Austrian Analysis by Anecdote

The Subjective Value of Mustard and Its Implications

2010-02-06T10:29:00Z

Assume a foil packet of mustard whose only use is to potentially turn a plain hotdog/bun combination into a hotdog/bun combination with mustard.

Given the Austrian Subjective Theory of Value, assume that you subjectively rank the end of consuming a mustard-hotdog above the end of consuming a plain-hotdog on your subjective, ordinal scale of value.

For this problem, asssume that no markets or exchange values exist.

Under these conditions, the actual mustard-hotdog and the plain-hotdog are first or lower order goods, capable of directly satisfying the corresponding consumption ends.

Since the foil packet of mustard can be added to the plain-hotdog to create a mustard-hotdog, it must be considered as a higher order good.

What is the subjective value of the foil packet of mustard, the higher order good?

The first thing that happens when mustard is added to the plain-hotdog is that we no longer have a plain-hotdog. Because of this sacrifice, the plain-hotdog was the opportunity cost of creating the mustard-hotdog.

We now have a mustard-hotdog that has taken the place of the lower ranked, lower value, plain hotdog. The degree to which it is perceived that we now have a higher valued hotdog is entirely due to the mustard.

Accordingly, we can associate this augmentation of value with the mustard foil packet and call it an 'opportunity profit.' This is the subjective value of the mustard packet.

IMPLICATIONS -

1. From its description, we would assume that a purely ordinal subjective theory of value would only be concerned with ordered rankings, i.e. which is higher ranked, not by how much.

However, as we can see from above, the degree of preference for one good or end over another is vital for determining the subjective value of a higher order good, in this case the mustard.

This doesn't mean that any counting or measuring or arithmetic operation is required, but simply that the degree of preference can be used to determine choice and action.

2. It is widely believed, within other contexts, that the price of a higher order good is imputed from the subjective value of a first or lower order good.

Above, it has been shown that the subjective value of a higher order good can only be determined if we have both the subjective value of the first or lower value good, and its opportunity cost.

You may greatly prefer a mustard-hotdog, or just slightly prefer it. This is vital to the subjective value of the mustard packet.

It seems to me untenable to believe that the price of a higher order good can be imputed from the subjective value of the first or lower order good alone while the subjective value needs the opportunity cost as well.

Regards, Don

REPEAT OF AUSTRIAN ECONOMIC PROBLEM PLUS SOLUTION

2009-02-25T20:34:00Z

PROBLEM:

From http://mises.org/Community/blogs/donlloyd/archive/2009/02/20/the-world-s-hardest-austrian-economics-problem.aspx

THE WORLD'S HARDEST AUSTRIAN ECONOMICS PROBLEM

by Don Lloyd

For background :

http://mises.org/journals/aen/aen21_3_1.pdf

REISMAN: If you open up the hood of an automobile, you see a number of individual parts that disable the entire car if they are broken. There’s a fan belt, a carburetor, a starter, among many other items.There’s no way that you can derive the value of those items from the value of the car, because you would have to attribute the entire value of the car over and over again. When you go to the car-parts store to buy another fan belt, you only pay a tiny fraction of the utility that you derive from it. You pay $20, but it restores the entire value of a $20,000 car. In this case, the value of the car is not imputed back to a part that makes it run. You are only paying a price based on the cost of production of the belt. What determines the cost of production is the value of alternative marginal products elsewhere in the economy.

While the above is primarily concerned with factor pricing, the following problem concentrates on the value of a component to the buyer, which cannot exist without a valued assembly and a valued end for which the assembly serves as a means.

On a business trip, you have left your two year old car in the airport lot. When you return you find a note on the car that indicates that the fan belt has been auto-parts-napped and is being held for ransom.

On your personal subjective value scale, the end that the car serves, auto-mobility, is presently ranked just above the sum of $20,000. For simplicity, assume that this remains true throughout this problem. (To illustrate one possibility, before you consulted the market two years ago, you ranked auto-mobility just above $30,000. However, the market caused you to rearrange your value scale, dropping the ranking nearly down to the $25,000 price of a suitable new car, one of which you purchased. Of course, this $25,000 is now a sunk cost and has no involvement with this problem. Today, used car equivalents to yours sell for as little as $20,000, fixing auto-mobility on your value scale. See note below.)

The initial problem is to describe in words how you would come up with a maximum dollar amount that you would be willing to pay in ransom for restoration of the fan belt and car function. Again for simplicity, assume that no fan belts are available, nor can any be fabricated, and thus the market cannot directly rearrange the ranking of a fan belt on your value scale.

The second problem is to repeat the first with an EFI (Electronic Fuel Injection) module substituted for the fan belt.

The third problem is to repeat the first with an EFI module being held for ransom along with the fan belt.

Note:

That is to say, opportunities for exchanging induce the individual to rearrange his scales of values. A person in whose scale of values the commodity 'a cask of wine' comes after the commodity 'a sack of oats' will reverse their order if he can exchange a cask of wine in the market for a commodity that he values more highly than a sack of oats. The position of commodities in the value-scales of individuals is no longer determined solely by their own subjective use-value, but also by the subjective use-value of the commodities that can be obtained in exchange for them, whenever the latter stand higher than the former in the estimation of the individual. Therefore, if he is to obtain the maximum utility from his resources, the individual must familiarize himself with all the prices in the market. -- Mises, The Theory of Money and Credit, page 48.

SOLUTION:

When the problem statement says :

On your personal subjective value scale, the end that the car serves, auto-mobility, is presently ranked just above the sum of $20,000.

What does it mean?

It means that you are willing to sacrifice as much as $20,000 in exchange for the services of the car. This could be because you simply prefer the services of the car to $20,000, or it could mean that you would prefer the services of the car to an even greater sum, but that the market has caused you to rearrange your value scale by making a car available for $20,000, leaving you no reason to pay more. The $20,000 sacrifice need not be limited to money, but can include assets that can be converted to money as well.

The key to solving this problem is realizing that the ransom to be paid is not the sole sacrifice to be made in restoring car service. In addition to paying a ransom for the fan belt, you need to throw the disabled vehicle into the pot as well. This implies an opportunity cost in that the disabled vehicle cannot be employed in a next best service, probably a sale to an auto salvage business. This implies that if you expect that you can get a total of $19,000 from a salvage sale, then your $20,000 sacrifice limit has only $1,000 remaining to pay in ransom for the fan belt.

Similarly, you may expect that a disabled vehicle without an EFI module may only yield $17,000 in a salvage sale, leaving $3,000 for a ransom payment for an EFI module. And finally, a disabled vehicle with neither fan belt nor EFI module may be expected to only yield $16,500 in salvage and a ransom payment of $3,500 at most for both the fan belt and the EFI module. Whether the estimates are accurate or not, they serve their purpose and will never be disproved if the ransom is paid and the car function is restored.

More generally, any bundle of parts, at least one of which is essential to function, can be analyzed the same way. You estimate the salvage yield of the disabled vehicle without the missing bundle of parts, and pay a ransom for the bundle, not to exceed the $20,000 total value minus the opportunity cost of not salvaging the disabled vehicle.

In an extreme case, you might retain the fan belt and have the rest of the vehicle to ransom. Wirhout the opportunity cost analysis, you might be left with paying the same $20,000 ransom for either the fan belt or everything else, depending on which you retain and what you need to ransom. Using the opportunity cost analysis, the fan belt will be associated with the much smaller number, whether it is the ransom or the opportunity cost., as would be expected.

end

THE WORLD'S HARDEST AUSTRIAN ECONOMICS PROBLEM

2009-02-21T01:41:00Z

THE WORLD'S HARDEST AUSTRIAN ECONOMICS PROBLEM

by Don Lloyd

For background :

http://mises.org/journals/aen/aen21_3_1.pdf

The second problem is to repeat the first with an EFI (Electronic Fuel Injection) module substituted for the fan belt.

The third problem is to repeat the first with an EFI module being held for ransom along with the fan belt.

end problem

Note:

Comments will be moderated and any that would spoil the problem prematurely will be delayed.

BTW, somehow the tags 'factor' and 'wages' got attached to this post. I didn't enter any tags and these two have nothing to do with the post and can't be editted out.

Would a Ban on New Gold Coins Work?

2009-02-10T19:27:00Z

Assume a gold coin money standard. Some believe that new gold coins should not be allowed to add to the money supply. The basis for this belief is that once a commodity is established as money, society will derive no additional benefit from either more or less money. This is a standard Austrian tenet, that any supply of money is capable of providing all the benefits that money can provide. From this, it is reasoned that gold used as money cannot be used in non-monetary applications, denying society the increased output at lower prices that could result.

Let's pretend that a law is passed that bans new gold coins, either from newly mined gold or from the conversion of existing non-monetary gold.

Without the ban, gold would tend to move freely between monetary and non-monetary uses, tending to make an ounce of gold of comparable value in all of its applications, and any new gold to tend to flow into all applications of gold. As an even somewhat healthy economy progresses, the increase in productivity tends to increase the purchasing power of each ounce of the constant supply of gold coin money if the ban is in effect. Thus, we can reasonably expect the value of an ounce of monetary gold to rise above the value of an ounce of gold in all other employments,. The ban prevents equalization of value in use.

The stated purpose of the ban is to allow all new gold to be used in non-monetary applications and not be 'wasted' as money. Will the full increased output of goods that use non-monetary gold be realized?

The question comes down to the following : If, as a manufacturer of a good that employs non-monetary gold, would I use an ounce of my gold stock to make a good for which the marginal revenue product of an ounce of gold is less than an ounce of gold? For example, using an additional ounce of gold from my non-monetary gold stock may result in an additional one-tenth ounce gold coin after selling the good. Without the ban, I would never use my gold in such a use which values gold in such an inferior manner. With the ban, who knows? Is it in my self-interest to trade one ounce of non-monetary gold for one tenth ounce of monetary gold?

Thanks, Don

The Disabled Car Because of Missing or Broken Essential Parts Problem

2009-02-03T21:39:00Z

Sparsely scattered over Austrian and other economic literature are treatments of both the valuation and the factor pricing (separately) of essential parts of an automobile whose absence or malfunction prevent the automobile from serving its intended end or goal. Known examples include a steering wheel and a fan belt.

This is a call for references to any such treatments or mentions, for automobiles or anything else.

Thanks, Don

John Law : French to English translation needed for Mises TMC footnote

2009-02-03T04:34:00Z

From Theory of Money and Credit, pg. 106 :

1 More than two hundred years ago, John Law, far ahead of his time and with an
insight amounting to genius, had seized upon this truth: 'II est raisonnable de penser
que I'argent s'echangeait sur Ie pied de ce qu'il etait evalue pour les usages, comme
metal, et q'on Ie donnait comme monnaie dans les echanges araison de sa valeur. Le
nouvel usage de la monnaie, auquell'argent fut applique, dut ajouter asa valeur, parce
que, comme monnaie, il obviait aux desavantages et aux inconvenients de I'echange; et
consequemment les demandes d'argent venant a s'augmenter, il re~ut une valeur
additionneUe, egale it I'accroissement de la demande occasionnee par son usage comme
monnaie. Et cette valeur additionneUe n'est pas plus imaginaire que la valeur que
I'argent avait dans les echanges comme metal, parce que teUe ou teUe valeur derivait
de son application atels ou tels usages, et queUe etait plus grande ou moindre, suivant
les demandes d'argent comme metal, en proportion de sa quantite. Le valeur addition-
neUe que I'argent recut de son usage comme monnaie provient de ses qualites, qui Ie
rendaient propre a cet usage; et cette valuer fut en raison de la demande additionnelle
occasionnee par son usage comme monnaie. Si I'une et I'autre de ces valeurs sont
imaginaires, alors toutes les valeurs Ie sont; car aucune chose n'a de valeur que par
I'usage auquel on I'applique, et a raison des demandes qu'on en fait, proportioneUe-
ment a sa quantite.' Considerations sur Ie numbaire et Ie commerce, ed. Daire, Econo-
mistesfinanciers du XVIIle siecle, Deuxieme edition, Paris I8SI, p. 447 f. Cpo further
Walras, Theone de la monnaie, Lausanne 1886, p. 40; Knies, ope cit., I. Bd., p. 324.
Objective theories of value are unable to comprehend this fundamental principle of the
theory of the value of money. This is best shown by the lack of comprehension with
which Marx confronts the arguments of Law cited above. Cpo Marx, Dos Kapital,I.
Bd., p. 56, n. 46; Eng. tr. E. and C. Paul.

Thanks, Don

Find the Austrian Theory for This Factor Price

2008-08-03T16:06:00Z

A single worker can, in one hour, produce a paperweight as described below.

Find the Austrian Theory that deals with the wage rate that the worker earns.

Paperweight Description :

Name - FRN-Brick Paperweight

Market Price - $200

Manufacturing Process - Start with a clean freely available brick and cover by pasting one of each of the standard Federal Reserve Notes with a face value of $100 or less. ($100, $50, $20, $10, $5, $1)

What can we deduce about the wage rate that the worker earns and quote an Austrian Theory source that supports that answer.

Problems with gold or any common currency?

2008-04-15T20:11:00Z

Let's say we have two economically and geographically isolated islands, each with the rough size and population of New Zealand. They are virtual clones of one another, and each has a functioning monetary economy based on a gold standard, with all prices expressed in ounces of gold in any physical form. If inter-island trade has suddenly become feasible due to technological advances in transportation, what possible economic effects may result?

[ed] The uncontrolled variable that may differentiate one island from the other is its gold money supply. If one island has ten times as much physical gold as the other, its gold prices of goods will not be exactly ten times those of the other island, but they could be, and will certainly be much higher. If trade has become possible, there will be a large flow of gold in one direction and goods in the other. The island with less gold will experience a large price inflation and a loss of goods available for consumption. The island with more gold will experience a large price deflation and a collapse of production as its producers cannot compete with lower-priced imported goods.

The common currency can produce an artificial comparative advantage even if the physical productivities of the two economies are identical in every respect.

This kind of problem also occurs when Congress tries to apply a Federal minimum dollar wage to Pacific island territories that use dollars, but for whom a fixed mainland minimum wage is entirely inappropriate.

A common currency can be expected to result in comparable prices in different regions only after a substantial equilibrating period of widespread trade.

Regards, Don

A Candy Bar Inflation Puzzle (+ hint + answers)

2007-10-18T16:55:00Z

A candy bar maker produces a chocolate bar of a size which permits 10 nominal bites and which sells for a price of $1.00.

Ongoing monetary supply inflation has increased the manufacturer's factor costs and forced him to decide between increasing the price to $1.10 or reducing the size to 9 nominal bites.

PART I

Considering only the effects of the manufacturer's decision, analyze and contrast both choices in terms of the directional effects on --

1. The purchasing power of the dollar.

2. The standard of living.

3. The cost of living.

4. The impact on the purchaser.

and decide which choice is more beneficial to society as a whole, as an unintended consequence to the manufacturer serving the interest of his shareholders.

PART II

What changes if the problem substitutes a bag of 10 individually-wrapped cough drops for the candy bar?

Hint --

Apply the Law of Diminishing Marginal Utility

Answers --

First of all, compare the alternatives of raising the price and reducing the size in terms of their effect on the consumer.

When the size of the candy bar is reduced from 10 bites to 9 bites, this is a subjective impact which is made for the application of the law of diminishing marginal utility. The reduction of one bite always is the loss of the last bite, the tenth. But we know that every successive bite has less subjective marginal utility than the previous one, and the experience of consuming a 9 bite bar may be almost imperceptably inferior to consuming the 10 bite bar. In this case, what is being purchased is a total candy bar for immediate consumption, and not a specific number of bites.

When the price of the candy bar is increased by a dime, the opposite occurs. If the consumer starts out with 12 dimes, the 11th dime is now the last dime spent, and reduces his residual from 2 dimes to 1 dime. Whereas before, the 10th and last dime spent only reduces his residual from 3 dimes to 2 dimes. Every sucessive dime spent is of higher subjective utility than the previous one.

From the above, it seems clear that reducing the size of the bar is almost always better for the consumer than increasing the price. This is because the sacrificed bite will be the least significant of all the bites, while the sacrificed dime will be the most significant of all the dimes.

This is a good point to jump ahead to Part II, where a bag of individually wrapped cough drops is substituted for the candy bar. The difference is that the bag is not consumed as a whole, but that its contents are individually consumed over time as needed. In this case there is no diminishing marginal utility with the number of drops and a cost per drop makes more sense than a cost per bite would have for the candy bar. However, the overall effect is still the same, or possibly larger. For the sacrificed tenth drop to be significant, we must assume that it would have been still available for use possibly months or years downstream, and not lost. Also, the fact that the cough drops are only used over time means that the tenth and last drop must suffer a time preference discount when reflected back to the time of purchase. With all of this in mind, it still seems likely that the consumer is better off with a reduced size product as opposed to a higher price. It should be noted that these are not universally true results, but are strongly dependent on context. A reduction in the size of a can of engine oil is largely a true reduction.

The choice of a price increase will result in :

- a loss in purchasing power for the dollar

- an increase in the cost of living

- a reduction in the standard of living

The choice of a size reduction will result in :

- no change in the purchasing power of the dollar

- no change in the cost of living

- a small reduction in the standard of living.

Finally, society as a whole benefits from the choice of a size reduction as compared to the cost increase.