Price of everything, value of nothing

An old joke goes: “An economist is someone who knows the price of everything and the value of nothing.” Upon hearing it for the first time, rather than laughing at the self-deprecating humour like normal people would, I thought about the validity of the claim.

It just so happens that last week’s edition of Tim Harford’s Undercover Economist column featured pricing policies, especially with respect to a “fair price”. This also reminded me of an entry on The Economist’s Free Exchange blog, ridiculing a poorly informed fashionista. Though I agreed fervently with the article’s content, I was less than impressed by the contemptuous tone and the intellectual gang-rape by the commentators.

Both pieces make full use of an idea basic to economics and market functions in general: a mutually voluntary transaction is beneficial to both parties. After all, if one party decides that participating in the transaction has greater marginal costs than marginal benefits, he/she would simply opt out. In fact, the net benefit of that certain transaction will even have to compete with the net benefits of all other transactions: if another transaction has a greater net benefit then that one would at least take time-preference. The premise is similar to that of Leibnizian optimism, except economists are realistic enough to recognise that the ends are far from the “best of all possible worlds” (mostly due to the market failures present – one of which I will discuss below).

I want to go a step beyond simple cost benefit analysis (CBA) though, and explore the implications of post-transaction CBA. We don’t simply have one quick CBA before undertaking a transaction – even after a purchase/consumption/utilisation, we continually assess our decision to check whether we were right or wrong. The reason why Ms. Thomas was dissatisfied with her purchase is because she miscalculated her CBA and it turns out that her net benefit was not as large as she originally had planned it to be. The perceived consumer surplus (however little that may be, seeing her reluctance to buy the dress) was lower than she thought, and may have even dipped into negative. Or at least, other transactions’ perceived consumer surpluses started to weigh higher, so she could’ve made better use of her money. This is where we would say we regret undertaking a transaction. With hindsight, if she decides that she wouldn’t have bought the dress, then the dress is not “worth” (laymen’s definition) the price (in her opinion). If however she still decides that she would’ve bought the dress, then she really has very little to complain about, since her consumer surplus may have been reduced in size, but is still positive and the greatest out of the options available to her.

This could be seen as a form of information failure. If there is a divergence between perceived costs and benefits and actual ones, the consumers are taking CBAs on incorrect information and may lead to bad (read: regrettable) decisions. Unfortunately, it’s an information failure that can never be corrected entirely: people will never have complete information. However, it does beg the question: does the government have a role, or perhaps even duty(?) to correct such information failure in order to minimise regret? Or should it let things be, allow people to make mistakes and let them take responsibility?

I think post-transaction CBA is significant in determining whether a good is “worth” its price, since that will affect demand for future/repeat buyers via word of mouth, reviews, etc. If too many people find the good to be not “worth” the price, then soon the good will not be “worth” the price (economically speaking) either, and will have too few buyers in the market to warrant existence.

This particular theory of value doesn’t only apply to goods and services either. Recently there was a complaint made on Radio 4’s Feedback that there was “too much” reporting on Prince Harry’s service in Afghanistan, that it was “blown out of proportions” and the exposure given to it to be “in excess of its intrinsic value”. Despite agreeing with his former criticism (my own subjective view), does anything have an “intrinsic value”? Or are values determined purely by the forces of supply and demand? I have my reservations about the media but they do exist to serve us, and they are only trying to predict audience demand. Living by de gustibus non est disputandum means that you have accept some people are willing to pay millions for a pickled shark, and still get a consumer surplus out of it (a friend recently referred to it as a “psychic benefit”. I quite like that.)

Finally I’d like to leave you with a (not entirely irrelevant) question that we’ve been bouncing around: “Is consumer surplus strictly superior to producer surplus?” The easy answer to that is no, we’ve already decided that but it’s never that simple. Only recently we’ve seen profit margins of chicken producers, British pig rearers, and EU dairy farmers being squeezed. “Greedy supermarkets” is the most frequently accused, but since most of that price cut is being passed onto the consumers, the argument doesn’t exactly ring true.

Even if it is the supermarkets retaining the profits, at what point does it become an abuse of monopsony power? Is there an optimal, or failing that, fair distribution of profits along the production line?