Sunday, March 1, 2009

Value Theory Before Menger

This post is part of a series exploring Principles of Economics by Carl Menger.  The following explores content from chapter 3.

Previously in this series: Menger on Wealth and Prosperity

What is it that gives a good its value? Throughout the history of thought, there have been two kinds of theories regarding this question: intrinsic and subjective theories of value. Intrinsic theories of value regard value to be inherent in the objective nature of the good, and how it came to be. For subjective value theorists, just as beauty is in the eye of the beholder, value is in the mind of the evaluator.

The Franciscan monk Pierre de Jean Olivi (1248-98), pioneered the subjective value theory known as the utility theory of value. He wrote that value was determined by usefulness (virtuositas) and desiredness (complacibilitas).

Another Franciscan, John Duns Scotus (1265-1308), conversely, developed a branch of intrinsic value theory: the cost-of-production theory of value. He claimed that value is determined by the producer's outlay, labour, and risk. This theory anticipated that of Adam Smith.

David Ricardo placed the key importance on one part of the cost of production in his labour theory of value:

"The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production."

Karl Marx followed Ricardo in adopting a similar labour theory of value.

But the French economist Frederic Bastiat absolutely devastated all intrinsic theories of value with the following scintillating argument:

We can give the general name of obstacle to everything that, coming between our wants and our satisfactions, calls forth our efforts.

The interrelations of these four elements—want, obstacle, effort, satisfaction—are perfectly evident and understandable in the case of man in a state of isolation. Never, never in the world, would it occur to us to say:

"It is too bad that Robinson Crusoe does not encounter more obstacles; for, in that case, he would have more outlets for his efforts; he would be richer.

"It is too bad that the sea has cast up on the shore of the Isle of Despair useful articles, boards, provisions, arms, books; for it deprives Robinson Crusoe of an outlet for his efforts; he is poorer.

"It is too bad that Robinson Crusoe has invented nets to catch fish or game; for it lessens by that much the efforts he exerts for a given result; he is less rich.

"It is too bad that Robinson Crusoe is not sick oftener. It would give him the chance to practice medicine on himself, which is a form of labor; and, since all wealth comes from labor, he would be richer.

"It is too bad that Robinson Crusoe succeeded in putting out the fire that endangered his cabin. He has lost an invaluable opportunity for labor; he is less rich.

"It is too bad that the land on the Isle of Despair is not more barren, the spring not farther away, the sun not below the horizon more of the time. Robinson Crusoe would have more trouble providing himself with food, drink, light; he would be richer."

Never, I say, would people advance such absurd propositions as oracles of truth. It would be too completely evident that wealth does not consist in the amount of effort required for each satisfaction obtained, but that the exact opposite is true. We should understand that value does not consist in the want or the obstacle or the effort, but in the satisfaction; and we should readily admit that although Robinson Crusoe is both producer and consumer, in order to gauge his progress, we must look, not at his labor, but at its results. In brief, in stating the axiom that the paramount interest is that of the consumer, we should feel that we were simply stating a veritable truism.

How happy will nations be when they see clearly how and why what we find false and what we find true of man in isolation continue to be false or true of man in society!

Intrinsic value theories, then, clearly fly in the face of common sense. So why have economists adopted them? Some economists have resorted to them as a desperate solution to the "value paradox." The value paradox seemed to sunder exchange value and use value. Bread is more useful to humans than diamonds. So then why do people pay more for diamonds? Surely, thought intrinsic value theorists, something besides utility must be behind exchange values. Perhaps diamonds have a higher exchange value because they require more labor (labor theory of value) or more resources (cost-of-production theory of value) to mine.

Bastiat, in the above passage, showed the folly of intrinsic theory in 1850. What was still needed, however, was a clear exposition of a complete subjective theory alternative. This was provided by Menger in his 1871 Principles; and it is the most famous of all of Menger's contributions to economic thought (and will be the topic of my next post).

Next in this series: Menger and Value-Free Universals

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