Murphy Twin Spin on TSA and Subjective Value
This month I have the EconLib article. It is on privatizing airport security. You have seen some of this discussion in other venues but here I take it further, for example:
By taking such critical decisions out of the hands of a government agency—which is not bound by rational cost-benefit calculations and yet, in a sense, is more accountable to public opinion—we could largely diffuse the sensitive issue of discrimination.
Currently, many Americans decry the “political correctness” of both the Obama and George W. Bush Administrations and demand racial profiling of airline passengers. Let’s stop patting down Granny, these critics say, and instead focus on the guy in a turban named Mustapha. Naturally, those Americans concerned about civil liberties deplore these calls and argue that such policies would do little to intercept actual terrorists.
By having their own money on the line, insurance companies would have the proper incentives to implement only those procedures that actually promoted safety, and their decisions would be less controversial because there would be numerical support to back them up.
Right now, life insurance companies charge much higher premiums for clients who smoke or have diabetes. Although some complain about such “discrimination,” most people understand that these are straightforward business decisions. If a particular health insurance company really were charging smokers punitive rates—perhaps because its CEO lost a parent to lung cancer and he had a chip on his shoulder—then competitors would offer lower premiums and capture the business of many of the smoking clients.
Then over at Mises.org I have an article on subjective value and objective market prices. A lot of this is statement of basic principles but maybe you never thought of it like this:
[I]f I buy 100 shares of stock at $10 apiece, we can conclude three things:
(1) I valued the 100 shares of stock more than my $1,000.
(2) The seller valued the $1,000 more than his 100 shares.
(3) The market value of the 100 shares equals $1,000. Someone else who owns, say, 50 shares of the same stock would think that it constituted $500 of wealth in his portfolio. All that statement means is that the last traded price was $10 per share.
Once again, we see the importance of distinguishing between subjective valuation and objective market prices.
Not to be picky, (3) takes a peculiar definition of market price. If I sell a gold plated Ford Taurus for $500 million, that doesn’t mean that someone owning 1,000 gold plated Ford Tauruses (Tauri?) should assume that $500 million is the correct “market” valuation of the good. The correct valuation is somewhere within the current bid-ask spread because the true marginal buyer is somewhere in between. It’s remarkably unlikely that the owner of those Tauruses would be able to find 1,000 buyers at that price.
I’m still defining this in terms of subjective valuations, not the actuarially correct price of the objective expected value of all amortized returns of the asset, so my distinction does not artificially impose objective market prices.
If I sell a gold plated Ford Taurus for $500 million, that doesn’t mean that someone owning 1,000 gold plated Ford Tauruses (Tauri?) should assume that $500 million is the correct “market” valuation of the good. The correct valuation is somewhere within the current bid-ask spread because the true marginal buyer is somewhere in between.
Not necessarily. Only if there is an outstanding market for these cars will there be publicized bid-ask spreads. If there is, then it would also depend on where that exchanged price resides within the current bid-ask spread (if it does at all, which is not guaranteed), and finally it depends on the price elasticity.
The $500 million price paid could be the same as the current outstanding bid price. If the price of the car is elastic, then someone who owns 1,000 gold plated Tauruses might value their cars below the current bid amount, since an influx of 1,000 cars into the supply will decrease its price even further, putting the market value outside the spread. If the price is inelastic, then the market value would be close to $500 million.
But for this example, since we know of only 1 car that was sold, and because there are at least 1,000 cars owned, then this car would represent a very thinly traded commodity, and so the owners would probably not even use market prices at all to determine the market value. They would probably use some other means to estimate the market value, for example cost, or cost plus interest, etc.
If we assume the car is highly liquid, such that the bid-ask spread is relatively tight, then the mid spread is typically used.
Ryan (3) is exactly how you determine someone’s net worth. When people say how much Bill Gates is “worth,” they are using that exact process. Even though if Bill Gates actually tried to turn his shares into cash, Microsoft would tank.
You’re right, if I used an example of Ford Tauri, then it would be a little ambiguous. Fortunately, I didn’t use any such example. What I said is perfectly true.
” If I sell a gold plated Ford Taurus for $500 million, that doesn’t mean that someone owning 1,000 gold plated Ford Tauruses (Tauri?) should assume that $500 million is the correct “market” valuation of the good. The correct valuation is somewhere within the current bid-ask spread because the true marginal buyer is somewhere in between. It’s remarkably unlikely that the owner of those Tauruses would be able to find 1,000 buyers at that price.”
Sure, but if there WERE 1001 gold-plated Ford Tauruses on the market, and it’s unlikely that the owner of the 1,000 would be able to find 1,000 buyers at that price, then it’s also unlikely that you would’ve sold your gold-plated Ford Taurus at $500 million in the first place, because your buyer would’ve haggled with the guy who had 1,000 and in all likelihood been able to negotiate a nicely lower price, which you would then either have had to match or beat, or decide you’d rather not sell. (Assuming the guy with the 1,000 didn’t only decide he wanted to sell all 1,000 at once AFTER you’d made your sale, and that buyers have a way of finding sellers of such goods and thus your potential buyers would know about the availability of the other 1,000.)
In any case, suddenly dumping 1,000 of rare goods whose value is partially based on unusualness and speculative desire (like art) (over and above the value of the actual melted gold in the Fords of course) is not rational behavior that the rational owner of 1,000 gold-plated Ford Tauruses would be likely to do.
For example, the estimated market value of a near-mint condition Feb 1940 “Whiz Comics #1” is supposedly around $80,000. If I, say, found a box of 1,000 of these in the attic of a house I just inherited, do you think I would suddenly flood the market with 1,000 all at once? No, because obviously the subjective value would immediately decrease. (Keeping the 1,000 a secret and putting them on the market one at a time would probably be the best strategy; the value is based on perceived scarcity and you’d be taking advantage of the market lacking information on the actual rarity; with each one you sell, the rarity would decrease and the market price would adjust lower. You could sell the first one for $84,000, the next maybe for $82,000, the next for $79,000, etc. At some point people will cotton on and the game will be up. You’re still better off keeping them though, than e.g. burning some.)
The value of shares has virtually nothing to do with their unusualness or interest to specialist hobby collectors; they’re not “collector’s items”, like numismatic coins, or gold-plated Ford Tauruses.
The speculation-component value of a collectors item (compared to its utilitarian value) is almost pure speculation, and nobody intends it to be otherwise. You don’t pay $84,000 for a comic book because you think it would be an interesting read while on the toilet; you’re either a hardcore collector, or a speculator hoping to find a buyer with even more money. In a post-armageddon Mad Max style world, the same comic’s value would be zero, you might be able to use it to help start a fire or something, but not much more than that. The value is INTENTIONALLY speculative.
Unless I am specifically engaged in speculative buying and selling, share prices are not intentionally speculative. If I buy 100 shares at $10 apiece, it’s because I believe that the managers of the company are skillfully capable of producing goods in the market at a profit that will allow them to earn enough such that I can earn a return on the investment; it’s based on some actual production of something, whether it’s a consumption or capital good, and whether my return is through higher share price at resale or dividends, either way, it’s based on production (in a normal market, at least, not one continually flooded with newly printed money as artificially easy credit etc. — if stock prices are rising just from money-printing inflation, then I might be buying them simply to hedge against artificially-created inflation, but that’s not the market at work, that’s just an attempt to hedge against the anti-market forces).
If I have a million shares in a company of which only a 1,000,010 were issued, then suddenly dumping all on the market at once would indeed likely lower their value, but because of a perception – a rational perception, in fact – that perhaps the shares were overvalued. Why is it rational? Because I wouldn’t be selling them all at once if I expected the company to be making big profits and paying out big dividends; since I’m presumably rational, I studied the company more than most, and came to the conclusion staying invested in them would be a losing proposition. That’s closer to your example of the Ford Tauruses, since you’re talking about a good where a single seller constitutes most the market. Robert’s example of 100 shares is probably presuming that’s a tiny minority of a company’s stock.
OK, read the article now …
“Perhaps it would help gold bugs abandon the dream of resurrecting the past to find the future by pointing out one simple fact: if we’re going to peg everything to gold, what is it that we’re going to peg gold to?”
Now I admit I’m no expert and don’t know much about economics, but this strikes me as a very stupid question to me. Ultimately, the amount of money we have, relative to the amount of money in circulation, effectively (and very loosely) represents, in a crude sort of way, the “percentage stake” we have in “overall production” of the current economy at that second in time. In other words, the value of gold is “pegged” (very loose use of the term) to “the economy – all of it”.
Assume the amount of gold in the world is fixed. Assume I own half of it. If I sit around for 30 years, and the global economy grows unabated for 30 years, I’ll still own half the gold, but I’ll be able to buy far more with it, and new technological goodies like iPads. If on the other hand, it de-industrializes for 30 years, and reverts to a more technologically primitive but still gold-based economy, I’ll be able to buy far less. Or, it could grow for 29 years, then 80% of the economy could be wiped out in year 30 by a supervolcano, and suddenly I’d again be able to buy far less with my gold.
In other words, it’s “pegged” to “overall production of everyone involved in the economy”.
There is no artificial way to “guarantee” that your money can buy the exact same number of the exact same type, over time. That would be totally silly, and would prevent not only wealth decreasing, but would prevent it increasing too (and you’d have to legislate against nature, to prevent supervolcanos or diseases). Every second, the overall structure and production capabilities of the global economy change in some way, and can change in ways we can’t predict or do anything about. This is the unpredictably we have to live with in this world, there are no absolute guarantees, but so what?
The fact that it’s not possible to “peg” gold to something is not an argument against the gold standard, for this applies to any currency systems, and fiat currency systems are worse, not better in these respects. Updegrove is basically arguing that because you can’t guarantee that a certain precise quantity of gold will be trade-able for an exact amount of (say) wheat from day to day, that it’s silly to think a gold standard could “work”.
… and you don’t need to “peg” gold because the quantity is (for all practical intents and purposes) naturally limited. Nobody’s invented a “gold printing press” yet. Honestly, “what do we peg gold to”, what a silly question .. the only reason to “peg” currencies is *because* they can be printed boundlessly, UNLIKE gold.
So how much net “utility” or “happiness” did you get out of that trade?
Scott Sumner wants to know.
According to the scientific model used by Professor Sumner, you were seeking utility in that trade.
How much did you come away with?
I believe the most appropriate answer to that question is mint chocolate chip.
Greg I don’t want to tell you because it would be redistributed to the Swedes.