Scarcity, Choice, and Value

0:00I want to start by way of introduction to say a few words about why the title. Why Introduction to Austrian Economic Analysis? Well, first of all, let's focus on the word Austrian. The title could have simply been Introduction to Economic Analysis, okay, if economics had not really jumped the tracks in the interwar period, that is in the 1920s and 1930s. It really veered off the track. From 1870, the so-called Marginal Revolution, until 1914, economics was flourishing, not just Austrian economists, but also American, British, Dutch, Italian, French economists, all were contributing to this growing body of doctrine and theory.

0:48names such as Federer, Wickstede, Clark, Davenport. These were all economists who contributed substantial treatises to the science right before World War I. But in 1930s as I mentioned, in the 20s but especially the 30s, we started to get a moving away from what we might call sound economics. Marshall and Knight developed the theory of perfect competition in the 1930s we began to get a reaction against that which was a wrong-headed reaction in the marginal monopolistic competition revolution then shortly thereafter we got the Keynesian Revolution mathematical economics which had been a sort of a cultish fringe The exchange movement up until the 1930s came into its own during that decade.

1:43So to make a long story short, by the 1950s, economics was on the wrong track. So had it not been for this tragic interlude between the wars, today universities would be teaching this course. So this course really should be introduction to economic analysis. The adjective Austrian is used to differentiate it from what developed after the 1920s and 30s. Hopefully in the future as more and more economists embrace this long tradition, this tradition that extends back to 1870, we can drop the adjective Austrian.

2:30and just talk about economic analysis. The second point I want to make by way of introduction has to do with the term economic analysis. Now many of you have had economics courses in college and there's a certain way that economics is characterized. Sometimes this became fashionable in the 1930s but it's even used today. This has been called the box of tools or toolbox. It provides us the means to answer questions or solve problems. These tools are supply and demand theory, theory of the firm, so on and so forth. And the way this is looked at, the mindset that you get from calling economics a tool set is that well, some tools eventually outlive their usefulness, they become obsolete and they're discarded.

3:23But at the same time, new tools are always being developed, and there's really no obvious relationship between these tools, except that they all give, quote, satisfying, unquote, answers to certain problems. More recently, the characterization of economics has taken a turn towards calling it a way of thinking, a way of thinking about the world. And in the textbook I know I use at my university, the second chapter is on how economists think. They think in terms of benefits and costs, or supply and demand, or the structure of incentives that people face. To put it more generally, they think in terms of simple models that are based on sometimes very simplistic or even false assumptions. But once again this economic way of thinking as it's often called gives satisfying answers. Finally, my all-time least favorite characterization of economics is that it's a set of open questions. Okay, open questions that economists argue endlessly about and that occasionally and from Some of which occasionally emerge some insights into the world around us.

5:00Some of these questions include what is the role of knowledge in the economy? Is entrepreneurial activity, the activity of entrepreneurs, is it always equilibrating or can it be disequilibrating? Do people always act rationally in their own interests or, due to certain behavioral quirks and propensities, do they depart in their actions from what are their true interests? That's a more recent question. Are expectations exogenous, that is, created outside the economic process or the market process, or is it endogenous, that is, created from within the market process? These are all questions, open questions that never seem to find a solution, but which supposedly constitute the main body of economics.

5:54Nowhere, nowhere in any of these characterizations is the word truth used, or knowledge. Do practitioners of physics, chemistry, biology, geology, do they regard their sciences in these ways as a way of thinking or a toolbox? Of course not, and neither does a lay person when he looks upon the results of the natural sciences. They regard it as a substantive body of truths about the real world. Of course, it's always being refined, it's always being improved, but chemistry is a body of truth about certain aspects of the real world.

6:41Well, economics, or the characterization of economics that I prefer, is also science, and therefore it's a substantive body of universal truths about cause and effect relationships in the real world in which you and I and everyone else acts. We call these truths laws or principles. What about economic analysis? Economic analysis involves a systematic application of these laws or truths or principles to the explanation of the causes or consequences of certain concrete conditions that we observe in the real world or that we observe in history.

7:30We observe in history, including the recent past. Let me give you some examples I've collected about on which economics can shed light. One example is that in 1995, there were 2400 people on a waiting list for heart transplants, 731 of whom died while they were waiting. In the same year there were 10,000 kidney transplants were performed. 30,000 people were waiting that year. 1,375 died waiting. Well, this is an issue which we can analyze.

8:20That is, use the truths of economics to explain. we would apply in this case what we call the theory of price controls which we'll talk about another example a few years back in uh... nineteen ninety six a baseball card featuring Honus Wagner, a famous baseball player from the turn of the century sold for six hundred forty thousand dollars It's one of the two that are in mint condition. So, what explains that? It certainly didn't cost $640,000 to produce.

9:06Well, economics will explain that. Economics, using general truths about the implications of acting, derives something called the theory of supply and demand, which can explain that high price. Another example along the same lines is that the John Lennon's handwritten lyrics, I Am the Walrus, sold a few years ago for $129,000. Another quite interesting example is that in 2000, a huge sub was discovered in the Andes Mountains, hundreds of miles from the ocean in Colombia. Why would someone build a sub in the Andes Mountains?

9:55Why would they enlist the support of Russian criminals and also Russian scientists to build this, illegally? By the way, it was built 7,500 feet up in the mountains and 210 miles from any port. Well, of course, this all has to do with the war against drugs. Because both the U.S. and Colombian government had cracked down on transporting drugs to the U.S. in various other ways, the response of the drug smugglers was to build this huge sub which could carry 200 pounds of cocaine into Miami.

10:40In fact, one of the Colombian admirals, one of the Colombian admirals, said it was one of the most sophisticated subs he had seen. Now, that can be explained by the theory of consumer sovereignty, or what we might call the theory of long-run supply. This is what economic analysis can do for us. It can give us true explanations of seemingly insoluble problems or seemingly mysterious problems. The other day I read an article in the Opel Ica Auburn newspaper written by a pastor.

11:29And it's entitled, God Keeps Record of How We Treat the Poor, okay? And he goes through, in the beginning of the article, the fact that Americans are in $200 trillion in personal debt and that they are paying 18.9% on their credit cards, so on and so forth. and he urges that the churches counsel Americans, counsel their members or people in their congregation how to live responsibly and stay out of debt but then he goes on and he talks about a relatively recent phenomenon called payday lending in which someone gets an advance from a payday loan company by going and showing how much they earn and then giving the company a post-dated check. So, for example, if you want to borrow $150 for two weeks, you would write a check for $150 plus $22 more, okay, and then post-date it for two weeks, at which point you get paid and then they will cash the check, okay, so in effect it's a loan to you.

12:46Now, why does a loan have to be made such a securitist way? As we'll see the law of price controls will explain why this whole phenomenon exists. Well, the minister goes on to condemn this because he figures that $22.25, that you must pay for $150 alone for two weeks, comes out to 450% interest. But as we'll see when we talk about the theory of time preference, it's easily explicable why people are willing to pay this and why in fact the interest rate is really irrelevant. Why in fact people just simply prefer or compare $150 today to $177 two weeks from now.

13:33So these are the types of, and by the way, before this innovative way of extending loans to people with very, very poor credit, before it began, people would go to mobsters very voluntarily and were willing to pay 200% per week on an annualized basis for their loans. So payday lending, to some extent, has displaced so-called loan sharks. We'll explain why that also occurred. And I could go on and on with the types of problems that economic analysis only allows us to deal with. But my point is that the explanations that we give are based on true laws, on a body of integrated knowledge that has been built up over the years, over the centuries, I should say.

14:29And that these are laws of reality, they are not a toolbox, they are not open questions that people debate ad nauseam about. It's not merely a way of thinking about the world, which may or may not give you satisfying answers or most of the time gives you satisfying answers. It's a way of arriving at true explanations of concrete conditions that we observe in the real world. So that's why introduction to Austrian Economic Analysis. I wore a jacket because I wanted to give you my final example. Yesterday I went to Belk Department Store in a mall here in Auburn, and I was looking to get some socks and underwear and things that I didn't bring down here for my stay, I went in and this jacket happened to catch my eye. It's a summer weight jacket. I looked at the price. I wasn't intending to buy a jacket. It was $195, the list price.

15:40And so I began to walk away, then I saw that it had been marked down to $99.95. And that was still not what I really wanted to spend. So there was a saleswoman near me and she said, that's really a good deal. And I said, yeah, it looks like a good deal. And she says, let me scan it in because there might actually be more off on it. So it turns out it scanned in for $69. So now I was interested, and then I had a 10% coupon in my pocket, and so that made it even less, so I got this jacket for over $60. There has to be a little bit of work done on it, it's a little bit long on the sleeves and so on, but that's the law of demand, right?

16:25It radically changes people's behavior, and we'll talk about that. When computers were $3 million for a mainframe computer in the 1970s, No individual ever thought that they would have a computer in their house. Well, computers today that are $500 and are faster and have more memory than that mainframe, people have two, three and four of those. Why? Because of the law of demand. These are all true laws, laws of reality, existential laws that allow us to explain what Mises sometimes called the concatenation of certain phenomena. Each historical event is a complex resultant of various causes. Economics allows us to isolate those causes.

17:14So now I can take this jacket off. It's hot up here. If anybody wants it for $80 or $90, I'm willing to sell it. Okay, economics, now let's talk about what economics is. I want to get into scarcity, choice and value. Three very, very primordial concepts of economic analysis. Okay, economics starts from a fact that no one would dispute. And that is that people are continually striving to achieve goals. As long as they're conscious, they're always in the midst of using certain means to achieve certain ends or goals that they value.

18:00Another way of putting this is that people are constantly seeking to improve their conditions. Something else that really can't be argued. Or another way of putting it is that they're struggling to satisfy their wants. Von Mises used the word felt uneasiness. Everyone is always attempting to remove their felt uneasiness. I don't use that. I think it's a little bit awkward. But it shows that human beings are imperfect. That all action stems from the imperfection of human beings. The fact that they're dissatisfied with their present conditions or with conditions as they believe A perfect being wants nothing because want implies lack and lack implies imperfection.

18:50So when we say that people act to improve their conditions, we mean simply that they use concrete means and technical ideas that they have about how to combine those means to achieve ends. Goals that they value more or less highly. Now there's three prerequisites of action. First, someone has to be dissatisfied with their present condition, which all human beings are. Secondly, the individual involved has to have the ability to conceive of a better state of affairs, a more satisfactory state of affairs. And thirdly, they must have ideas about how to achieve the more desired state. Let's say I have tickets for an Atlanta Braves New York Mets game and I hear it's going to rain that day.

19:43Well, I can conceive a better situation. The better situation is that we have a sunny day. It's not too humid, but yet I have no idea about how to achieve that goal. I don't have any technical recipe that allows me to turn a rainy day into a sunny day, so I don't act. The third ingredient is missing. Also, I'm a very big Beatles fan, and there's a group now, including one individual who plays on the David Letterman show, in the band of the David Letterman show, another individual who plays in the band on the Conan O'Brien show. They're extremely good. They reproduce Beatles music perfectly on stage, even songs that the Beatles never performed because they stopped touring after 1966.

20:30In any case, having seen them, I think, six times in the last two years, they don't tour very much because of their jobs that they have in New York. They all have regular jobs. In any case, that's really whetted my appetite for a Beatles reunion concert. I would love to see the Beatles in concert. However, I don't have any technology for resurrecting John and George. They both died and there's no way to... so I don't act in that situation. Well, you get the idea. So let's move from action now to scarcity. What action implies, in fact, is that all human wants are not satisfied. which in turn means that there are not enough means to satisfy all human wants.

21:16Most of the things that we desire, that we feel will improve our conditions, are scarce. So hamburgers, compact discs, concert tickets, houses, candy bars, automobiles and so on, all are scarce. By scarcity, we simply mean that there is not enough of the thing to satisfy all human wants for that thing. A good sign of scarcity is that the thing has a price. There is no price for air in a normal situation. Therefore, air is not scarce and it is not a good. That is, it's not something that we strive after.

22:01It's not a means that we want to obtain in order to achieve our ends. Despite how beneficial it is to human beings, that is, we can't live more than five minutes or whatever without it, it is not a good. Goods imply desirability and limitation. Air is certainly desirable, but it's not limited in a normal situation. People certainly are willing to pay for tanks of air when they go scuba diving. In that situation, air is a good that is scarce. Also, for people who have respiratory problems, it becomes a good. So tanks of air do have a price. Something that's very, very, very rare, the tuberculosis bacterium, is not a good because it's not desirable.

22:49So, we might call tuberculosis an ill or a bad, and on the other hand we would call air, sometimes called a free good, but that's sort of an oxymoron, given how I define goods as scarce means, and Mises called it a general condition of human welfare, that is, we don't have to consciously strive to obtain enough air to satisfy our wants, there's enough around in a normal situation. So it's not really a good. I mean you could call it sort of, you know, in a non-technical way you can call it a free good because it is good for us, but I think technically from an economic point of view it's just a general condition of human welfare. So how do we define goods? Goods are concrete means, real elements of our real world environment that directly or indirectly satisfy our wants or serve our achievement of human, of our ends.

23:50And we can classify goods into two broad categories. One is consumer goods. Consumer goods are things that very simply directly serve our ends, hamburgers, economic lectures, iPods, and so on. The other category of goods is producers goods. They indirectly serve means. No one gets any satisfaction out of a ton of steel or out of a barrel of oil or out of a can of paint or out of gasoline that is at the pump. All of these things require further development before they can be transformed into consumer goods, which then directly satisfy our wants.

24:38However, all of these things are valuable because they indirectly serve our wants. That is, when you combine them with other producer goods, they can be transformed into final consumer goods. So what are some of the subcategories of producer goods? First, we have the original factors of production, which are nature-given means, that is, labor, we use the term labor, that came into economics in the 19th century, and actually before then, but to mean simply human energy, any energy expended in the process of production, it could be the energy of someone digging a ditch, or it could be the energy of a brain surgeon, mental energy that's expended by a brain surgeon.

25:25So, all of that is classified as labor. Land, again, came into use in agricultural society centuries ago when economics was developing, but land now refers to all natural resources, forests, fisheries, wild game, mineral deposits, anything that has not yet been transformed by human energy, that is nature-given. All natural resources are considered as land. Then we have the intermediate factors of production, all capital goods. Okay, in fact that's another term for intermediate factors of production, capital goods. That includes machines, tools, means of transportation of various types, raw materials, half-finished products, even farmland that has been fertilized and made ready for cultivation.

26:18Okay, that's a capital good because it's not nature-given. Finally we have The recipes, the recipes for combining producers' goods and getting the consumer goods, those recipes are called technology. And basically, technology is simply ideas about combining and transforming means to satisfy our ends. Now, something that's very interesting about technology, technology, once it has been discovered, once it has been discovered how to bake an apple pie or how to start a fire, Once the first, once a primitive individual discovered how to rub two sticks together and start a fire, that technology no longer became scarce, was no longer scarce, okay? It could be used simultaneously to serve all the human wants for the recipe for fire, the same thing for apple pies and so on.

27:10So technology once discovered is a free good, if you want to call it that, or a general condition of human welfare. But before it's discovered, it requires a tremendous amount of resources, research and development, so new technology is a good in the technical economic sense. Now, one other point I want to make. To undertake any action, time is required. All action begins in the present and is always aimed at improving conditions at some point in the future. If you're making yourself a glass of lemonade, that point in the future could be three minutes from now. If you're planning to bring a new car model to market, if you're an American firm that used to take five to seven years, a Japanese firm did it in three or four years, but yet again, time is required.

28:05So time is scarce. Time itself is a scarce means, both as consumers and producers. Well, as a result, people have a desire to achieve their ends as soon as possible because time is scarce. They'd rather, they prefer to have a goal, all other things equal, achieved sooner than later. We call this in economics time preference. Just some examples of this. In a world where there's no time preference, where people didn't prefer a satisfaction in the present to the same satisfaction at some point in the future, you would have certain things occurring which would be absurd. For example, if you have a frozen dinner tonight that can be stored for years, let's say, and you went home and you were hungry, You wouldn't eat that frozen dinner. You would postpone the satisfaction to some point in the future because satisfaction in the future is valued more.

29:11That is, if there's no time preference, you would never consume any durable good. You keep saving it for the future. But then when tomorrow came, you would never use it to assuage your hunger because, well, it has an even higher value later or in the remote future. The example I give my undergraduates is something that they understand. Let's say a guy wants to ask a girl for a date. So he approaches her and he says, What are you doing next week? I'd like to take you out. And she says, Well, I'm busy next week. And he says, What about two weeks from now? We can go out to dinner. and she gives him the same response, so I'm pretty sure I'm going to be visiting my mother that week, I won't be around and you know, so she puts him off and he says, well when can I see you? And she says, well call me in five years now in a world where there's time preference

30:05where sooner is better, we would take that as a brush off and rightly so, but in a world where there's no time preference, a guy would take out his book, write it down, say yeah I prefer it in five years to now okay, all other things equal Okay, well you get the idea. We're going to talk more about time preference when we talk about capital and structure production. One other point to be made, and that is, any time you do anything, you are approaching your goal. You're pulling your goal closer in time. Even if it's a goal to become a surgeon and you're just starting out in pre-med, As you go through and take the steps necessary to become a qualified surgeon, certified surgeon, a licensed surgeon, you are pulling the goals closer in time.

30:52So that's why, for example, von Mises says that all action implies time preference. Absolutely. because not acting means that you're allowing the goal to recede into a further future at which point it would be more valuable but because no one acts that way because everyone uses means now it means that they're pulling some goal closer to them and that expresses time preference okay let's talk about production very few goods, very few things that we call consumer goods are given by nature So people must produce, that is use producer goods, use elements of their environment to get consumer goods which then satisfy their goals or satisfy their wants.

31:47People can attain very few goals without production. Now, production used to be defined, and by the way, a managerial textbook I use in my MBA class, also defined this way, that is, as the creation of goods and services, but of course, human beings can't create anything, we can't create something from nothing, create implies bring something about or producing something ex nihilo, that is, from nothing, and this is pointed out in 1802 by a great economist, Jean-Baptiste Jean-Baptiste Say, he said, human beings cannot create, only God can create. All that human beings can do is to transform resources into goods that are more satisfactory to them, okay?

32:34So, what is production? Production is a combination and transformation of factors of production. Factors of production will be the term that we use to denote all producers' goods, okay? Synonymous terms that we'll use are inputs, resource or resources, so all production takes time and proceeds in stages.

33:19Okay, it begins with the original factors of production, which we call land and labor. There's a combination of land and labor. Human beings work on the elements of their environment. They produce intermediate goods or capital goods. And then eventually, after a longer or shorter period of time, those are transformed into consumer goods. Now, what people are interested in is not the consumer good itself, But the services provided by consumer goods in satisfying their wants or in achieving their goals. So consumer goods are also known by the way as final goods. So this is the way production proceeds. Production proceeds from original resources, from land and labor, to the actual consumption of the services of the consumer goods that yield the satisfaction.

34:08Now, as we'll see later on, value proceeds in the opposite direction. A diamond mine, which is a nature given factor, which is land, only has value because diamonds themselves yield services that satisfy human wants. It's those services that are directly valued. Because those services are embodied in the actual physical consumer goods, the consumer goods, the values imputed back to the consumer goods. And because those consumer goods are created by capital goods, the value then that consumer goods have is imputed backwards to capital goods and then backwards to the diamond mine.

34:56if suddenly people no longer desire diamonds, if they thought they were ostentatious, sort of against their religion and so on a good example of this is in southeast pennsylvania, the Amish avoid all sorts of ostentatious apparel they don't even have buttons they use sort of hooks and so on in any case if everyone adopted that code of values then the price of diamond mine would fall to zero The wages earned by highly skilled jewelers would drop to zero. So it is not the cost that determine the price, but really the other way around. It's the high price people are willing to give for diamonds that determine the value of the diamond mines ultimately.

35:48Let's talk about choice and value now. We're actually, before we do that, I just want to say a few words about an imaginary construct that we use in economics. It's called Crusoeconomics. And basically, everyone knows the story of Robinson Crusoe, a fictional character that's shipwrecked on an island. He really only has, well, I took it down, he really only has original factors, his labor and the land elements that exist on the island. So, for example, if Robinson Crusoe was hungry and wanted to satisfy his hunger, He would have to go, he has the choice of doing that with his hands, simply going to a stream where there are fish and trying to grab the fish with his hands, or first constructing a fishing pole or net that is transforming certain resources into capital goods and then using those capital goods and combining them with the land elements and transforming the product into the actual fish that he then has to cook and consume.

36:50so we're going to be going back and forth between sort of our daily lives and crucial economics in the early part of the course okay now we talked about scarcity okay goods are scarce and resources are scarce they're not enough consumer goods and land resources to satisfy all human wants for them so that scarcity implies choice that is because people cannot do not have enough means Choice means to achieve all of their goals, they must rank their goals. Choice implies a value scale, a ranking of goals according to how important they are to the individual actor. Another way of putting it, a value scale shows subjective valuations of the satisfaction that the actor expects to derive from the achievement of these various ends.

37:48So we call, then, this ranking of ends a value scale. Now, people do not walk around with value scales in their head. Someone does not say, or they may say this, but it's not a value scale, someone might say, I like that Porsche better than I like that Cadillac CTS out there. That's not a value scale, that's just a statement. The person is not demonstrating that he prefers a Porsche to a Cadillac, all he's demonstrating is that he prefers to talk about this to anything else he could be doing at that moment in time. Okay, we'll come back to that point. Let me put a diagram up then to show you examples of value scales.

38:31Let's first look at CRUSO. Can everyone see that? Should it be zoomed in? Is that clear enough? Is there a way to make it clear? Let's say Crusoe can work 12 hours a day, and the other 12 hours he needs to rejuvenate himself. So the maximum he can work is 12 hours a day. And he has a number of ends for his labor. And let's assume that each one of these ends consumes four hours of labor. So he has 12 hours of labor to disperse in increments of four hours among the various ends.

39:18So the ends keep going. I mean, they don't stop at five. The ends are almost unlimited. He has a lot of one. Scarcity is very great on this island. He ranks four fish first, eight coconuts second, third, five pounds of wild mushrooms, all of these things he can attain in four hours of work. So, how will Crusoe choose to allocate his labor? Well, he'll allocate it among the first three ends, because they are the most important to him, subjectively. were he to choose to build a hammock for the four hours, he would give up a higher ranked end, let's say the third end. He would never consciously, he would never deliberately choose a lower ranked end over a higher ranked end.

40:04So value scales only come into being when people are confronted with a choice of allocating their scarce resources. forces. That's when value scales become relevant. Let's assume that someone has just graduated college and receives a college graduation gift from a rich aunt. That person could spend three months in Europe on European vacation with friends, that would take $10,000, or they could buy a new car, well a new pre-owned car for $10,000, or they could save that money Money for graduate school, or they could just, for the next year, just party, okay? People have done that. They just go through that money by spending on wine and entertainment and great restaurant meals and so on.

40:56Or they could make a loan to their brother who's starting his own small business. So on and so forth. Note that value scales do not imply selfishness, as we'll talk about, or involve only self-regarding activities. But in any case, in this case, if each of these alternatives absorbed the full $10,000, then this person would choose what's highest on his value scale for European vacation. That's not to say that he might not regret it later on. We'll talk about that. When economists use the term maximizing utility, what they mean is choosing, and we'll get to utility in a little while, choosing that end which has the highest value to themselves. that's maximizing utility. The final example is relevant to you and then we'll go back and talk about some of the properties of value scale for the moment.

41:49You chose the Mises Fellowship, you chose to spend two months here, time is scarce, so you must, whenever it comes to allocating your time, you also must formulate a value scale. You could have had a summer job and earned income. You could have spent the summer, let's say, at your family's lake house. Again, partying with friends is ubiquitous. That's always a good thing to do. And there were many other things you could have done with the two months. You could have taken a local college course. In any case, you chose to come here. Again, that's something you may regret later on. Especially after you give your oral presentations and we critique them, but don't worry about that. In any case, any good including time is scarce and must be allocated.

42:35Now, what about the properties value scales? First of all, they're strictly ordinal, they're strictly ranked. You cannot say that a European vacation gives me three times the satisfaction as a new car, and a new car gives me six times the satisfaction of loaning money to my brother. Value is an intensive magnitude. It's not an extensive magnitude. You may have learned, if you've taken economics courses, that there are things that economists call utils. And we can assign utils to this. Well, you know, European vacation gives me a hundred utils of satisfaction and a new car gives me thirty-three utils of satisfaction, so it's three times as great, and so on. But of course, The question becomes, what the hell is a utile?

43:29We know what a foot is, we know what a pound is. These are units that have extension in space. They're fixed and they're objective. Satisfaction is an intensive magnitude. There are no units developed to measure satisfaction. Satisfaction cannot be measured. Not only can it be measured interpersonally, but it can't be measured intrapersonally, it can only rank. It makes no sense for you to say that I like this three times as much as I like that. Nor do you have to to act. In fact, when this debate was going on about utility being ordinal rather than cardinal, was in the 1930s and the Austrian influenced economists at least earlier in his career Lionel Robbins later became Lord Robbins and became Lord Robbins after he worked with Keynes to develop the Bretton Woods system so he became sort of an evil baron or a baron as a result of his evil activities in any case he pointed out correctly that value is like love you can say let's say you're dating three different women

44:51And you like them all. You can say, I like woman number one better than woman number two, or I love her more than number two, and I love number two more than number three. And you can demonstrate that preference by marrying woman number one. But it's absurd, and we'd laugh if someone said, I love her three times as much as I love the second woman. makes no sense well, values like love in that sense it's absurd to say that you value something by a certain number of times more than something else that gives you a higher measurable level of satisfaction than something else does and as I mentioned before, maximizing utility means choosing what's highest on your value value scale, at least as Austrians use the term maximizing utility, means getting the highest value with your resources.

45:49Another point I wanted to make is that, and I mentioned this before, all ends are ranked and compared on a value scale, whether they are material, cultural, spiritual. Remember, in the Bible, Judas Iscariot compared his loyalty to Jesus and 30 pieces of silver, and he ranked 30 pieces of silver above his loyalty to Jesus. So he compared spiritual virtue and loyalty in a specific case with money. That's not to say that he was comparing loyalty to money for all time or for his whole life. In that specific moment, he preferred the 30 pieces of silver to the maintaining loyalty to his spiritual leader. Or take, for example, a woman who decides to go take a part-time job on Tuesday and Thursday evenings.

46:43She could be home with her children, or she could volunteer at a church, or she could take this job and increase her kid's college fund. So those are, you know, we're comparing receiving income with charitable work, with love for your children. All of these things are compared on a unitary value scale. So there is no assumption in economics that people are selfish. Mother Teresa, no less than anyone else, just to take one example, maximized her utility or believed that that's what she was doing. and I'll talk about that when she helped the poor in India. Also, think about this, if Mother Teresa was given a donation by a philanthropist in the United States, let's say she was given a tract of a hundred houses that had just been built and the maximum price you get for those houses are $200,000 a piece, let's say.

47:50Well, she has a choice of selling those houses at below that price, let's say for $100,000, to poor people in the United States. Let's also assume as the World Health Organization, the last figures I saw, that a person can be fed and nourished for a dollar a day. Well, for every dollar price cut that she gives to the poor American, that's one day that one person in India goes hungry. So, Mother Teresa would sell them at the highest price possible if her highest rank goal was to feed as many people as she can with her resources.

48:39Okay, the other point, a couple of other points, value skills are only relevant to and revealed by action not by talk. Someone can say, I love my wife and my family and they can very carefully plan to allocate their salary to their children's clothing, to their children's college fund, to food for the household. But then they can be walking down the street after they got paid and they can see their friends in a bar and they can go in and stay in there all night and drink up their salary. Well, the point is that action doesn't imply that people are calculating or deliberate or responsible or moral.

49:26Simply that in their judgment, that particular end, at that moment, in those concrete conditions, will give them the highest satisfaction. So, that person, at least in that particular case, did not engage in an act of, or rank drinking with his friends above these acts of love that he could have used these resources for, okay. So, another way of putting that is people are not prisoners of their value scales. They're not value scales out there that control your actions. Value scales emerge in a given situation at a given moment, and in fact, action reveals your values.

50:11Some economists, even good ones, sometimes say that all people have departed from their value scales, they've worked against their value scales. For example, Philip Wicksteed and Robin, both who were very Austrian influence, talk that way. That is, your actions were inconsistent with their value skills, but Mises came along and pointed out, well, in fact, that's assuming that people's value skills are constant. They're continually changing from moment to moment. So when economists say that people choose rationally, at least when Austrian economists say that, they do not mean that their choices are selfish, or hedonistic, or ethical, or responsible, or calculating, or legal, or moral, or non-impulsive, or non-self-destructive. They simply mean that such choices are purposeful. That is that they aim at ends that are ranked most highly on their value scales.

51:02So someone injecting heroin knowingly is acting just as rationally or purposefully as someone donating money to a charity. Someone robbing a bank is also acting purposefully and so on. A murderer acts purposefully. People often say, well, when you murder, you know, it's irrational and so on. Well, the murderer didn't try to use a banana to kill the person, they used a gun. And they didn't do it in broad daylight, they did it at night. So, the action was rational. We just didn't like the end. Well, we couldn't conceive of ourselves as ranking the end of killing someone that highly. Finally, right? But that doesn't mean the action wasn't purposeful or rational from the point of view of the actor's scale of values, okay?

51:56Now let me just talk a little bit about benefit and cost and profit and loss, okay? Now, all actions take time and are aimed at improving our conditions in the future. Human beings do not have perfect knowledge of the future. We must forecast, based on our expectations of how things will develop, and based on our experience, what conditions we will face in the future. And that leaves us open to error. So, all action involves uncertainty of the future, involves us formulating expectations, and also involves the very real possibility of making a mistake. okay so what is a psychic benefit psychic benefit is what we expect the satisfaction we expect from the action okay psychic cost is the greatest satisfaction we must forgo in order to achieve the end that we're aiming at so So in the case, if I put this up here again, of these value scales, let's use the $10,000 example, the psychic benefit is the expected satisfaction from the European vacation, okay?

53:18The cost of the vacation is not the $10,000, that's the price. The cost is the expected satisfaction from the new car that we are forced to sacrifice or renounce because we've used the resources for a higher valued use. So cost is always the next most valuable alternative on a person's value scale. Or to put it another way, it's the most valuable alternative that we must sacrifice in our action. If the person was happy after the fact, with their vacation, then we say benefit is greater than cost, and there's been a psychic profit. So when benefit is greater than cost, there's a profit.

54:11You can't measure it, but you've gotten something with your resources that was more valuable than what you gave up. Now, let me introduce the terms ex ante and ex post, Latin terms. Ex ante means before the action, viewing the action in advance, before undertaking it. Ex ante, everyone always believes that their action will yield them a psychic profit. Otherwise, they wouldn't voluntarily undertake that action. So benefit always is greater than cost, there's always a psychic profit ex ante, but ex post, after the action has taken place and the person is looking back, based on conditions that they have developed, two things may occur, the person may be correct and be happy with their actions and gain a profit or they may suffer a loss because the benefit was less than the cost.

55:13Let's say this person goes on the European vacation and didn't anticipate that the weather wouldn't be good, that he would not like the food, that he confronts a lot of anti-Americanism in Europe. In that case, the European vacation may stand very low on his value scale, maybe a hundred. So he's given up a new car for something that he ranks much lower. That is a psychic loss. That is a waste of resources, a misallocation of resources. Now, he didn't do it deliberately. He wasn't irrational, as some economists would like you to believe. It was simply that he made an entrepreneurial error because his expectations were incorrect.

55:58We all know people who continually make bad decisions, right? We all make bad decisions at one time or another, but some people consistently make bad decisions. They are bad entrepreneurs in their daily lives. So if you choose a certain college and you wind up disliking it, that's a psychic loss. You regret that decision. Or if you choose a certain major in college and when you get out you find that the market for that major has dried up and that your income is going to be much less if you can even find a job than you had anticipated If you've paid it, then that's a massive psychic loss, okay? You've sunk all of these resources, including your time and your tuition money and so on, into something that has a much lower value than you could have obtained.

56:52So, psychic loss is reflected in people's regrets about their decisions. Some people just run their lives better than other people. They're better entrepreneurs. Now, those people that tend to be more right than wrong, tend to make good entrepreneurs in the business world. We're going to bring over this whole analysis of S. Ante and X. Post, profit and loss, benefit and cost, into business, ultimately.

57:25Okay, now let's get to the concept of value and marginal utility. Now you may or may not have heard, you probably have heard, of the paradox of value. It's often also called the water-diamond paradox or the bread-diamond paradox. And it bedeviled British classical economics, which existed from the mid-1700s until 1870, when we had the Marginalist Revolution in which the Austrian School began or was founded. This paradox was resolved in 1870 by Carl Menger, but it had been actually resolved by some French and Italian theorists earlier.

58:12Basically, the paradox goes as follows. Take something like diamonds. It has a very, very high exchange value or price on the market, but a very low use value, Meaning that it doesn't add much to human life. It appeals to people's vanity or ostentation and so on. It's a mere frivolity. On the other hand, bread, pound for pound, has a much lower price than diamonds do. And yet without bread, the human race would be a lot worse off. okay it's a bread is a real staple okay the paradox lies in the fact that bread has a low exchange value but high use value while diamonds have a very high exchange value and low use value okay well the classical economists never really solved that paradox they pushed aside the question of use value they said yes for good to be a good it has to have use value but then they just pushed that aside and they concentrate on explaining exchange value and they And they explain exchange value by saying the higher the cost of producing a good, the greater the price will be.

59:22So diamonds have a higher price than bread because it costs more to produce diamonds than it does to produce bread. A philosopher and economist, Condeac, French, in the same year that Adam Smith wrote his treatise in 1776 and couldn't solve the paradox, Condeac wrote a book, the title escapes you right now, it's been translated into English though, in which he said, Men do not, let me rephrase, pearls are not expensive because men must dive deep beneath the sea to get them. Rather, men dive deep beneath the sea to get pearls because they are so valuable.

1:00:09So in other words, it's not the cost that causes something to become valuable, but it's the high value that causes people to undertake the high cost of obtaining that thing. Now, how did Menger solve the paradox of value? Well, he asked this question, a very important question. What determines the value of a unit of good, of a good? So what he did was he focused on concrete units of the good. He didn't, like the classicals, focus on abstract classes of the good. He didn't say, didn't focus on diamonds in general and bread in general. or water in general. He focused on an individual who was choosing between uses of concrete units of the good.

1:00:58So let me show you then, going back to Crusoe Economics for a moment, Crusoe's value scale for sacks of wheat, okay, so this is very similar to Menger's example, and what Menger did was to rank the various uses of sacks of wheat. Again, Crusoe's alone on the island, he's just harvested, let's say, five sacks of wheat, he has unlimited wants for wheat, how will he allocate the wheat? Well, to the first five most important ends. The first sack of wheat he'll bake into bread to sustain his life, okay, it'll just keep him alive for one year. Second sack he'll use to sustain his health, to keep him healthy so he can achieve other ends.

1:01:45The third sack he'll put aside for seed for the next harvest or he'll plant a seed so he'll be able to stay alive a year after that. The fourth sack he'll use for feed for farm animals, okay, chickens and cows and so on. So we can have eggs, milk and meat, as well as bread. The fourth sack, I think Menger used the example of turning it into brandy, but I like vodka better, so he'll make vodka out of it. Okay, so he then uses, is about to use these sacks of wheat to achieve those five ends. Now, let's assume, this is how Menger solved the problem. He said to himself, or he said to his readers, excuse me, he said, what is the value of a sack of wheat?

1:02:37Is it the highest valued use? Is it some average of all the uses? What is the value? And how do we arrive at the answer to that question? Well, he went on to say, let's take the following example. Let's say we lost one of these sacks of wheat. That is, that Crusoe found that during the night, before he was going to use these sacks of wheat, a family of foxes broke in and devoured, let's say, the second sack, sack number two. Would Crusoe go without bread that would sustain his health? Of course not. All he would do is reallocate that sack, which was just sufficient to serve the lowest end on his values, the fifth end, reallocate that to the second end.

1:03:30So no matter which of the five sacks he lost, what end would he forego? So, always the lowest ranked end that the limited supply was capable of serving. He called this, he didn't call it, actually Wieser came up with the term marginal utility. He called the satisfaction from the lowest ranked end that the supply of wheat was able to serve, he called that end the marginal utility, or at least later Austrians called Let's call that marginal utility. Utility meaning satisfaction, marginal being the relevant end, the end that's given up when one unit of the supply is lost.

1:04:18So, the utility of the marginal unit is the fifth end. So what he went on to say was that each of those five sacs is valued according to its marginal utility. Which one is lost, what satisfaction is given up? The marginal satisfaction or the marginal utility. Now once that sack is lost however, what happens to the value of the remaining sacks? They increase because now the fourth end, the fourth most highly ranked end depends on one of those sacks. So if that sack is lost, you lose a higher ranked end. So, thus the law of modern utility, the greater the number of units of a supply of a good, the lower the value of that good.

1:05:05So if he found the sixth sack someplace, or he found that he could harvest the sixth sack that he had neglected, then the value of a sack of wheat would fall, because now he could serve a lower end, the sixth end, that is he could keep some parrots to keep him company and talk to him. So, how does this apply to solving a paradox of value? Well, in a normal situation, bread is much more abundant in relation to human ends than diamonds are. So, even though you might need bread to sustain life and so on, there's so much bread around that the marginal utility of bread is much lower than the marginal utility of diamonds.

1:05:53Let's change for a moment to water and diamonds. Now put yourself in a position of being in the desert, and you have not had a drop to drink in, let's say, three days, or however long a human being can last without water, three to five days, whatever it is, and someone comes along to you and offers you a pint of water for, and let's say you happen to have in your pocket, and I love to use this example, the eight million dollar diamond that Kobe Bryant, the basketball player, gave to his wife, the purple diamond, to atone for his infidelity. Would you trade the eight million dollar diamond for the pint of water? Well, if you ranked your life, at least until you can get the next amount of water, if you ranked your life above the satisfaction from the diamond, yes you would.

1:06:41Because now the marginal utility of water is so high that the value of a pint of water is higher than the value of a diamond. Thus, there is no inconsistency in the use value in a normal situation of a diamond being low relative to bread or water, yet its exchange value being very high. So Menger, in a stroke of genius, solved this problem. Let's focus on the second example here. Let's see if you understand the principle. Let's say that there's a farmer who has two different supplies. By the way, we define supply as a number of homogeneous units or a number of units that are interchangeable in serving human ends.

1:07:33So every one of those sacs, those five sacs that Crusoe possessed, any one of them could have served any one of the five ends. They were completely interchangeable or homogeneous from the point of view of his ends. So they all must have the same value. Now in this case we have horses and cattle. These goods are not homogeneous, they're two different supplies. So let's say that the farmer now ranks the uses of these two different goods, horses and cattle, in the following way. The first two horses he would use for plowing, the first cow he would use for milk, the second cow, which is his fourth end to produce beef, and the third horse, which is his fifth end, would be pleasure riding.

1:08:21The point to be made is that, or the question to be asked of course, is which horse, which animal is more valuable? Well, the way to answer that is, which animal has the higher marginal utility? You don't look up here and say, well, horses are more valuable because they serve more valuable ends. You look at the bottom, and you ask a question like, if the barn was on fire, and I could only save four animals, which animal would I leave in there? You'd leave a horse, because the marginal utility of horses are lower, the fifth end, than the marginal utility of cattle. So, in this situation, cows are the more valuable animal. Once you've lost that horse, however, what happens to the marginal utilities? They're reversed.

1:09:07Which is the more important animal now, or the more valuable animal now? Assuming the fifth one is gone. The horse. Because if you lose the horse, you lose your second end. It makes your plowing easier. Whereas if you lose a cow, you lose your fourth end. You lose your supply of beef, which is lower ranked. In a more modern context, the example I like to give my students, the undergrads, because they always sort of bristle at this example, let's say a family has three automobiles and they're all pretty interchangeable for all the ends that the household has. One is for the primary breadwinner to get to and from work, second car is used, let's say, by the spouse for second income, and also to do household errands, and the third is used by junior, to go out on dates and drive around and whatever.

1:10:01So let's say the old man cracks up his car, first then, primary breadwinner in this case. What happens? Do you go without the primary income? No, junior loses the car. Because the marginal utility of keeping junior from borrowing your car all the time is much lower than the end of having a steady primary income. So the point being now each of the remaining two cars has greater value because a higher valued end depends on that. and that is the second income and having household errands done.

1:10:46What about total utility? Modern economists talk a lot about, or non-Austrian economists talk a lot about, total utility. Well, here to tell you that there's no such thing as total utility. That is, you can't add up the utilities of all of these goods, or let's put it this way, you can't multiply the marginal utility by five, if you have five sacks, you can't multiply it by five and say total utility is equal to, because there's no unit now, there is a use of the term total utility if you mean that total utility is the utility of the entire stock of a good if you're ever in a situation where it's relevant to talk about trading the entire stock of a good for a another good Total utility simply means what? Taking all of the stock you have as a marginal unit and comparing it to what you're going to get in exchange.

1:11:48And let me give you a little diagram of that. Actually, two diagrams here.

1:12:00First of all, on marginal utility, this diagram is a pure ranking. Let's say you have four units of a supply, okay? Obviously, and this displays the law of marginal utility, the greater the number of units of supply, the lower the marginal utility and value of the good, okay? So, I put no units on the y-axis or the vertical axis. It's simply a pure ranking. The first unit serves a more important want, so it's simply higher. The second unit, a less important want, it's lower. And the third is even lower and the fourth is even lower than that. There's no significance to be attached and you shouldn't try to measure these lines.

1:12:48So as the use of supply increases, you'll see these x is getting lower and lower to indicate that the ends that they're serving have less and less utility. and therefore lower value. Okay, let me just now show you something that has to do with, oh, I forgot to, well, okay. Let me just fix something here. There's a little mistake in this. This should be four sacks. Okay. Let's go back to Ramsey Kruse for a moment. Let's say Friday's on the island and offers him a horse for his entire supply of wheat. What about the entire supply of wheat? Let's say it has five sacks.

1:13:33Well, given the way I've drawn this, we'll talk about exchange in the next lecture, given the way this is drawn, it shows us that the horse stands higher on Crusoe's value scale than the entire five sacks of wheat. So the horse adds more to his welfare than the five sacks of wheat. Will he exchange the entire supply? Yes. In that case then, you can talk about total utility, or the marginal utility of the entire, of the entire supply. Now, what is the law of total utility? The law of total utility is simply that, and that's why I put these other entries here. The larger the supply, a larger supply of a good is more valuable than a smaller supply of the good. Why is that? Because a larger supply of the good, six sacks are more valuable than five sacks, which are, in turn, more valuable than four sacks.

1:14:23A larger supply of the good allows you to serve more human ends. And the more human ends that you satisfy, or the more wants that you satisfy, the better off you are. Because goods are scarce. So the law of total utility simply tells us that the greater the supply, the higher the utility of the supply is. It's not adding up utilities. It's not trying to add up the utilities of six versus utilities of five. It's simply saying that, look, when we have six sacks, there's another end that I can fill or serve. That is, in this case, feeding a parry. Okay, that was the sixth end, which I cannot with my fifth sack. And if I only have four sacks, there's one less end that I can use my means for, and therefore, I am less well-off.

1:15:12Okay, these are the fundamentals of scarcity, choice and value. and when we get we're going to use these fundamentals as a basis for the law of demand will first explain the exchange in the next lecture and then deriving from that a law of demand showing how prices are determined by demand and supply as we'll see prices are objective but their roots are in the subjective values of individuals as Mises once put it prices reflect the war of scarcity that's continually raging in the human soul so everything is ranked anything that's scarce is ranked and those rankings interact through exchange to produce objective prices which entrepreneurs can then use to allocate production to best-serve consumers but it all comes back to the utility rankings and people's choices ultimately consumers control the direction of the economy through their choices I'll stop here and I'll take some questions we have about fourteen minutes I'll usually try to go an hour and fifteen minutes and then leave around fifteen minutes for questions. Yes?

1:16:35An entrepreneur in the business sense, in the sense that we know an entrepreneur An entrepreneur is the individual who makes the decisions regarding what to produce, how to produce, where to produce. In other words, makes the decisions of how to allocate the factors of production. We distinguish that type of entrepreneur, which we sometimes call a promoter entrepreneur, he's one who promotes new businesses and so on, from a pure entrepreneur. A pure entrepreneur is all of us in the following sense, And whatever decision we make, we're faced with uncertainty. And we're always trying to allocate our resources in the face of that uncertainty in a way that will leave us best off.

1:17:25We're always trying to maximize our utility in the face of uncertainty. So it doesn't have to be someone who has a lot of capital and invests that capital in a business. It can be someone who is deciding whether I should be an accountant or nurse, a woman who wants to go into accounting, wants to go into nursing. That woman has to then forecast what the market for nurses and accountants are going to be four years from now and make her choice on that basis. So all laborers when they act are entrepreneurs. Anyone who lends money to anyone else is an entrepreneur because we never know what that other person's conditions will be when time comes to pay back that loan. So, and also, landowners, entrepreneurs, because when they rent out, maybe lease out a piece of land for five years, they are speculating that they're not going to get a higher price for that land a few months down the road, okay?

1:18:21Okay, so, there are, every function in production, okay, embodies entrepreneurship. However, the entrepreneur that drives the economy and that is continually reshuffling resources to better serve consumers is a promoter entrepreneur. That's someone with typically a lot of capital and access to much more capital who has to continually anticipate the future and make decisions based on those anticipations. yes okay it's a good question yes it is true capital is frozen labor it's past labor and land and time so capital good is really frozen labor land and time but But let's forget about the land for a moment and just talk about labor and time.

1:19:26Now, I don't think you can replace it with labor. The reason is, at this moment in time, at any moment in time, you have a structure of capital goods. If you look around, we have factories and machines and so on that are durable, that will last, and that have to be continually allocated. And so there is a difference between that factor and labor. One of the differences is that capital goods have a natural life cycle. They can be replaced. That is, you have to continually renew the structure of production. You have to make decisions about whether I should reproduce this capital good or use the proceeds to invest in another capital good. With labor, labor is an original factor of production. Your energy is always there and ready to be used. So there is a difference in the concrete means and they can be kept distinct.

1:20:13Okay, other questions? Comments? Criticisms? Okay, I'll stop here. Thank you.