01 Sep 2016

## Why Market Exchanges Are Not Acts of Measuring Value

Hoisted from the comments of my last post:

This is in response to Tel, but I’m doing it stand-alone so it doesn’t get lost in the indentation:

Shoot, Tel, I meant to hit this point but I forgot. When Jim trades 10 pizzas to Sally in exchange for a painting, we can say that the painting has the same market value as 10 pizzas. However, there is no measurement going on here.It’s not that they each had a certain amount of “market value” inherently, and then we put the pizzas up to the painting to figure out how many “pizza market values” were contained in the painting.

E.g. when you put a meter stick against a barn and measure it as 13.4 meters, it works because you assume they both possess units of length and you’re seeing how many of the meter stick’s lengths *equals* the length in the barn.

But when Jim trades 10 pizzas for the painting, he does it because he thinks the painting has MORE value than the 10 pizzas, and vice versa for Sally. They are not measuring market value, they are consulting their subjective value rankings. They are not using equality, they are using inequality.

So there is nothing at all analogous in two people making an exchange and thereby producing a market exchange rate, and a person using a meter stick to measure the length of an object.

#### 20 Responses to “Why Market Exchanges Are Not Acts of Measuring Value”

1. Chris says:

So this makes sense to me when the units are not divisible, but I don’t fully understand when they can be infinitely divided. I’m pretty sure Mises addressed this but I could only find a statement where he says it’s still “a serious blunder” to try to equate marginal utilities with infinitesimal utilities (on 706 of Human Action). But if I prefer 1.51 ounces of Coke to 10 ounces of water and prefer 10 ounces of water to 1.49 ounces of Coke, is there any real problem in saying 10 ounces of water is worth 1.5 ounces of Coke (or whatever infinitesimal amount when I start to prefer one over the other)?

• Tel says:

That was one of my arguments… but stronger than what you said, because not only do humans stumble into situations where they happen to be trading divisible items, there’s a demonstrable historic trend that humans have been attracted to divisible items for the purpose of trading with them. And it’s kind of obvious why working with those adjustable quantities makes it easier to achieve a transaction (even for barter transactions that use a small “top up” of some third commodity just to smooth the deal).

This isn’t merely money, this is all of the things that are quasi similar to money and have been used as trade goods:
* salt (Roman era)
* flint (Neolithic)
* tin (Minoan)
* spice (Medieval)
* alcohol (early American & early Australian)

People seek these things out, that’s why they are remembered in the history.

• Chris says:

Yeah I agree but I don’t think you even need to make a distinction for what is actually used for trade. When I am making subjective value judgements for any infinitesimally dividable good there must be some point where I switch from preferring one to the other. At those points it seems like I could measure one in terms of the other whether I actually make the trade or not. Maybe it’s not a useful measurement because it wouldn’t scale constantly (1.5 ounces of coke=10 of water does not imply 3 ounces equals 20), but I always thought the Austrians were a bit too stuck on this point.

• Darien says:

I’m a simpleton, of course, but to my mind, one significant problem involved in saying “1.5 oz of Coke is worth 10 oz of water” is that it implies that there’s a constant ratio between them, rather than the one-time preference of one good over another.

For example, if we stipulate that 1.5 oz of Coke is worth 10 oz of water, that seems to imply that .15 oz of Coke is worth 1 oz of water. While that may (or may not) be true, I think there’s a sense in which the absolute quantity of beverage matters as well. Perhaps I would take a swig of Coke over a glass of water, but would I necessarily likewise choose a minuscule drop of Coke over a swig of water? Describing the Coke as having a certain amount of water-value per ounce implies that I would.

• Chris says:

Wow good timing. I just talked about this in reply to Tel’s commnet above. Like I said, I agree that the concept of measurement might not be a useful one, but I also don’t see why it’s so important to deny any kind of measurement.

• Tel says:

You would expect the ratio or water to coke to be non-linear with a diminishing marginal return.

If the individual has plenty of water but no coke they are more likely to offer an attractive price for coke, but each additional unit is worth less than the one before. At some stage they would completely stop showing any interest in coke because the marginal return (for that individual) is no longer sufficient.

That said, lack of linearity in itself does not imply that we don’t have a value measurement. It does limit the applicability of that situation to other cases, but individual preferences are not portable anyhow so you haven’t really lost anything.

• Darien says:

That’s more or less where I was going. I guess my concern is that if we can’t do interpersonal or intertemporal comparisons and we can’t establish a scalable ratio, it seems a bit perverse to claim that we’ve “measured” anything. “To me, right now, in this exact situation, this specific 1.5 oz of Coke is worth that specific 10 oz of water” strikes me as so inapplicable as to be not worth the trouble.

Even moreso, of course, because the whole concept relies on the idea that we can calculate our preferences in such specific terms, and, as Mises explained, preferences are revealed only by actions. I’m not rightly able to apprehend the set of actions that would reveal this “measurement;” in any conceivable situation, I’ll choose either the water or the coke (or possibly neither, if neither is worth whatever other sacrifices I’d have to make). The choice is fraught with so many uncontrollable confounding variables that I can’t see any path to isolating just “1.5 oz of Coke” and “10 oz of water” sufficiently that I’d be able to determine that they are equal in value.

• Chris says:

But your logic seems to apply also to ordinal preference rankings. I agree it’s very hard to find a value where they are exactly equal. But it’s also very hard to have a preference scale for every possible amount of every good. These are just tools we use to approximate reality and I still don’t see the harm in defining a value where they are very very close to being equal as just being exactly equal

• Tel says:

Fair enough, it depends on how strict you want to be in your definition of what a “measurement” is.

As I pointed out already, taking units of length, mass, time etc from the physical sciences and holding that up as the standard for what a measurement system must deliver, is a very high bar. What’s more it’s a high bar that the physical sciences also would have been unable to achieve some thousands of years ago when they got started.

Economics as a science is only several hundred years old and spent a lot of that time just getting together the basic principles (which are still under discussion).

• Gene Callahan says:

““1.5 oz of Coke is worth 10 oz of water” is that it implies that there’s a constant ratio between them, rather than the one-time preference of one good over another.”

Nah, it just means *at that moment* that is the ratio.

• Sean says:

If you’re saying you prefer A (1.5 oz of Coke) to B (10 oz. of water) and B to C (1.49 oz of Coke) then it doesn’t follow that A=B but that A>B.

So 1.5 ounces of coke isn’t worth 10 oz of water to you, it’s worth more. And by how much cannot be measured because your preferences are ordinal.

With regards to a good that can be infinitely divided, there shouldn’t be any confusion. A good that can become infinitely divided proportionately isn’t even an economic good.

With regard to infinitesimals, I believe Mises was emphasizing that preferences don’t behave like mathematical curves where if 1.5 oz coke command some use value “n” then 1.5+h commands a use value “n+h” (because again, ordinality).

• Chris says:

So are preferences not complete? If I get closer and closer to the value where your order changes, you can’t tell me which you prefer at some point? Maybe you can make the argument that when you get down to an atomic level you wouldn’t be able to divide anymore, but aren’t they close enough that assuming continuity doesn’t change any important implications?

• Tel says:

In the sense of an observable empirical measurement, preferences are NOT complete.

That is to say, you observe the action of the individual, so you know this was the highest preference under the circumstances, but this gives no information about second preference, third preference, etc. You don’t even know how much consideration that individual gave to other options, nor do you know whether the individual knew that other options were available.

When Bastiat talks about “the seen and the unseen” you have to remember that the unseen is pure speculative imagination.

• Chris says:

Sure an outsider can’t measure, but preferences are complete as long as for every possible pair of goods I prefer one to the other (weakly prefer – indifference is fine too). It doesn’t matter if I am actually faced with the choice in reality. I don’t see any reason why Mises’s analysis is incompatible with complete preferences.

• Sean says:

In the mathematical sense? Taking from wikipedia:

“In order for preference theory to be useful mathematically, we need to assume the axiom of continuity. Continuity simply means that there are no ‘jumps’ in people’s preferences.”

In reality, preferences don’t behave like a continuous function where there is a corresponding output to every change in the amount of a good that you want. Our wants/needs change with respect to time, place, and circumstance. From this it would follow that while it might be mathematically useful to assume preferences are complete, this isn’t the case in reality.

• Gene Callahan says:

“From this it would follow that while it might be mathematically useful to assume preferences are complete, this isn’t the case in reality.”

Right. But models are NOT reality!

• Sean says:

I didn’t intend to argue that modeling economic behavior in that way (with continuous and complete preferences) wasn’t useful for reflecting reality, I was just attempting (I hope somewhat successfully) to clarify the Misesian viewpoint on how preferences behave.

2. Sean says:

useful to assume preferences have continuity*

3. J Mann says:

Isn’t this one pretty obvious? Market exchanges are a good way of estimating market value, but not subjective value.

So if I offer my wine collection as collateral for a loan, the lender is probably going to use recent sales of those vintages as a substantial part of estimating how much my collection would go for if they have to exercise their lien. But if you want to know how much the wine is worth *to me*, the market value is probably only good as an approximation of the floor. (Because if the market price – transaction costs was much over my personal value, there’s a good chance I’d sell).