all nations.
We are going to divide the production of some consumer goods into five processes. (See table 1.) The first process is obtaining raw materials from mining or agriculture. We shall assume that we hire 20 men who work this first year obtaining the needed raw materials. The wages of each man come to $5,000 a year, for a total labor cost of $100,000.
We assume that the second year we move on to the second process, the making of simple tools. For this we also employ 20 men. We pay them $5,000 each per year, for another expense of $100,000.
The third year, we make machinery with 20 men at a cost of another $100,000. The fourth year we manufacture the consumer goods with 20 men at $5,000 a year each, for a total labor cost of $100,000 more. The fifth year is a selling period, during which 20 men sell the goods at a cost of another $ 100,000.
|Year||Process||Men at $5,000 per year||Labor Bill|
|I||Obtaining raw materials (Agriculture & Mining)||20||$100,000|
|II||Making simple tools||20||100,000|
|IV||Manufacturing consumer goods||20||100,000|
This is all in conformity with the theory that only labor creates value. The total values produced then belong to the laborers. They are the only ones who contributed to increasing the values of the raw materials. Capitalists should get back only the costs they actually paid.
But is this the way men act? This would mean that those gentlemen who worked a full year in the first process would have to wait until the goods were sold, four years later, to receive their wages. Where is the money going to come from for them to live on until their raw materials are transformed into consumer goods and sold? What about the men employed for the second, third, and fourth processes?
Of course, today, the answer is very simple. Let the government pay them. Everybody understands this today, but where was the government going to get the money in the days before governments learned how to print money and produce "paper gold"? In real life, do workers wait years for their wages? No. This is not the way men act. If we are going to have an advanced civilization, one engaged in multiple production processes, beyond the simple stages of catching fish and picking wild berries, some people must be induced to consume less than they produce, and then make their savings available to pay those who engage in the early processes of a complicated, time-consuming production system.
Costs Include InterestSomebody has to pay the men engaged in the first process four years before the goods will be paid for by consumers. Somebody has to pay the men in the second process three years before the goods are available, and the men engaged in the third process two years ahead of sales receipts, and the men in the fourth process one full year in advance of the final sale of the finished products.
This requires savings. This requires not only that some-body must save money, but also that he must be willing to make it available to others. Man is so constituted that he will not regularly make his savings, his money, his wealth, available to strangers for nothing. He must have some inducement. In this case (see table 2), and in Böhm Bawerk's examples, this inducement takes the form of interest. Interest is payment for time. You pay interest to get something now rather than wait until later for it.
As I mentioned last night, time is a part of every human action. It is a cost that must be taken into account in every business transaction. It comes before any allowance for profit or loss, which is something else entirely — profits or losses depend upon whether or not consumers will buy the goods or services produced at a price that covers the costs.
Here we are discussing an element in the cost of all goods, the payment for time, or interest. Let us assume an interest rate of 5 percent. I am merely doing here what Böhm Bawerk did many years ago. Five percent is today an historical interest rate. Using a 5 percent per year interest rate, and leaving it at simple interest, without going into the complexities of compound interest as we would have to do in real life, the interest charge would come to $5,000 for every year for which $100,000 was advanced to pay wages. We would have $20,000 interest expenses for the first 20 men, who have to be paid four years in advance; $15,000 for those engaged in the second process; $10,000 for those in the third process; and $5,000 for those in the fourth process. We thus get a total interest expense of $50,000.
So the total cost, without any profit or loss, is not $500,000, the labor cost. It is $550,000, which includes an additional 50 cents per consumer unit. The real cost of production is thus $5.50 per unit.
Now interest expense is something that communists and socialists neglect, because they still hold the labor theory of value. Today you hear this theory frequently. When increased capital investment helps workers increase production, it is argued that the increased values should all go to labor. This policy has even been sponsored by former occupants of the White House. If production goes up, it is held that increased values all belong to the workers and it is not "fair" if they do not get them.
(Assuming five processes)
|Year||Process||Men at $5,000 per year||Labor
|I||Obtaining raw materials (Agriculture & Mining)||20||$100,000||$20,000|
|II||Making simple tools||20||100,000||15,000|
|IV||Manufacturing consumer goods||20||100,000||5,000|
Modern Value TheoryThe sound solution of this problem requires an understanding of the modern theory of value, the subjective or marginal theory of value. This theory holds that value is in the minds of men. Value is not objective. It is subjective. We value things according to our understanding of their ability to satisfy some human need or want. Economists have developed this theory over the centuries. It was not discovered all at once. In fact, it has only been in this century that Professor Mises has applied this theory thoroughly and precisely to the theory of money. This, unfortunately, is little understood. It will be the subject of my fifth lecture.
One of the first men to come up with this subjective theory was a German by the name of Hermann Gossen (1810–1858). He wrote a book whose title, translated into English, is The Development of the Laws of Exchange Among Men and of the Resulting Rules of Human Actions. This book appeared in 1854, 13 years before the first volume of Karl Marx's Das Kapital appeared in 1867. But neither Marx nor economists in general were aware of this book. The author, considering his work a failure, had the publisher return to him the unsold copies, which he destroyed before his death in 1858. However, his book was mentioned in an 1858 German history of political economy that was read by an English economist, who advertised for a copy for several years before getting one in 1878. Although Gossen was not the first economist to bring these principles to public notice, he was the first to publish a book devoted solely to presenting this modern theory.
In his book he presented three laws, now known as the three laws of Gossen. The first holds that the amount of satisfaction derived from the consumption of a good decreases with each additional unit or atom of the same good until satiety is reached. The second maintains that, in order to attain the maximum of satisfaction, a man, who is in a position to choose several goods whose consumption gives him satisfaction, must choose part of each of the several goods before he satisfies completely his total desire for the good he first desires most. In short, he must choose portions or quantities of each desired good in such proportions that at the moment his consumption ceases the satisfaction from each good chosen is the same. The third states that subjective use value attaches to a good only when the supply of the good is smaller than the quantity demanded. As more units — Gossen's word was "atoms" — are supplied, the subjective value of the additional unit approaches zero.
These were Gossen's ideas or contributions. But as previously indicated, his book was not discovered until years after others had presented somewhat similar ideas in their own words. The first to do so, in 1871, was Carl Menger, an Austrian and the founder of the Austrian School of economics whose theories I am trying to present in these lectures under the sponsorship of the Centro de Estudios sobre la Libertad. This modern marginal theory of value was also brought forth separately by an Englishman, William Stanley Jevons, who published his book in late 1871. In 1874, Léon Walras, a Frenchman living in Switzerland, published a similar book on the same subject. Unfortunately, Walras and, to a lesser extent, Jevons resorted to the use of mathematics in their defense of the idea that the value of any one unit is to be found in the value of the marginal unit. As shown in the first lecture, mathematics cannot and does not apply to economic theory, because there are no constants or standards by which ideas or values can be measured.
These three men, working and writing independently of each other, came to the same general conclusions. They held that value is the significance a good has for the well-being of a human being or beings, and that the value of any specific good or service is determined by the importance attached to the utility of the marginal, or last available, unit in satisfying some human longing.
An economic good is a good in short supply, a good for which the quantity available is less than the demand for it. When there is a sufficient quantity to supply every human want, it is a free good, like the air in this room. When it is an economic good, the value of each unit comes from the use to which the last unit is put, because that is the lowest value that the available supply can satisfy. That is the value lost if one unit is lost or destroyed.
Value of Marginal UnitNow, what is the definition of this last unit that determines marginal value? There has been some refinement in the definition over the years. Here are the definitions of the top economists of their time. First, Gossen wrote in 1854 that the marginal value was "the value of the last atom." In 1871, Menger's book stated that marginal value was "the importance of the satisfactions of least importance among those assured by the whole quantity and achieved with any equal portion."
Jevons, whose book was published a few months later in 1871, not then knowing what Menger had stated, wrote that the marginal value is "the final degree of utility, the degree of utility of the last addition, or the next possible addition of a very small, or infinitely small quantity to the existing stock."
Walras, writing in 1874, without knowledge of what either Menger or Jevons had written, used the French term rareté, which he got from his father, another economist. This he defined as "the source of the effective utility on account of the quantity owned … the intensity of the last need satisfied by any given quantity consumed of a commodity."
We move on to Böhm Bawerk (1851–1914), who followed Menger in the Austrian School and was the teacher of Mises. He defined the value of the marginal unit as "that concrete want or partial want which has the lowest degree of urgency among the wants that can be covered by the available supply of goods of the same kind."
Now we come to my teacher, Mises (1881- ). In 1949, Mises wrote in Human Action that the marginal value is the "value attached to one unit of a homogeneous supply on the basis of the value of the least important use of the units of the whole supply."
This is how we value all economic goods, according to the value of the last unit. I shall go into this in a little more detail in my presentation of the modern positive theory. But first let me paraphrase Böhm Bawerk:
Goods acquire value when the total available supply of that kind is so limited as to be insufficient to cover all the demands which call for satisfaction by those goods, or so nearly insufficient that the withdrawal of the units being valued would render the supply insufficient. Goods are valueless when they are superabundant.
Actually, of course, when you increase the supply of any particular good, the use value of each available unit of that good goes down. There can come a time when you have more units than you want. That particular good then becomes a free good of no economic value. The additional units may even become a liability — a minus value. This is something that those who believe in the labor theory of value fail to take into account. Nor are these facts taken into account by the so-called Mathematical School of economics, those who try to calculate the gross national product, or what we call the "GNP." Actually, the larger the quantity you have of anything, the lower the value of each unit must be. If you increase production of a good by 10 percent in quantity, other things being equal, you do not increase the value of the production by 10 percent. This is difficult for many people to understand. Some need must depend on each unit. Since each additional unit satisfies a less important need, its value must be less.
Value and Exchange PostulatesNow, having given you this introduction to the subjective, marginal theory of value, permit me to return to the presentation of some more deduced postulates of human action. These are what I call the postulates of value and exchange. They are deduced from the a priori postulates that men act to improve their situation, that the factors available for doing this are limited, and that men make mistakes.
The first of these is that men have value scales. As stated earlier, you know what you want. You know the order of the importance of different things to you. Nobody else can tell you what that order is. This isn't true only of goods. You also know the relative importance to you of non-market factors. You place your own order of importance on your honor, your glory, your virtue, your health, as well as things that touch only your heart. You know the order of their importance to you. They are either ends in your life or goods of the first order whose relative values are immediately known to you.
Our problems come in calculating the value of raw materials, wage rates, and interest rates — the factors that are needed for the processes which, in an advanced market society, ultimately produce consumer goods and services. For these, we need economic calculation. But in our daily lives, in buying the things we need as consumers, we know which things are most important to us. We know the order of their importance to us. Allowing for the fact that we make mistakes, this order is always known to us.
Values are formed in our minds. They change with changing conditions. Let me give you an example of what I am trying to say.
The assumed marginal utility scales of Mr. Smith, who owns four horses and four cows, are presented graphically in Table III. He ranks them in this order: first, a cow; second, a horse; third, a cow; fourth, fifth and sixth, horses; and at the bottom, seventh and eighth, cows. Assume that he is faced with the choice of losing one animal, a horse or a cow, or of losing two animals, two horses or two cows. His decision is very obvious. He would get along with one or two less cows.
|1 — C|
|2 — H||Simple if choice is to lose a Horse or a Cow, or to lose 2 Horses or 2 Cows.|
|3 — C|
|4 — H||But if his choice is to lose all of his Horses or all of his Cows,|
|5 — H|
|6 — H|
|7 — C||then Mr. Smith must rerank (revalue) into (new) units according to the actual situation.|
|8 — C|
The value scale in table 3 does not help us at all. He is faced with a new situation. He is no longer considering units of one horse or one cow. He has to revalue the situation. He must re-rank his units. The units are now only two, one of four cows and the other of four horses. He instantly forms a new scale of values. Under this new condition he immediately makes his decision as to which is the more valuable unit, which he will rescue.
What I want to stress here is that values are compared. They are not measured. You cannot say how much you value one thing more than another. You have no constant standard for measuring such differences. Valuing is expressing a preference. It is like love. Can you say how much you love one person more than another? There is no unit for measuring love. There is no unit for measuring value. It is always a comparison under the conditions that exist at the time. It is not permanent. It is subject to change constantly. We shall soon be discussing that at greater length.
Each Additional Unit Worth LessGoing back to the postulates of value and exchange, the second asserts that each additional unit of any economic good is of diminishing importance, or use value.
We live in an automobile age. Here in Argentina, as well as in my country, you try to cross the street and you realize it. So perhaps you can understand this better if I use the example of automobiles. If you are a one-car family, you have to be careful about the use of that car. It can only be used for the most important uses of the family. In my country, the most important use of a family car is for the dates of our teenage children. This comes first. All other uses of the family car have to wait.
If you are prosperous enough to have two cars, then Mama also has a car. She can be the family chauffeur and take the other family members around. If you are plutocrats and have three cars in the family, then, as we say in the States, the old man gets a car. He can go about his business or even play golf on the weekends without consulting his children. There is a story of one father who got so furious that he actually said to his son, "The next time I want the car I'm just going to take it!"
This is the problem we have in fully understanding that each additional unit of the identical thing has a lower use value. Let me give you an example from Böhm Bawerk to help make this clear. (See table 4.) This is basically his, though I must admit there is one change, which I shall mention later. Assuming an isolated farmer, this is his value scale for six bags of grain, according to the importance of the uses he expects to make of them: He plans to use the first bag as food to sustain his life, and the second bag as food for good health, so that he will be more robust. The third bag he expects to put aside for seed. The fourth he will use to produce meat, that is, he will feed it to cattle or chickens to improve his diet. The fifth bag he will use as food for pets, and the sixth he will use to make whiskey.
The one change that I have made is that Böhm Bawerk ranks whiskey as No. 5, above the pets, which he ranks as No. 6. The first time I presented this example, a lady in the audience objected that she preferred pets to whiskey. So, in deference to her, I changed it. This gives me an opportunity to show that we all have different value scales.
|No. 1||Food to sustain life.|
|No. 2||Food for good health.|
|No. 4||Meat — feed for cattle or chickens.|
|No. 5||Food for pets.|
|No. 6||To make whiskey.|
This should make it clear that the use value of every additional unit of anything is less, because it is put to what you consider a less important use. In life we are usually considering whether to add one more unit or to get along with one less unit.
Values Not ComputableNow this tells us something else. It shows that values of the same things differ according to the number of units being valued. This means that there is no way of calculating the total value of a supply, if only the value of a part of the supply is known. Likewise, there is no means of establishing the value of a part of a supply, if only the value of the total supply is known. Many people, including many so-called economists, make the mistake of trying to find total values by adding or multiplying the known values of certain units. This is a basic error in all national income and gross national product (GNP) figures. They are completely unrealistic.
You probably can see it more easily with stock exchange quotations. Assume that you can buy a hundred shares of a particular stock for, let us say, 200,000 pesos. Does that mean that you could buy all the shares of that corporation at the same price per hundred shares? Suppose you wanted to buy 51 percent control of a firm. As you bought more and more shares, you would have to pay higher and higher prices. Likewise if you are selling shares, the more shares you sell the lower prices you will get.
This whole idea of dividing total values and multiplying part values does not apply in real life. This is an error many people make, including so-called economists, particularly those known as "mathematical economists." Judgments of value refer only to the supply with which a concrete act of choice is concerned. Men decide on the basis of the value of the least important use they expect to make of the supply under consideration. For them, that is the marginal unit.
This is the reasoning that supplies the answer to the paradox of iron and gold. Nobody wants all the iron or all the gold. People want a specific quantity of iron, or a specific quantity of gold. They value only the quantity that is important to them. Therefore, although all iron may be more useful than all gold to men, men acting in the market do not compare the values of all iron with all gold. They compare the values of specific quantities that interest them and not the values of the total supply. Given the available supplies of gold and iron and the many uses to which these supplies can be put, one pound of gold is usually worth much more than one pound of iron to most men.
We are constantly thinking in terms of the value to us of one more unit or one less unit. The use values to us of one more unit or one less unit are two entirely different values, even though the units are identical. In considering these varying values we have no standard, no constants, for measuring the differences in their value. It is always a matter of comparing. If you have N units, you must consider N plus one or N minus one unit. You are always considering the importance to you of that one more or one less unit, that is, the least urgent or marginal use to which you put that unit. No other result is thinkable.
This is the subjective use value, the value that is in the minds of men who are eager to satisfy their most urgent wants according to their own value scales. So, the magnitude, the size, of value is relative and depends upon the importance of the concrete want that will be satisfied by the unit under consideration. This unit that is being valued is always the marginal unit. An identical unit has one value in selling and another value in buying. The value of goods may be ranked, but only with the ranking of specific concrete wants. Wants are fractionable, divisible, and of different importance, and we know the importance of each one to us.
Values DifferNow, getting back again to the postulates of value and exchange, we come to the third one: Different men have different value scales and the same men have different value scales at different times.
You know yourselves that you have different value scales from those you had ten years ago. In fact you now have different value scales from those you had this morning. Perhaps, when you got up this morning, the first thing on your value scale was a cup of coffee. Once you had that coffee, it went down lower on your value scale. Your value scale is constantly changing. As you satisfy one want, as conditions change, or as you get new information, your value scale changes.
Likewise, different men have different value scales. Perhaps you can see this if you consider a factory where 100 men are employed to do the same type of work and all are paid the same wages. I would feel safe in making a bet that no two of the 100 families involved would spend those wages in the same way. They would all have different wants. Some would have babies. Some would have special hobbies. Some would have in-laws to support. Some would have sick members and doctors to pay. Also, some would like one kind of meat, while others would prefer another kind, or fish, or something else. No two of them would spend their earnings exactly the same way.
It is also true that values change as conditions change. For example, would you place a higher value on a gallon of water or a pound of gold? In a modern society, you would, of course, put the higher value on the pound of gold, if you were legally allowed to own it. But if you were in a desert far from civilization, a gallon of water would be worth much more to you than a pound of gold. As conditions change, our values change. Since conditions are constantly changing, so are our values and value scales.
Perhaps one of the most dramatic changes in values in all history occurred at 11:00 on the morning of November 11, 1918, when the World War I Armistice was signed. At that time, the values of the whole Western civilization changed. To celebrate the occasion, I was let out of school, but that wasn't important. The important thing was that up to that moment Western civilization had for several years valued highly anything and everything that would help win World War I. After the Armistice was signed, those things immediately lost value. They could only be sold at a loss. The government was soon selling off food and other Army supplies for less than 30 percent of what it had paid for them. Army uniforms were very cheap. There was no market at all for battleships.
Values are changing constantly. Values change with new inventions, new knowledge, new desires. All of these things are constantly changing. Sometimes a commodity has value. Sometimes it does not have value. Take uranium. Twenty or 30 years ago there was no known use for uranium. Now people are looking for it all over the world. Values of many things are constantly changing. Except as people meet in the market place, it is difficult to compare their ever-changing values. This, of course, is one of the fallacies behind the Marxian progressive income tax. The burden of an increased tax is different for each individual, and there is no way to compare these burdens.
Market Exchanges Mutually ProfitableLet us pass now to perhaps the most important postulate of value and exchange: Only men with different value scales can and do exchange for mutual advantage.
When people fully understand the significance of this postulate, they really understand the importance of the free market economy. Only people with different value scales can and do exchange for mutual advantage.
Let me explain. Suppose you want a suit. You go into a tailor shop and see a suit you like. The price on it, let us say, is $100. You decide to buy this suit. Why do you buy that suit? Because the suit is worth more to you than $100. In fact, it is worth more to you than anything else in the world that you could then buy for $100. Otherwise you would not buy the suit. Instead you would buy whatever you considered more valuable. Now, take the man who sells you that suit. For him, $100 is worth more than the suit. Otherwise, he would not sell it for that price.
Both parties give up the asset on which they place the lower value and receive in return the asset on which they place the higher value. In other words, free and voluntary exchanges occur only when two people place different relative values on two different specific assets. In the market, one of these assets is usually a quantity of money.
You go into a department store. You see goods and their prices all around you. When you see a price on a good which is lower than the value of that good to you, you buy, and you buy additional units of that good until you reach the point at which another unit is not worth that price to you. It is the same in a grocery store. It is the same in any store.
Likewise, when you see a market price you think is high, so high that you think you can buy or make the good for much less, you go into the business of making or reselling that particular product. You offer it for a little more than your costs and a little less than your competition. No one buys or sells unless he believes he is improving his situation.
It is these differences in the value scales of different individuals that make the market function. It is these differences in value scales that keep the free and unhampered market economy in harmony with the Golden Rule. In every market transaction you improve your situation, and the other party is also improving his or her situation, barring force, fraud, or human error. In a free market, there is no use of force. Some people may resort to force or fraud, but it is the function of government to keep the use of force or fraud to a minimum. As previously mentioned, all men make mistakes, but they try to keep their mistakes to a minimum.
You may take the suit out in the daylight and find it is not quite the color you thought it was. Or you may take it home and try it on in front of your spouse. He or she may not like it. He or she may say, "I won't be seen in public with you in that suit." Then you know you have made a mistake. But barring force, fraud, or human error, you never enter into a free market transaction unless you expect to improve your situation. This is also true of all other parties to the transaction.
This is true not only of buying and selling, but also of hiring an employee or taking a job. In a free market you take a job because in your judgment that job gives you the best return of all the jobs open to you. The advantages may not be monetary only. They may be the hours you prefer, the kind of work you like, or the location you desire. You take all conditions that you value into consideration, and you make a choice — you choose the one that gives you, from your viewpoint, according to your value scale, the greatest returns. Similarly, if you employ someone, you hire that available person who you expect is going to give you the greatest return for the money you pay out.
The same is true in borrowing or making a loan. You borrow $100 at 10 percent interest, because you prefer having $100, or what you can buy for $100, now, to having $110 a year from now. The man who lends you the money has a different value scale. He may want the money for some future trip or to send his child to college next year. He prefers to part with his $100 for a year in return for $110 a year from now.
Exchanges Increase WealthAll free market transactions are exchanges of two sets of assets, in which each set of assets moves from those who place a lower value on it to those who place a higher value on it. These are all comparisons. They are not measurements. There is no way to say how much more you value that suit than $100. Possibly you would have paid $105. Possibly you would have paid $110. But in real life you do not waste time thinking about what does not matter.
You always try to use your available means so as to get the greatest possible satisfaction that you think you can get for them. You never try to waste your assets. You never exchange them for assets on which you place a lower value. We are always trying to improve our situation. We are always trying to eliminate some uneasiness. We are always trying to exchange something we have, our time, our energy, our scarce goods, or our money, for other things we prefer.
We have been talking about the use values of consumers' goods. Our use values are our value scales and the result of our own ever-changing judgments. In a market society, there is also a market price, or market value, for every economic asset. In a market economy, identical assets always have the same price, or market value, at the same time and place. The exchange value of an asset is its capacity to obtain in exchange a certain quantity of other assets.
In life we are constantly comparing our use values with market values. The clothes you have on have a higher use value for you than their market value. When their use value to you falls below their market value as second-hand clothes, you will sell them. Everything you have that you don't want to sell has a higher use value to you than it has to anyone else. Otherwise you would sell or exchange it. When you find something whose use value is higher to you than its market value, you buy. On the other hand, when someone offers you more for your automobile, or anything else you own, than its use value to you, you will sell it.
One of the important things to remember about a free and unhampered market is that goods and services are always moving through market exchanges from those who place a lower value on them to those who place a higher value on them. In a market economy, all the factors of production are allocated, by voluntary exchanges of mutual advantage, to those alternative uses that are expected to yield the greatest human satisfaction. By free market transactions every economic good is moving to persons and places where it is more valuable.
Political Intervention Reduces Human SatisfactionWhat does all this mean in terms of political or governmental intervention, or higher costs of any kind? Suppose the politicians in power have a welfare program that they want to finance to help them win the next election. Suppose they levy a sales tax of 10 percent on that suit we discussed. Then instead of paying $100 for it you would have to pay $110. There will be a lot of people who would prefer that suit to $100, but who may not prefer it to $110 — particularly those who have only $100. They must then buy something that is less valuable to them. They will have to accept what they consider a lesser satisfaction. Likewise, the man who would have sold the suit has to get along with a lesser satisfaction. This also applies to the men or women who make suits. In fact, the farmer who raises the sheep from which the wool is taken to make the fabric would also suffer as a result of this governmental tax.
Let me say here, taxes needed for the protection of life, property, and the market place are not a burden on the market. The market needs protection. It can only operate under peaceful conditions. Such taxes are just as necessary as the costs of any of the factors of production.
However, every unnecessary rise in costs or prices, every unnecessary increase in taxes, and every governmental intervention must reduce the first-choice transactions of consumers. They must also reduce the sales of those who are otherwise best able to satisfy consumers. Such interferences with the free market must therefore reduce human satisfactions below their highest possible potential.
This has to be so. This is not a question of my opinion, of how I think it should be. Every use of force for other purposes than the equal protection of all must prevent people from getting the highest potential satisfaction that they would enjoy in a free market.
Values are an order of preference, a value scale that registers your preferences. You cannot measure values. You can only compare them. If you cannot get the assets you value most, you must accept assets that are less valuable to you. When governmental interventions hinder or prevent market transactions that benefit all parties, they must necessarily reduce human satisfaction.
Such political interventions are not only taxes or higher costs. They may be laws that stop you from buying something that someone wanted to sell you. Your work may prevent you from going to a barber or hairdresser except on evenings or Saturdays. So, a law that requires the barbers and hairdressers to be closed on evenings or Saturdays hurts both you and those who might like to serve you. Every governmental intervention, that is not necessary for the protection of life, property, and the market place, or for a peaceful adjudication of disputes between citizens, must reduce the satisfactions of all those affected by the intervention.
SummaryTo review, briefly: Value is the significance a good has for the well-being of a human being or beings. The value of a good is determined by the importance attached to the utility of the marginal unit in satisfying some human want.
All life is change. For men, life is a series of choices by which we seek to exchange something we have for something we prefer. We know what we prefer. No other man or bureaucrat is capable of telling us what we prefer. Our preferences are our values. They provide us with the compass by which we steer all our purposeful actions. And last but not least, a fair exchange is not an equal exchange. A fair exchange is an unequal exchange from which all parties expect to gain.
Barring force, fraud, or human error, every free market transaction provides all parties with a psychic profit or higher value, according to their own scale of values. Anything that raises cost or hinders the free and voluntary transactions of the market place must keep human satisfactions from reaching their highest potential. Today the greatest obstructions to the attainment of higher human satisfactions are the well-meaning but futile political interferences with the mutually beneficial transactions of a free market economy.
Questions and AnswersWe shall be glad to entertain some questions and answer them to the best of our ability. I've tried to be clear, but it isn't always easy to present this subject simply, particularly when working with a foreign language and in a country where ideas and conditions may differ. But we are all human beings and we are discussing the immutable laws of human action. Being a human being, I must make mistakes. If you can call them to my attention, I shall certainly appreciate it, as I want to improve my understanding of these matters.
Progressive Income TaxQ. Please expand on what you said about the progressive income tax and its relation to the marginal theory of value.
A. Well, you can compare the value scales of different people only when they meet in the market place. Then, when they have different relative values for two different things under consideration, they will trade. The progressive income tax is based on the fallacy that all men have similar value scales, and thus any tax on a higher-income group will mean only a sacrifice of unessential things which lower-income groups cannot afford. Thus the tax will not affect or burden taxpayer satisfactions as much as taxes levied on those in all income groups. This, of course has several fallacies in it.
Perhaps the most important popular fallacy that supports the progressive income tax is ignorance of the fact that, in a market society, where prices, wages, and interest rates are free to shift so as to reflect shifts in supply and demand, the progressive income tax does not necessarily burden most those in the higher tax brackets. The truth is that it is a tax on every participant in the market, and the market determines how the burden is distributed. It breeds friction. It breeds bad feeling. It leads low-income people to think the rich should pay still more, and it leads high-income people to think they are paying more than their share. Both groups are wrong.
In a market economy, the market determines who bears the burden of the tax. If a corporation has to pay a business executive, say the president of a shoe company, $200,000 a year so he can take home $50,000, the executive is merely a tax collector for the $150,000 tax. Much of the tax will work its way into the price of shoes. A higher price for shoes means that fewer people can afford shoes. Then fewer people will be employed in that shoe factory. The burden of that tax will fall on the consumers, the workers, the investors, and the high-income executives too. But how it falls on all these people will depend upon market conditions and not on who sends the check to the Treasury.
Getting back to the question of the relation of the progressive income tax to marginal value: For a man with a low income, who spends everything he gets, a higher tax may mean that he drinks a little less beer or smokes a few less cigarettes. But a man with a high income, let us say $50,000 a year, may have committed a large part of his income to specific payments. He may have bought a house with regular mortgage payments. He has life insurance, with regular premiums to pay. He has entered into other investment and payment agreements based on an expected income of $50,000, less whatever current taxes are then in force, say $10,000. Suppose his taxes are doubled, to $20,000. That extra $10,000 may be marginal to the point that it means he has to lose his house and/or his life insurance. It may mean something very drastic to him, possibly bankruptcy. His situation is not the same as that of the low-income man. Men's situations and value scales are different in every case, and there is no way that you can make them the same.
Actually, of course, the best income tax is one with the same rate on everyone. Such a tax would not cause the frictions, the class warfare, that the progressive tax causes. Then, if anyone proposed increasing government expenses by 10 percent, everyone would know that his taxes would go up 10 percent. He could compare the expected benefits with his costs, and thus be able to vote more intelligently on the issue. Today, in my country and in many other countries, many spending measures become popular because most people think that only the rich and the corporations will pay for them. But actually everyone pays for them, and the people who feel it the most are the low-income people who have to pay more for their bread and shoes.
Is Intervention Necessary?Q. Is government intervention necessary to modify the demand to promote welfare?
A. Well, I should have to say that government intervention, as I define government intervention, is never necessary. It is never generally helpful. Of course, if there is a crime, a murder, a theft, or a fraud, governmental action is needed. But such governmental actions are not interferences or interventions into the peaceful operation of the market. However, all so-called "welfare" interventions do interfere with the market. Their purpose is always to help some people at the expense of others. Such interventions are not necessary. What we call "welfare" today is a burden on all individuals, and not a mutually helpful governmental function, as is the suppression of violence. We now have the socialistic idea that the rich and the corporations should take care of the poor. Actually such measures are making more people poor every day. Ever-increasing numbers of poor people now believe they have a legal right to welfare and that therefore they do not have to work any more. In my country, in New York City, we have 1 million people on one program — public relief. This is about one person in eight. In many cases they consider that living on relief is better than working. Of course, some women have more illegitimate children because then they get higher welfare checks.
If this were taken care of by private charity and the churches, the poor would feel thankful for it and try to get off welfare. Now, they spend their time trying to find ways to get more welfare. In my country the welfare recipients are organizing into unions and demanding more things. They have to have a telephone, because somebody might get sick and need to call a doctor. They have to have raincoats, because they could catch colds and then they would be a further expense to the government.
Last year there were two rather extreme examples of this. The women on relief invaded department stores, disrupting business and demanding charge accounts. They also wanted enough money for the "American standard of living," including Christmas toys for their children. When there are large numbers of unemployed and other difficulties, "we" have fallen into the rut of thinking that the answer is always more government. In later lectures I shall be dealing with this problem. In my fourth lecture I shall also be discussing why we have so much distress, why we have so much unemployment, and why we have ever-increasing demands for welfare. This is always the result of prior government intervention, and I hope to make this clear.
Influence of Henry FordQ. What has been the influence of the ideas of Henry Ford on the money cost of wages in the economy of the United States?
A. Of course, I must first ask which Henry Ford you mean. The old gentleman and his grandson are two entirely different individuals of two different philosophies. If you mean the elder Henry Ford, he was not a perfect economist, but he was a very intelligent human being. He did not advocate paying unneeded men to stay on a farm. He offered former farm workers the high wage of $5 a day, which was then much more than they could earn on the farm, to make automobiles. He then sold those automobiles at prices which were considered bargains by those who bought the cars. He helped both the workers and the buyers of automobiles while incidentally making himself rich.
If you want to become rich, find something with which you can save people the equivalent of ten pesos. Then make a million of them, split the profit of ten pesos on each with your customers, and you will have 5 million pesos, while every person who buys one of your products is five pesos better off. Henry Ford, the original Henry, contributed to the American success in ending the depression after World War I without any serious governmental intervention. His grandson, the present head of the Ford Motor Company, does not have these ideas. His grandson believes in, and advocates, many of the governmental interventionist policies. These, of course, are leading to a different end in the United States.
Equality Before the LawQ. Why don't you speak a little more about equality before the law rather than equality of fortunes?
A. Of course, what I've been trying to say is that I believe in equality before the law. Equality before the law means that we are going to be unequal. Actually, there is no way to make men equal. This is very fortunate, because some people have certain talents and can contribute certain things which others cannot contribute. We are all different and we profit from these differences. We are very unequal and there is no means to make us equal. These socialistic attempts to level fortunes, to level money income and wealth, are the basic problem of the day. They derive from the fact that we no longer believe in equality before the law. It used to be that we depicted Justice as a woman with a blindfold over her eyes so that she could not see who was in front of her. But now, as one of my friends says, Justice lifts up the blindfold and peeks to see who stands before her for judgment. If it is a member of a labor union, she renders one decision. If it is a member of the business community, she renders another decision. We no longer have equality before the law. This is one of our great difficulties in all countries. I know it is so in mine.
Youths Seek TruthQ. What do the young people in the developed countries think about the principles that you have talked about?
A. Well, unfortunately, I do not have a very large audience, but those whom I have had in my classes, those I've had for a sufficient time, have grasped these basic principles with enthusiasm. But the means of mass education and the means of mass communication are largely in the hands of those with different ideas. The young want the truth, but they seldom find it today. This is one of the reasons for the unrest in the universities.
Increased Production Benefits AllQ What is the difference between something you desire and something that is a necessity?
A. The questioner seems to feel that there is a difference between something you desire and something you consider a necessity. There is no difference between these in either theory or action. Actually, as we shall be revealing as we go along, there will be more production of what people really want under a free market society. The more production there is, the less burden taxes are on production and the more everyone will have, including those down at the bottom of the ladder. They are the ones who suffer most from this welfare state approach. Everybody suffers, but the well-to-do can stop producing and go play golf, retire early, or take a long vacation, when they think income taxes are too high for the extra effort involved.
If a high-income doctor is approached to take an appendix out, he can say, "I should get $500 for that. It is November, and I am now in the 50 percent bracket, so I will have to charge $1,000." Who pays that $500 tax, the patient or the doctor? The doctor can quit and go play golf. Then the patient has to go to a less competent doctor who charges less and whom he can afford under those conditions. Both the doctor and the patient are hurt by the tax, but the poor patient feels it more.
In a free society everyone is benefited by increased production, and the greatest answer to poverty is the increased production of a free market. The standard of living in the Western world, and in my country particularly, has risen because of the free market. Starvation exists in the socialist and communist countries, the countries that do not have the free market, such as China, India, and places of that type. Where you have a market economy, no one need starve.
I wish I had the time to tell you the story of the early communist attempts in America. Communism was tried in our very first colonies, at both Jamestown and Plymouth. For three years they put everything into the common warehouse and doled it out according to what the ruling powers decided were the needs of the different individuals and families. In every one of those first three years, in both Plymouth and Jamestown, more than 50 percent of the people starved to death. The rest of them were saved only because new shipments of food and necessities came from Europe. When they adopted the private enterprise principle that each family could keep what it produced, there was no longer any starvation. The women, the children, and all of them put forth their utmost effort, where previously they had stolen food from the fields before it was even ripe.
Mathematics and EconomicsQ. Is mathematics absolutely divorced from economics?
A. Mathematics in the field of economics is always statistics, and statistics are always history. Mathematics cannot and does not enter into measuring the ideas or values that determine human action. There are no constants in these. There is no equality in market transactions. Therefore, mathematics does not apply. The use of mathematics requires constants. Mathematics cannot be used in economic theory. Mathematics can be used in economic calculation, but this depends upon a monetary unit whose purchasing power does not fluctuate violently. Mathematics may be helpful in presenting economic history, but not economic theory, on which all human action is based.
Effect of Progressive Income TaxesQ. What about the progressive income tax in relation to the decrease in the marginal value of incomes?
A. What I've tried to say is that everyone has different value scales. These different value scales cannot be compared except when those who hold them go into the market and compare their use values with market values. When they find two different relative values, they trade. Then you know the buyer places a higher value on the product than he does on the price, while the seller places opposite relative values on these two items.
The problem of the progressive income tax arises, of course, with changes in tax rates. A change in the tax rates affects different people differently, according to their particular conditions at the time of the change. When a tax is set and not changed, market prices already reflect the tax burden. We make our plans and our choices in accordance with the existing taxes. We make our long-term contracts, buying things over a period of time, investing, renting, or leasing, with the present tax burden in mind. Now a new and higher tax becomes law. It affects most the persons who have these long-term commitments. They are less able to adjust than a person who does not have such commitments. So frequent changes in taxes upwards — and that's the only way they go these days — are the source of our troubles. This means that people who have learned to expect higher taxes will hesitate to make long-term commitments. Such commitments are necessary for a high standard of living. It takes years to produce some of the things that we now want. That means that savers and investors should feel confident, in making long-term contracts, that their calculations are not going to be upset by new taxes after they have made their commitments. Of course, if we did everything just on a day-to-day basis, this effect of tax changes would not be there. But then, we would have to live in a day-to-day economy, and would not be able to make long-term plans or enjoy products that require long-term planning and production processes.
"Welfare" Measures Reduce Wealth
A. I hold that free market economics is the only system of the division of labor that advances the general welfare of all the people. It is in accordance with the Golden Rule. We advance ourselves as we help others. The more we help others, the more we receive in return. This is an incentive to increase production. Everyone does the best he can. People have choices of action, and they usually choose to make those market contributions which they expect will bring them the greatest returns.
The welfare state relies upon taking from some and giving to others. It reduces the production of those who get something for nothing, and it reduces the production of those who know their increased production will be heavily taxed. Reducing production does not increase the general welfare. The general welfare is served by policies which increase production. Most important, as I said in the last lecture, is the fact that all increased savings invested in production for the market must increase wages, increase production, and reduce prices. Thus increased savings help everyone. If we want to help the poor people, we should adopt policies that increase savings. This would increase the bidding for labor, increase the production of wealth, and lower prices. As a result everyone who participates in the market would get more for his or her contribution.