The Power of Preference

Preference has tremendous power because it guides all transactions in a market economy. The preferences of individuals govern all economic activity. You have power because of your preferences. Choose them with care.

For the most part we take our preferences for granted. After all, they are ours and ours alone. We get to choose whether we like yellow or blue. We get to choose whether we like hamburgers or fish sandwiches. And we get to choose whether we like iPads or Androids. But, those preferences don’t seem to affect anyone else.

Your preferences, however, play a vitally important role in your life and the lives of others. In your life those preferences determine what you wear, what you eat, where you live, and whom you choose to have as friends. When you go to the grocery store it matters to you whether you prefer oranges or bananas. It matters to you whether you buy raisin cookies or just raisins. How you act based on your preferences, of course, makes a difference in your life. But, what difference does it make in the lives of other people?

You don’t share preferences with other people. Your preferences belong to you only. You may have preferences similar to others, but you have chosen them for yourself. So again, what difference do your preferences make to other people?

Would you find it difficult to believe that market systems developed based on the preferences of many many individuals. The preferences of individuals represent the sole source for what we refer to as economic value. The preferences of individuals — or their subjective value — provide the basis for the value of anything bought, sold, or exchanged in a market economy.

Thus, the next time you or someone else makes a statement about the value or worth of the good offered for sale on the market, ask “In whose opinion?” Nothing has any economic value unless someone else prefers it to either what they have or what they have an opportunity to acquire.

Preferences have tremendous power. All economic activity occurs because of people acting on their preferences. In this blog, I will return frequently to the importance of preferences for two reasons:

First, because of its importance in effecting every economic activity; and
Second, because the truth of subjective value turns most economic models on their heads.

What’s It Worth?

The worth—or value—of any good is always unknown and unknowable. Use the consideration of this reality to trigger useful questions regarding market behavior.

If you have followed my posts to this point, you realize this question—”What’s It Worth?”—has only one answer: “The worth—or value—of any good is always unknown and unknowable.” Even an individual cannot quantify the worth of things he values. So, should this question always become a conversation ender?

No. Frequently pondering questions to which we have no answers plays as important a role in understanding as does having a ready answer. I will examine reflections on this unanswerable question at three levels:

  • Individual
  • Enterprise
  • Economy

Individual

When you pose the question” What’s it worth?” to an individual, what do you really mean? Since he cannot answer the question as phrased, you probably want to know what price he would pay for the item. What would he give up that he values less (usually in terms of money) to gain the item in question, which he values more? The answer always depends on his personal assessment. It may not work for you; but that does not make the answer wrong or right.

Enterprise

At the enterprise level the” What’s it worth?” question, again, generally refers to price—not value. In this case the” asking price” of an item usually results from a price discovery process in which a number of individuals, through individual acts of buying or not buying, signal how much they will voluntarily give up in order to acquire the item.

The price discovery process does not amount to a collective decision. Nor does it mean that the individual buyers have reached a consensus on a precise price for the item. It means that the asking price falls within a range in which the buyers willingly give up something—usually money—they value less than the item they buy.

Economy

The “What’s it worth?” question becomes a bit more complex when speaking of an economy. People use the Gross Domestic Product (GDP) as a common metric for the “value” of an economy. But does GDP provide any real indicator of value or even a measure of price? No.

It cannot indicate value because the diverse value judgments of millions of people regarding millions of items cannot represent a measure at any level.

GDP cannot provide useful information regarding prices. The varied prices of multiple goods simply cannot be aggregated. Just try to add the prices of hamburgers, autos, and cameras. You can’t do it.

So, is GDP a useless statistic? No. But, you must understand what it does measure. It simply measures the number of dollars exchanged for defined categories of goods. (GDP also suffers from logical flaws, which I will discuss in another post.)

Conclusion

Next time someone asks you,” What’s it worth?” stop and think. What does this question really mean? (You may not want to take the questioner through all your thought processes, but, the pause might clarify your own reasoning.)

Individually does this really refer to price?

For an enterprise, what range of value does the discovered price indicate? Can prices move up or down within a range within that range?

In an economy does the” value” metric provide useful information? Or, does it provide misinformation?

Consider the value of an unanswerable question.

The Importance of the Individual

The discrete nature of humans makes the individual the center of all market activity. They decide what has value and how much. Their actions based on those evaluations make free markets operate effectively and efficiently.

The subjective theory of value reveals that the individual plays the most important role in the development of all economic theory. The effective and efficient allocation of resources throughout an economy always depends on satisfying the needs and wants of individuals.

I will mention briefly some of the reasons why individuals are so important to understanding free markets:

Discrete Nature

Like all things in nature people will always remain separate. Individuals simply cannot form collectives. Communities of all sorts consist of networks of individuals. They have separate minds and the act separately. The subjective theory of value remains consistent with this fact.

Market Power

Because individuals provide the source and measure of value they also represent the predominant market power. All market transactions result from the actions of individuals. When organizations act, they do so as a result of the consensus of individual decisions.

The idea of individuals as a source of market power turns most economic theory absolutely on its head. Market power comes from the bottom of the hierarchy; not the top.

Inverted Cost Structure

The fundamental role of individuals inverts the popular model of market cost structure. The amounts that buyers willingly pay for goods and services determine the costs of retailers, distributors, and manufacturers, not the other way around. Goods cost what they do at every level of the production structure because of the demands of consumers for other products requiring the same resources.

When attempting to determine the cost of any good or service don’t look to the source of the resources used. Look to what buyers willingly give up to receive that good or service.

Determination of Market Prices

The bidding of individuals to purchase goods determine market prices. The competition between suppliers does not play the dominant role in holding down market prices. The bidding of individuals for goods actually stimulates competition between suppliers.

Determination of Wealth Distribution

Many people misunderstand the determination of the distribution of wealth. A good only has market value when individuals willingly offer something in exchange. The same holds true of the market value of resources. They only have value if they produce something for which individuals willingly exchange.

This fact holds true of the market value of financial assets. The ownership of a particular stock signifies wealth only because others desire to own that stock. Without legitimate demand — demand backed by substance — the stock becomes worthless.

Political Power

Like market power, individuals determine the source and level of political power. An individual gains political power when others delegate that person to exercise illegal or unauthorized force against another individual — or individuals. This does not change the original source of power i.e. the individual.

The role of the individual in the distribution of political power becomes important with a discussion of market intervention. I have previously defined free markets as those free of violent intervention—markets free of political power.

Conclusion

No process exists that eliminates the role of the individual in the operation of markets. Individuals determine what they value and how much they value it. No other source exists. As a result, the individuals reside at the center of the operation of any market.

I have only touched briefly on some of the aspects that make the individual so important to the development of economic theory. I will allude to the importance of the individual many times in the course of my blog posts.