Recently, the Barrett Jackson Auto Auction made automotive history by auctioning off the original George Barris “Batmobile” for an astounding $4.5 million. Not a world record but amazing nonetheless. The 1964 Aston Martin DB5 used in James Bond films sold in 2010 for $4.6 million. The value individuals place on such rare automobiles is merely reflected in their price. It is not inherent in the price. This opens up a great opportunity to discuss the difference between value and price.
We learned from the work of the economic great mind of Carl Menger, that value is actually subjective. This all new approach in economic thought became known as the “marginal revolution” of 1871. The term “marginal” became popular because of the way Menger described value in terms of marginal utility. Utility is a subjective concept. It refers to “satisfaction” or even “happiness”. That is, goods are placed in an ordinal ranking, not a cardinal ranking, by their subjective value in the ability to satisfy desired ends by individuals. It rises when the individual increases his or her state of satisfaction or “utility”. Further, when the individual considers themselves in a worse state of affairs, or worse off, his utility decreases.
To illustrate, an individual may operate a horse farm. He owns five horses already. Two mares for producing more horses, a stallion and two geldings (castrated male horses) for pleasure riding. This year the hay crop comes up short due to an extended drought. The cost of maintaining all five animals would be unprofitable for his business and he must decide which of the five horses to sell off. The farmer is faced with making a choice of marginal utility. He calculates that he can over winter three animals and must decide, based on his marginal utility, to sell one gelding but maintain the other. He also decides to sell off one brood mare.
You might ask, “Why doesn’t he sell both geldings and keep the production opportunity in both mares”? This is where subjective value comes in. One gelding has been on the farm a long time and represents a certain sentimental value to the family. He is not going to part with this horse. No amount of money could replace this member of the family. A modern economist might have advised him to sell both geldings and would never have contemplated subjective value in this regard. The amount of subjective value assigned to this gelding couldn’t be measured and therefore wouldn’t be plugged into the equation or model. Econometrics cannot account for subjective value in terms of human action. There is no unit of measure for utility or satisfaction. There is no way to assign a cardinal value on what people deem as valuable. Hence, value is subjective according to each individual.
Another farmer might have come up with a different solution but this is what works for this specific farmer. He had ordered the marginal utility of each horse in his own summation of what satisfies him the best.
Here is a list of the farmers marginal utility:
1. Brownie the old gelding
2. Daisy the younger mare
3. Wanderer the stallion
4. Sunshine the older mare
5. Digger the new gelding
Remember, this list is ordinal and not cardinal. There is no specific cardinal value assigned to any one horse. The horses are listed only by the farmer’s subjective value according to his marginal utility (most satisfactory to the least satisfactory) for each animal. He could have easily sold the stallion and retained the other mare. Perhaps the cost of paying for stud fees would have been to prohibitive for the business. The farmer made his calculation according to his knowledge of events. The key point is that we cannot make an interpersonal comparison of subjective value. Only the farmer knows what outcome would be best in his case. An outsider certainly would not possess the necessary knowledge required to make the correct decision for the farmer. Yet, modern “main stream” economists do just that almost every time.
Marginal utility actually means the utility of enjoying an additional good. It certainly does not mean the increment of utility. This would entail that utility (satisfaction) could then be measured. As we stated before this is impossible. As Murray Rothbard stated in his seminal book, “Man, Economy and State”:
In order for any measurement to be possible, there must be an eternally fixed and objectively given unit with which other units may be compared. There is no such objective unit in the field of human valuation. The individual must determine subjectively for himself whether he is better or worse off as a result of any change.
So, what does it mean to be worse off? This is where the law of diminishing marginal utility comes in.
Diminishing Marginal Utility
The law of diminishing marginal utility defined is; the marginal utility of each homogeneous unit decreases as the supply of units increases. That is, with each increase of supply of any single good, it’s intended satisfaction or utility decreases. In our example, the farmer’s supply of five horses decreased his utility. It left him worse off. The supply of hay was diminished and wouldn’t support five horses. It gave him more satisfaction to sell two horses in order to fulfill his goal of maintaining the horse farm. Conversely, the marginal utility of a larger sized unit is greater than the marginal utility of a smaller sized unit. This is known as the law of increasing total utility. Had the initial supply of hay been larger, the farmer could have maintained his five horse farm and received more satisfaction (utility). In other words, the farmer substituted a more satisfactory state of affairs for a less satisfactory one. This is the fundamental axiom of human action.
Notice that the above list was an ordinal ranking of the farmer’s five horses. He didn’t decide to sell just any two horses. He chose the two which gave him the least marginal utility. Those at the bottom of the list, in his subjective valuation, fulfilled the farmer’s desired ends the least. Because means are scarce and have to be economized in order to realize desired ends. In our example, the hay supply was scarce so two horses had to go in order for the farmer to maintain his end of keeping the horse farm.
How Does this Apply to the Batmobile?
We saw an amazing display of auctioneering during the back and forth over the Batmobile. After the auction had ended the new owner was asked why he paid so much for the car. His reply was that he “…came to the auction for that car and he wasn’t leaving without it.” In other words if we apply the laws of marginal utility, his supply of money was large enough to satisfy his desired ends. In order for him to attain his goal of Batmobile ownership he was willing to part with large sums of dollars. In this case, the law of diminishing marginal utility says that his supply of money was not satisfying his desired end to own the Batmobile, thus they had to go. To be rid of the excess dollars he gave himself an increase in his total utility. In his subjective value, the Batmobile’s price of $4.5 million left him better off.
Notice, we never spoke about price in relationship to value. Because price and value do not relate in hard terms. Prices are objective and value is subjective. Would you pay $4.5 million for the Batmobile? Probably not. If you were in this buyer’s financial position and thought the world of Batman, then possibly. But, again, value is subjective and prices are not.
When people engage in a voluntary exchange they do so because both parties involved think of themselves better off than before the trade. Not to be redundant but, value is subjective. That is, it’s in the eye of the beholder.
If I were to purchase an item, say a frozen turkey at my local grocer, it is because I value the turkey more than the dollars in my wallet. The grocer, on the other hand, values my money more than the frozen turkey. If we exchange at the agreed to price then we both think of ourselves better off. I got my frozen turkey and the grocer got my $20. This doesn’t mean the turkey was worth $20 to me. On the contrary, I thought the turkey was worth more than $20. For had I thought the turkey to be actually worth $20 then I never would have parted with my money – I wouldn’t have been better off in my calculation of subjective value. Another way to put it, the use of the scarce resource of my money would not have given me an increase in my marginal utility. The grocer accepted the trade because he believed the turkey to be worth less than $20. Therefore, we both agreed that the price left us better off so we exchanged a turkey for money. The price is objective. It helps the grocer to calculate if his customers are satisfied with the exchange they receive and how to order new supplies of inventory. If turkeys are over priced then he will have to reduce the price until inventory clears or stop selling them altogether if the lower price doesn’t leave him better off. The price mechanism communicates information to entrepreneurs on how to calculate their respective businesses. They do not reflect value or what something is worth. The grocer has no idea what I think the frozen turkey is worth. We stopped at $20. I may have paid more. Well, maybe not much more.
Likewise, the Batmobile sold at it’s price, not because the buyer thought it was worth $4.5 million, but because he thought it was worth more!
Exchanges like this happen all the time, millions of times a day. The auction of the Batmobile allowed for a good lesson in what subjective value really is about. Prices are simply a mechanism that communicate to entrepreneurs on the state of their business at any given time. They are nothing more than a snapshot of current economic conditions. Although invaluable for an entrepreneur to make the correct calculations, they do not reflect value of a good. They reflect how much a customer is willing to pay at a specific time. Value or what something is worth, is subjective. Value, as was said, is in the eye of the beholder.