Friday, February 19, 2010

Basic Economics - Value

Beauty is in the eye of the beholder. This phrase meant to mitigate ugliness is the most fundamental economic truth. All value judgments are intrinsic. There is no such thing as absolute value. No set standard of what something is worth to all people at all times. Each one of us determines how much everything is worth to us at a given time. How do we do it? No one really knows, it's what makes us human, unique. What differentiates us from each other. Some people determine value in a painstakingly complex process, others decide on a whim. It's not exact, nor scientific, and never absolute.

Today, when you are well fed and fat, food is worth less than a Porsche. Tomorrow when you are starving and dangerously thin, you'd give 10 Porsches for a single morsel of food. When you were ten, a GI Joe action figure is what you wanted, valued, more than anything in the world; today you wouldn't pay 10 cents for it. You spend your money on a trip to Paris, I would never spend money on the same trip. Clearly we value the same trip differently, so can one say what the value of a trip to Paris is? Look around and you will see hundreds of different cars that all cost the same. Why so many? Why does not everyone pick the same car, the most valuable one? Maybe to each, the one he has is the most valuable to him?

Think about every single thing you own, can you come to any conclusion to what the value is? I mean a specific price at that point in time? You can't. What you can probably do is give an estimation, this item is worth more to you than that item, and perhaps you can arrange them in order. Perhaps your neighbor can do the same, I bet his order differs from yours.

While all this may seem obvious, it is very important because many economic fallacies are predicated on the belief that someone else can determine what is most valuable. The reality is that there is only one person who can determine what is most valuable to you: you. And your determination is inexact at best. If we equate happiness with obtaining or doing that which is most valuable, then getting a trip to Paris that you don't want is completely worthless.


Geoff said...

This post is a must read! This concept is so simple, yet so misunderstood - or ignored.

Here is a simple scenario:
1) I buy a computer from store XYZ for $1000 on Monday.
2) Store XYZ lowers the price of the computer to $900 the next day.

Did I get a good deal?

Yes! When I made my choice, I valued the computer at at least $1000 or I would not have spent that much on it.

Someone else who only valued the computer at $900 can now purchase it and be satisfied.

In the end, we both got the computer we wanted! VALUE is in the eye of the beholder!

Adam Freund said...

Geoff, every transaction is based on the fact that each party values what they get more than what they give up. Otherwise, no one would trade. What your example points out is that two people value the same item differently and both are more than happy to give up their money (which they value less) for the computer (which they value more).

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