----------------- HES POSTING ----------------- Bill Williams wrote: 'I take seriously the notion that as Stigler said, the best criticism is to provide a better theory.' Very well said. It does seem that theory of value is in serious need of a better theory, as the recent discussions here show the presence of a wide variety of opinions. I submit that there are several dimensions in which the theory of value may be improved. Here is a short list of issues. 1. Numeraire (Absolute versus relative value): What is something worth is a question whose answer is not available in an absolute sense. Even if it were, it would be of little use in economic analysis. We need to consider the value of something in relation to some other thing, and that some other thing must be the payment. In an exchange, there are two goods that pay for each other. The value of each good is to be understood in terms of the good that serves as its payment. We are not allowed to consider an arbitrary numeraire. That is, if payments are made in money, we must count the value in money and not in imaginary fidgets. Take an arbitrary numeraire only if you want to kill theory of price in its embryo. The route to a wrong theory of price lies in the arbitrary numeraire. Price must be defined in one and one way only: it is the quantity of payment per unit of the good. (The implication is a completely new theory of ! money, and hence a completely new macroeconomics. For Stigler's sake, do not ever imagine that the so-called nominal price can go up and down arbitrarily. The buyer must pay in money, and money cannot be arbitrarily increased or decreased. That is, do not think of a price as a mere unit of measurement, but think of a price as an actual payment, because price is nothing less and nothing more than the quantity of payment.) 2. Observational Basis (Formal definition): Formally, the value of something is the quantity multiplied by the price, while the price carries the relative measurement. I propose to break down value into price and quantity, and then propose two different equilibrium conditions for them. First, for each good individually, the equality of demand and supply determines its quantity, but not the price. Secondly, equivalence determines the price so that the goods that pay for each other are made equal in value. Equivalence works on the relation between the quantities of the two goods that pay for each other. Utility is not observable, and hence it is advisable to be much ashamed of having to mention it. Careless use of terms is a serious source of trouble. The term utility was invented so that one would not confuse it with value. Let us resolve to use value strictly to mean nothing more and nothing less than <price times quantity>. 3. Quantity equilibrium: From the demand side, the optimizer reaches equilibrium when the price is equal to marginal benefit, which is lambda times marginal utility, where lambda is the so-called marginal utility of income. From the supply side, equilibrium is reached when price is equal to marginal cost. The key is to calculate cost, price, and benefit in the same unit (of the good that serves as payment). If the payment is in money units, then price, cost, and benefit all must be measured in units of money. This avoids the trouble with measuring a subjective utility. Instead of saying how many utils an apple gives, we must say how many bananas give as much utility as one apple does, if the payment is made in bananas. If the payment is in money, we ask: how many units of money give as much utility as one apple, even though money is not a consumer good and is not consumed, because we must know that money is a claim on the ! next best real good. That is, it may be the case that one sells bananas to buy apples, but in two steps. In the first step, he gives up bananas for money, and in the second, money for apples. Thus even if we measure benefits in units of money, we are till measuring the benefits in terms of bananas via the money-price of bananas. 4. Optimizer versus entrepreneur: Only under subsistence the producer is identical with the consumer so that the quantity of subsistence output is chosen when marginal cost is equal to marginal benefit. But this does not apply under trade, where the seller and the buyer are different people, and must both be entrepreneurs. By definition, an entrepreneur intends to achieve net pure gains or profits. Thus the producer as an optimizer allocates given factor endowments to produce so that marginal cost is equal to given predetermined price. But as an entrepreneur, he seeks to get a price higher than marginal cost. It is possible because the producer may find somebody else who is indeed willing to offer a price higher than marginal cost. Likewise, the buyer is also an entrepreneur who seeks to get something for nothing above and beyond the payment he delivers. That is, the buyer seeks to get a price lower than the marginal benef! it. In short, under subsistence, marginal cost=price=marginal benefit, but under trade marginal cost< price< marginal benefit. 5. Intermediation: Price must be determined by agreement between the buyer and the seller, both of whom must act as entrepreneurs and not as optimizers. As an optimizer, one allocates given resources, and achieves no net gain, because no matter how one allocates a budget, it remains the same budget. An optimizer must presume a price, otherwise there is just no basis to choose either demand or supply. But as an entrepreneur, the same individual must bust the budgets, and seek to get something for nothing, that is, create new value-added. This is possible because different people assign different relative prices to the same pair of goods under subsistence. Thus the apple producer's marginal cost of an apple under subsistence (when he produces both apples and bananas) may be 1 banana per apple. But because there is another person who is willing to give as many as 1.5 bananas per apple in exchange, the producer of apple resort! s to the enterprise of selling apples and buying bananas for a net gain of half a banana per apple. On the other side, the banana producer may also make a net gain, because his marginal cost of an apple may be two bananas, and it is clearly gainful for him to buy apples at a price lower than his own marginal cost. This of course means that as a seller of bananas, he makes a net profit by selling them at a price (2/3 apples per banana) higher than marginal cost (1/2 apples per banana). The critical element in this part is the presence of intermediation. An entrepreneur must act as an arbiter in settling a price through a bargaining process: he must buy cheap (from himself, at marginal cost) and sell dear, (to the other person, at a price above marginal cost). Then we will encounter the shock of having to examine the case of a pure arbiter: one who buys something without an intention to consume (and hence disregards marginal benefit), and then sells something without having produced it (and hence disregards marginal cost). Let us learn how to derive a demand curve without an underlying utility function, and a supply curve without an underlying production function. It should be funny and profitable, because merchants are the most active buyers and sellers in the real market, though they are neither producers nor consumers. I hope that each of the five points above offers some improvement. Let us hope that this begins a serious reexamination of the theory of value. Mohammad Gani ------------ FOOTER TO HES POSTING ------------ For information, send the message "info HES" to [log in to unmask]