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How do subjective preferences get translated into objective money prices?

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bovicide posted on Tue, Mar 29 2011 1:12 PM

Along with all modern schools of economic thought, the Austrian school maintains that human value judgments are subjective and ordinal. Yet these subjective preferences determine market prices, which are expressed in terms of objective, numerical quantities of money. How does the Austrian school explain this? More specifically, how does the market price of any good or service represent all the different preferences of the different individuals in the market?

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James replied on Tue, Mar 29 2011 1:30 PM

If there's only one bidder and one seller engaged in simple barter, a voluntary exchange indicates that each trader believed the exchange to be worth it.

Money happens because lots of people are trading broadly similar goods for a broadly similar purpose.  If you're pffering a good to a million potential customers, the price you offer it at is calculated, to the best of your ability, at level such that it will generate the greatest possible revenue from sales.  A sort of sweet spot where people will be willing to part with the most amount of money, in total, for your product.  Of course you can't bid a price that will satisfy everyone.  A lot of people probably wouldn't want your product as a gift, and there's no point you making it at all if you don't profit.

Maybe I don't understand what you mean when you say that money is objective?  The physical quantity of any good may influence how it's value is perceived, but the perceived value remains fundamentally subjective.

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The objective value is the medium between two subjective preferences.

"When you're young you worry about people stealing your ideas, when you're old you worry that they won't." - David Friedman
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Sorry if I was unclear--when I said "objective money prices", I meant that money prices are cardinal numbers (e.g., $2/ream of paper) and that they do not exist solely within the minds of market actors. By contrast, utility/value can only be conceived of as a ranked preference: the "util" as a unit of value is a meaningless fiction, and moreover interpersonal utility comparisons are meaningless.

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AJ replied on Tue, Mar 29 2011 2:26 PM

Oh, then you don't need Austrian economics to explain that. Just note that posted prices are simply there for convenience of the retailer and customers. This prevents haggling over the price of small items. Or serves as a starting point for negotiations that lead to subjective price determinating for each sale. The only way the posted price (or, for instance, the spot gold price) is "objective" is in the fact that it usually reflects the objective fact that many sales were previously closed at or near that price (that's why there's no actual single gold price besides the "bid" and the "ask").

Or even easier: just consider the price tag an offer by the seller. The price tag lets you know the subjectively determined price at which the seller is definitely willing to make the deal. It is an objective fact that the seller has printed a price tag with that subjectively determined price, but that doesn't make the price itself (nor the valuation) objective.

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bovicide:
Sorry if I was unclear--when I said "objective money prices", I meant that money prices are cardinal numbers (e.g., $2/ream of paper) and that they do not exist solely within the minds of market actors. By contrast, utility/value can only be conceived of as a ranked preference: the "util" as a unit of value is a meaningless fiction, and moreover interpersonal utility comparisons are meaningless.

I think your issue is that you are conflating a preference, which is a psychological phenomenon with an object, which exists in physical reality.

"When you're young you worry about people stealing your ideas, when you're old you worry that they won't." - David Friedman
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Yes, I'm trying to figure out how subjective preferences give rise to the objects known as prices.

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A price is just an expression of a quantitative relationship between two goods set by trading agents. As well as you can say that one apple is worth 2 Dollars on the market, you also could say one Dollar is worth 0.5 apples. But since you generally use Dollars currently you will use the Dollar as the common denominator. And since most people use the same good to express their subjective valuation of various goods, it gets easy to compare value scales with other people.

Also a price in general will not reveal the real subjective valuation of people. If I buy an apple at 2 Dollars doesn't mean that I would not have paid even10 Dollars. But this you only could find out if you'd shut down competition and try selling me the apple as monopolist. A price just means the buyer values what he gives less than what he receives, and the seller vica versa. There is a negotiation margin.

As I did yesterday already in a different thread I also want to offer you to read Carl Mengers Principles of Economics. It did help me a lot to understand that stuff. Menger knows how to explain clearly.

"Quis custodiet ipsos custodes, qui custodes custodient? Was that right for 'Who watches the watcher who watches the watchmen?' ? Probably not. Still...your move, my lord." Mr Vimes in THUD!
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Awesome, thanks for the reference! I'll put it on the reading list.

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Gero replied on Tue, Mar 29 2011 5:27 PM

Read Subjective Value and Market Prices by Austrian economist Robert P. "Bob" Murphy.

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This is also explained in Lessons For The Young Economist, by Bob Murphy:

http://mises.org/resources/5706/Lessons-for-the-Young-Economist

My long term project to get every PDF into EPUB: Mises Books

EPUB requests/News: (Semi-)Official Mises.org EPUB Release Topic

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I think maybe a good way to approach the issue is by first looking at direct exchange (i.e. barter).

Let's say Smith has cows and Jones has chickens. Now for some reason, Jones would like to have at least one of Smith's cows. He figures that Smith won't be willing to just give him one or more of them. The only thing that Jones can offer in exchange is chickens.* So the question is, how many chickens is he willing to give up for one of Smith's cows?

There's no correct answer to that question. It's all a matter of what Jones prefers. On the other hand, it's not entirely up to Jones, for if it were, he'd be able to get one or more of Smith's cows for free. After all, that's surely what he prefers the most. So it's not just a matter of preferences per se, but a matter of marginal preferences - what's the largest number of chickens that Jones prefers one cow over?

Now what about Smith? Who's to say that Smith will prefer to give up one of his cows for the same number of chickens that Jones is willing to give up in exchange? The answer is no one, of course. But if Smith doesn't accept Jones' highest offer, then there will be no exchange. Of course, if Smith doesn't accept Jones' highest offer, that also means that Jones doesn't accept Smith's highest offer.

But let's say that Jones and Smith reach a deal. Where does the price come from? Well, the price emerges from Jones' and Smith's interaction. It's an exchange ratio of cows to chickens that both men find preferable to their current situations. For example, if they agree to trade one of Smith's cows for five of Jones' chickens, then that means Smith prefers the five chickens over the one cow and Jones prefers the one cow over the five chickens.

One very important thing to note here is that, strictly speaking, every price is unique. Why is this? Because every exchange is (again strictly speaking) unique. So where do market prices come from? Well, if you conduct an exchange with someone in front of other people (i.e. "publicly"), you're effectively sending a signal to those other people. This signal is "I'm willing to exchange good/service X for good/service Y at this ratio." Once you send that signal, those who know about it will likely see no reason to offer more than that ratio. It also serves as a signal to others who are trying to conduct the same exchanges (i.e. your competitors) - they'll see less reason (if any) to demand more than that ratio.

With the above, note that money hasn't been mentioned at all. That's because money isn't strictly necessary for these economic phenomena to come about. Prices are simply exchange ratios of one good/service for another. What money does is help make exchanges happen, albeit in a less direct fashion.

 

* Strictly speaking, Jones can also offer to exchange his labor (time and effort) for one or more of Smith's cows.

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