(7.2) Value

(A) What is value?

In ancient Roman, before the time of Roman emperors and even the Roman Republic, the kings required each citizen to list his full name and his family members with the court, and to also assign a monetary value of all his property. This value was used to measure each man's wealth, and thus what he "owed" to the Roman king. For instance, the wealthier a Roman the more likely they were to be conscripted into military service for important battles. Knowing that the wealthy would seek to understate the value of their property to avoid military service, it was made clear that any man caught lying about this value would forfeit all said property and would be sold into slavery. That is ample incentive to be honest, but how exactly would one measure the value of their property? How could you tell if he was lying?

Modern day Americans are taxed according to the value of our house and land, but the government calculates this value for us, and they do so by estimating how much our house and land would sell for if placed on the market. It would seem plausible that the Romans did likewise. They observed the going price of land and multiply that price by the amount of land they own.

But to what extent does price signify value? Consider water and diamonds. Water is virtually free and diamonds are among the most expensive things in earth, yet diamonds provide almost no direct benefit to our life while water is absolutely essential for survival. The price of water and diamonds, does not reflect their importance to us. This is referred to as the diamond-water paradox, and played an important role in the first major book on economics: The Wealth of Nations, by Adam Smith, written in 1776..

(B) Total value and marginal value

The solution to the diamond-water paradox is found by separating total value from marginal value. Marginal value refers to the value of one more unit, and the reason water is so cheap is due to its ample supply. Certainly, if water was very scarce it would be priced higher than diamonds, but it is not, and while we would pay a large price for one gallon of water each day, we will pay only a small price for the 35 gallon of water used each day. Conversely, if diamonds were as plentiful as sand it would sell for a very low price. The total value of water is much larger than the total value of diamonds, but it's marginal value is much smaller.

Markets tend to sell at a price roughly equal to its marginal value, and because this marginal value is higher for water due to its enormous supply, its marginal price is low (compared to diamonds).

(C) Economists' definition of value

Economists must have a scientific definition of value, and for it to be scientific they must be able to observe it. For this reason they have defined value to be the maximum amount of money people will pay for something, where they must have the money and really be willing to pay it—not just say they would. This has the odd result that a starving, penniless person places a value of exactly zero for food, simply because they do not have any money.

The video below is funny because we know the true value of a dollar: exactly one dollar. Moreover, everyone agrees that the value of a dollar is a dollar. For most goods people differ in their desire for it, and if we want to measure this desire for each person and call it "value" we simply identify the maximum number of dollars the person will pay for the good.

Video 1—The Value of a Dollar (From The Onion)

When the government is considering an action that saves lives, like widening a median between lanes of a highway, they try to do so only when the value of the action is greater than the costs. It is relatively simple to estimate the cost of widening a median; any contractor can give you estimates. But what about the value? Economists measure this value by estimating the number of lives a wider median will save and multiplying it by the value of a statistical life, which is between three and seven million dollars for Americans.

How do they measure the value of a "statistical life?" It's relatively easy. They look at jobs were workers are willing to accept a greater chance of death in return for a higher salary and compare it to safer jobs requiring similar skills and qualifications.Working in mines, for instance, is safer than working at McDonalds, and both require unskilled labor. Economists then look at the reduction in wages at the safer job compared to the riskier job, and view that as the price people pay to reduce the chance of a job. There is a minimum discount people will accept for safer work, and that is the maximum price they pay to reduce the chance of their death. Add a few more assumptions, and you find people "value" their lives at about three to seven million dollars each year.^(N1)

   Next month, a major bridge over the Schuylkill River just outside Philadelphia will be declared too unsafe for trains to use. Its wood ties are rotten and officials fear the rails, expanding in the summer sun, will pull the trestle apart.
   ...
   The Southeastern Pennsylvania Transportation Authority, or Septa, says the bridge hasn't been fixed because Septa is being required to spend money on a different safety program. The other program is designed to prevent trains from crashing into each other.
   ...
   Central to the debate is the delicate matter of putting a dollar value on saving a life. It is an age-old regulatory predicament—namely, whether or not spending to make one thing safe steers money away from addressing a more serious threat elsewhere.
   ...
   In the case of the upgraded train signals, the Federal Railroad Administration, which regulates passenger and freight trains, in 2009 put the installation cost at 15 times the economic benefits from prevented accidents. The FRA came to this number by applying a standard government formula.
—Mann, Ted. June 17, 2013. “Rail Safety and the Value of a Life.” The Wall Street Journal. A1.

As another example, I was once given a grant by the government to study the value people place on cage-free eggs, relative to cage eggs. To measure they I recruited people from Texas, Illinois, and North Carolina to participate in an auction where they submitted auction bids for cage and cage-free eggs, and from these bids I found that the average American was willing to pay about $0.60 more per dozen for cage-free eggs, but no more. This means that if cage eggs sell for $1.00 and cage-free eggs sell for $1.61, the average will not buy cage-free, but if the cage-free price was $1.59 they would.^(N2)

Video 2—Todd Margaret Values This Endorsement at Exactly $50,000^(C1)

(D) Four types of utility

Instead of using the word "value" economists often use the word "utility". Utility is meant to refer to preferences, where you say you get more "utility" from good A than good B if you choose good A (and if they are priced the same). For this class, you can just think of utility as value, if everyone had the same amount of wealth. Whereas the penniless, homeless person values a meal less than Bill Gates simply because the homeless person has no money to spend, they can both acquire the same satisfaction from the good, and can be said to receive the same utility from the burger.

Economists like to say that the value / utility of any good is can be broken into four components, each having its own unique contribution to the overall value of the good. The four types of utility are

1. Form utility—referring to the actual good itself and how much pleasure it provides
2. Time utility—referring to when we receive the opportunity to purchase it
3. Place utility—referring to the actual place we can purchase it
4. Possession utility—referring to the convenience of purchasing it

(D.1) Form Utility

Anything that changes the quality of the good, the pleasure it provides, its usefulness, and the like changes the form utility of the good. Even a banana individually wrapped has more form utility, if (for some unknown reason) people like it better.

Video 3—The form utility of an individually wrapped banana

I don't want a bushel of wheat delivered to my door. Instead, I want the wheat processed into flour and then combined with water, yeast, salt, and other ingredients, and then baked and packaged. I don't want raw wheat, I want cooked bread, and food manufacturers who sell me bread at the grocery store make raw wheat into a more valuable form.

(D.2) Time Utility

Christmas trees are worth more at Christmas, so that is when Lowes sells them. Turkeys are worth more around Thanksgiving, so stores make sure to have plenty in inventory. One might think that stores would charge more for turkeys at Thanksgiving, since people value them more around that time. The reverse is true. Stores routinely sell turkeys at or below cost shortly before Thanksgiving, because they know it provides good-will between them and the consumers, and consumers will show their appreciation by shopping at the store more.

(D.3) Place Utility

Some goods are more valuable at certain locations than others. Grocery stores in a convenient location can charge more for their products because their location saves consumers time. The value of a crop also depends on where it is sold. The graph below shows wheat prices in Oklahoma, where prices are stated relevant to prices in Kansas City. Notice that prices in Eastern Oklahoma are much higher than those in Western Oklahoma. Why? Because most of the wheat will be sent to Eastern Oklahoma to be loaded onto barges for export. This means someone who buys wheat in Wesern Oklahoma must pay for the wheat to be shipped all the way across the state. This makes wheat in Western Oklahoma less valuable to them. Its place utility is lower, and so sellers in Western Oklahoma must accept a lower price than their eastern counterparts.

Figure 1—Regional Wheat Prices in OK

(D.4) Possession Utility

There is often a transaction cost involved in buying or selling a good, and the easier and safer it is for a buyer to take possession of a good, the more they value it. An example is the use of credit cards. Farmers markets are usually unable to accept credit cards as payment, and this is an inconvenience for many buyers who are accustomed to paying for everything with their card. This means that Farmers markets must be able to provide better form, time, and place possession to make up for this inconvenience.

(E) Declining marginal value

The marginal value of something is the value you place on one more unit, and typically economists say that the marginal value of any unit is less than the value you placed on the last unit. Your first hamburger brings you particular delight, but the second hamburger not so much. As usual, we can rely on The Simpsons to illustrate this, where the following video is humorous because Homer's marginal value for a doughnut does not seem to be decreases the more he consumes, when for most of us, it would.

Video 4—Homer's marginal value of a doughnut doesn't seem to fall the more he eats.

The jodling (pronounced yodling,—emphasis on the o,) continued, and was very pleasant and inspiring to hear. Now the jodler appeared,—a shepherd boy of sixteen,—and in our gladness and gratitude we gave him a franc to jodel some more. So he jodled, and we listened. We moved on, presently, and he generously jodled us out of sight. After about fifteen minutes we came across another shepherd boy who was jodling, and gave him half a franc to keep it up. After that, we found another jodler every ten minutes; we gave the first eight cents, the second one six cents, the third one four, the fifth one a penny, contributing nothing to Nos. 5, 6, and 7, and during the remainder of the day hired the rest of the jodlers, at a franc apiece, not to jodel any more. There is somewhat too much of this jodling in the Alps.
—Twain, Mark. 1897. A Tramp Abroad: Following the Equator, Other Travels. Edited by Roy Blount Jr. Library of America (2010): NY, NY. Page 187.

It stands to reason that—since we only buy something when its value is greater than the price—because the marginal value of a product declines the more we consume, we will only purchase more units when offered a lower price. From this we get the famous demand curve, a curve showing the quantity (Q) people will buy at various prices (P). The lower the price, the more people buy.

Figure 2—Demand Curve

There’s no accounting for tastes

The Golden Rule about measuring value in economics is that we let the people themselves determine how valuable something is. I personally think golf is boring to watch, but that doesn't give me the right to call it worthless—not when my grandfather would watch every televised match. My grandfather mattered as a person, so whatever he was fond of has value for him.

When it comes to questions like whether individually-wrapped banana or grapes 'labeled' organic has value we defer to the consumer and the citizen. No economist, politician, or interest group has the right to tell you what is valuable and what isn't. Sometimes following this rule can be frustrating, as people sometimes seem to have ridiculous and often irrational values. But because 'it is self-evident that all men are created equal' we give their preferences equal weight as our own.

There's an old saying that goes, "There's no accounting for tastes." We can't always rationalize why people like some things and don't like others. Preferences, at their core, are not something that be explained. My daughter once asked my why I like chocolate ice cream better than vanilla. How do I answer that? By saying, "I just do." And so it does for society. Their preferences are not to be justified or explained, but measured, so that we can help people acquire the things they desire.

Video 5—There's no accounting for tastes (from College Humor [website] on May 25, 2013)

References

(C1) Cross, David [creator]. Hardcastle, Alex [director]. Pye, Shaun and David Cross [writers]. Pye, Shaun, David Cross, Clelia Mountford, and Mark Chappell [producers]. October 15, 2010. "The Snooker Player, the Black Canadian, the Turkish Terrorist, and the Peanut." The Increasingly Poor Decisions of Todd Margaret. RDF Television and IFC Original Productions [production].

(N1) Norwood , F. B. and Jayson L. Lusk. 2007. Agricultural Marketing and Price Analysis. Prentice-Hall.

(N2) Norwood , F. B. and Jayson L. Lusk. 2011. Compassion by the Pound: The Economics of Farm Animal Welfare. N2) Oxford University Press.