Fallacies in Value & Pricing

I think that most citizens misunderstand the concepts of value and price. They seem to think that value represents an inherent quality of economic goods and that suppliers of goods have total control of prices. They miss the fundamental principles and theories behind Mises’ concept of the sovereignty of the consumer.

The Subjective Theory of Value

The Subjective Theory of Value represents one of the distinguishing concepts embraced by the Austrian School of Economics. The development of this theory not only sets the Austrians apart, but it also exposes some fundamental fallacies in the theories of value espoused by many other economists.

Briefly, The Subjective Theory of Value says that actors—at all levels of production and consumption—establish their values based on their subjective judgments of their requirements for economic goods. People discussing economic values need to understand the idea that the subjective nature of values applies at all levels for all products. Even sophisticated analysts, who use complicated discounted rates of return calculations, use subjective judgments of value. In doing so they use the subjective value judgments of other actors buried in the historic rates of return they choose to use.

Pricing and Catallactics

Fallacies of pricing relate closely with those of value. Many people seem to believe that producers establish prices, on which ultimately consumers have no influence. They believe that prices somehow determine supply and demand, instead of always the other way round. Historic prices have only an indirect influence on supply and demand and thereby on current and future prices.

A price represents the ratio at which parties to a transaction willingly exchange one good for another—including money. In direct exchange, the price might amount to one horse for three pigs. In an indirect exchange, the price might amount to one horse for $100, for which the seller hopes to buy three pigs. The nature of price means that it always depends on the ratio established at the point of exchange.

Mises spends a considerable amount of time discussing theories—he calls “catallactics”—that deal with the use of price in the market economy. This excellent definition comes from the Ludwig von Mises Institute web site:

Catallactics, n. catallactic, adj. The theory of the market economy, i.e., of exchange ratios and prices. It analyzes all actions based on monetary calculation and traces the formation of prices back to the point where acting man makes his choices. It explains market prices as they are and not as they should be. The laws of catallactics are not value judgments, but are exact, objective and of universal validity.

Subjective value and money combine to form the foundation for catallactics. Acting man requires money to make economic calculations regarding the market. One cannot separate money from economic calculation. J. M. Keynes made the error of trying to separate money from the “real economy.” (See Henry Hazlitt, The Failure of the New Economics.)