A Short Course in Economics

2. The Subjective Theory of Value

Deriving from the axiom of human action, we know that every human being has a scale of values; that is, a ranking of each desired end on a scale.  The most desired ends are given the highest rank; that is, the most desired ends are the ones with the highest value.  Value is, therefore, entirely subjective, depending on the individual and the circumstances.

The value scale is ordinal – it is merely a qualitative order of values.  No mathematics calculations can be done on values.  It cannot be measured and there are no units associated with it.

Note that this is in stark contrast to the mainstream theory of valuation.  Mainstream economics claims that value can be measured objectively, and measured and calculated using the unit they call “utils”.  But when economics is built up from the axiom of human action, it is clear that the objective theory of value is a fallacy.  Unfortunately, this fallacy underpins mainstream economic theory.  The whole concept of Pareto efficiency, which is the basis of “welfare economics”, is invalid because it requires an objective theory of value.   

It is useful to assign a name to this value scale.  We are not concerned with the specific content of men’s ends, but only with the fact that they rank them in order of importance.  The scale may be called happiness or welfare or utility or satisfaction.  The name does not matter, but it permits us to say that by whenever an actor has achieved one of his ends, he has increased his happiness, welfare, etc.  And when fewer of his ends are being attained, his happiness, satisfaction, etc, has decreased. 

All action, then, is an attempt to increase “psychic revenue”.  With reference to any given act, if the action succeeded in raising satisfaction, there is a “psychic gain” or “psychic profit” where the psychic revenue exceeds the psychic cost.  If there was a “psychic loss” then the action was in error.  Only the individual performing the action will know for sure whether any given action of his resulted in psychic profit or a psychic loss.

Humans value means strictly in accordance with their valuation of the ends they believe the means can serve. 

• Consumers’ goods are valued according to the ends men expect them to satisfy. 
• 1^st order producers’ goods are valued according to the expected contribution in producing consumers’ goods. 
• Higher order producers’ goods are valued according to the expected contribution in producing lower order producers’ goods.

Thus, the process of imputing values to goods takes place in the opposite direction to production.  The original source of all valuations is the human scale of ends.

Each physical unit of a means that enters into human action is valued separately.  Men do not value “coal” or “butter” in general, but specific units of coal or butter.  In choosing between acquiring cows or horses, the human does not choose between cows and horses in general, but chooses between specific units of them – e.g. two cows versus three horses.

Consider this example: An individual possessing two cows and three horses has to choose between giving up one cow or one horse.  When making this choice, it is clear that he must consider his whole stock.  He is choosing between giving up his second cow or his third horse. 

How will he choose?  It will depend on the ends that will be served by each unit.  For example suppose he had the following ends on his value scale:

1. Milk for his family (requires one cow)
2. Plough for his farm (requires two horses)
3. Milk to sell at market (requires one cow)
4. Pleasure riding (requires one horse)

In this case, it is clear that he will choose to give up one horse, because then he will only have to forego his fourth end, pleasure riding.  If he gave up a cow, he would have to forego the milk to sell at market.

Now, with a stock of two cows and two horses, suppose he is faced with the same choice: to give up either one cow or one horse.  He will obviously choose to give up a cow, because if he gave up another horse, he could no longer plough his farm, and this value is higher on his value scale.

The units are valued separately and a unit is defined as the smallest amount of the good which is useful.  Here, for example, if the man had only one horse, it would be no use ploughing his farm: that task requires two horses.  With only one horse, he would use it for pleasure riding.

The horses here are interchangeable from the point of view of the human.  Any two horses are equally capable of satisfying the various ends.  When a commodity is available in homogeneous units like this, it is called a supply.  The example started with a supply of two cows and three horses.  If one horse is considered to be more capable than another then they become different goods.

The third horse, used for pleasure riding, is referred to as the marginal unit.  It is the unit “at the margin”; the one that will be given up if lost.  The end that will be given up if the marginal unit is lost is known as the satisfaction provided by the marginal unit, or utility of the marginal unit, often shortened to marginal utility of the supply.

The value of each unit of any good is equal to its marginal utility at any point in time, and this is determined by the relation between the actor’s scale of wants and the stock of goods available.

The Law of Marginal Utility: The greater the supply of a good, the lower the marginal utility.  The smaller the supply of a good, the higher the marginal utility.

This law, derived from the axiom of human action, applies to all goods.  With two cows, the marginal utility – having milk to sell at market – is lower than with only one cow, where it is having milk for the family.  The 1^st cow is valued higher than the 2^nd cow; the n^th unit of a good is valued higher then the (n+1)^th unit of that good.

It is clear that the value, or utility, of a consumers’ good is the value of the end that it will serve.  The utility of a producers’ good is its contribution in producing consumers’ goods.  Since production involves multiple factors of production, exactly how will the actor value each factor?  He will evaluate a unit of supply on the basis of the least importantly valued product which he would have to forego were he deprived of the unit.  In other words, he will evaluate unit of a factor as equal to the satisfactions provided by the marginal unit.  The product foregone by a loss of the marginal unit is referred to as the marginal product, and its value is determined either by its marginal product, or, if it is a consumers’ good, the utility of the end it satisfies.

Since man wishes to satisfy as many of his ends of possible, and in the shortest possible time, it follows that he will strive for the maximum product from given units of factors at each stage of production. 

The Law of Returns states that with the quantity of co-operating factors held constant, there always exists some optimum amount of the varying factor.

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