How Value is Determined
How much does a car cost? How much does a pair of shoes cost? How much should life-saving medicine cost? Who really determines the prices of the products around us? Why does a cheeseburger cost $2 at one restaurant and then cost $12 at another? Who decides how much we pay for things? How does a population go from poverty to wealthy? Because when it comes down to it, the human race is incredibly resourceful and has a fierce determination for survival.
Let's return to the first question of the cost of a car. Imagine you want to buy a car. The first thing you have to decide is what reason the car needs to be purchased. There are many types of cars that serve many purposes. Will you be transporting a lot of people? A van or SUV might be a good option. Will you be transporting large objects? Maybe a truck would be better. Are you concerned about gasoline usage, speed, looks, etc? The point is to say that what would be practical for you, may not be practical for me. A car of a certain type is literally more valuable to you than it would be for me. You probably would have a set price in your mind of how much money you are willing to spend on your preferred type of car, and likewise so do I. Would I be willing to buy your preferred type of car at the amount that you are willing to spend for it? I doubt it. Would you want to buy my type of car at the same amount that I am willing to pay for it? I doubt that as well. This is because the “value” of the product is not a constant. I will say that again for emphasis: the value of a product is not a constant. Every single person on this earth assigns different values to everything around them.
So then where do prices come from? A price is simply what the seller believes the consumer values the product at. Suppose I want to sell cheeseburgers. I buy the cheapest meat and cheese that I can find so that I can sell them at a low price and still make a profit. Maybe I sell this cheeseburger for only $2. If someone is hungry they may value that cheeseburger more than $2 so they would buy it. Thus increasing their quality of life as well as mine. But what if they don't like my cheeseburgers? I used the cheapest ingredients, and consumers have figured it out. If a consumer thinks my cheap cheeseburger is not satisfactory, they may value you it far less than $2, and they would not be willing to buy it.
Now say somebody else makes a cheeseburger with the best ingredients that can be found. Those ingredients may cost a lot more, which means that this person has to sell the cheeseburger for $12 to make a profit. But some people may enjoy that cheeseburger so much that they value it more than $12. They are willing to pay that price for a better product. Each individual constantly rationalizes how much they value something before they decide to buy it. I might not want to spend $12 for a cheeseburger, but if I am really hungry then my value of the cheeseburger changes and I may end up buying it. Or I can go somewhere else and find something cheaper to eat. This decision-making process happens all of the time and changes repeatedly. Likewise, with the low quality $2 burger, I might not enjoy it, but if I am really hungry I might value it enough to pay for it. The price that I value things at is changing constantly and never ends.
So why would somebody sell something? It must be something they have little value for, but know that someone else would value it. Yet the seller often does not want to just give things away. The seller usually asks for payment, and this payment is valued by the seller more than the seller values the product he or she is selling. This transaction benefits the seller because they are receiving a payment for something that is higher than what they value it at. The buyer, on the other hand, values the product more than the payment. This is an incredible phenomenon! Both the seller and the buyer are receiving something that they value more than the item they gave up. Both have benefited from this transaction. It is a mutual transaction with mutual benefit.
Because both parties have received something that they value more, it can be described as saying that they both have increased their wealth. The quality of life has increased for both of them in a cycle of increasing wealth. When both parties gain something, both have grown their personal wealth at the same time. If this is done over and over, with more and more people, then everybody has the chance to increase their wealth through the quality of life. The wealth of the nation grows as people sell and purchase goods and services. A person would not make a transaction if they felt they were not getting something more valuable in return. For this reason, it is essential that both parties involved consent to the transaction. If the transaction is not consensual, then it means that one of the two felt forced to do it and that they lost something of value in the transaction. Only consensual, mutual agreements increase wealth for both involved.
This remarkable phenomenon of mutual benefit is the concept of free market capitalism. But can it be twisted to hurt consumers? Let's look at some possibilities and outcomes.
Suppose there is only one shoe maker in a certain area. Anybody who wants to buy shoes goes to this shoemaker. If people value his shoes than he knows he can raise the price. He would continue to raise prices to become more successful, but one of two things will happen. Either competition will regulate it, or the lack of interest will regulate it.
In the first case, someone else will see how rich the shoemaker has become and want to earn money in the same way. Person B can learn to make shoes and sell them at a slightly cheaper price. Who do you think consumers will go to? Consumers want to find the cheaper and better products. It's human nature. At this point, there would be two shoemakers trying to sell shoes to the locals. Maybe one has better quality while the other is cheaper. There are two options, but enough people buy shoes from them that both shoemakers are making a profit. Now suppose a third shoemaker joins the game whose prices are far cheaper than even the second one. What better outcome could we have for the consumers? The prices are going down! This cycle continues as more and more competitors join the frenzy. All of them lowering prices and making better quality shoes. They are meeting the demands of the people.
But what if the supply becomes larger than the demand? Eventually, everyone will want to be a shoemaker and shoes will be so cheap that everyone has several and does not need to buy more. The demand drops. Now all of the shoemakers will be unable to sell. Maybe some of them become so desperate that they change their focus entirely and start to make hats instead. Don't forget that the sellers need to sell something in order to survive. If the competition has flooded the market with an over supply of the product, the seller must figure out a way to convince you to buy from them, or create something else entirely. Thus the shoemaking industry would always be in a flux of competitors joining and leaving as they fight to have the cheapest or best products to meet the demands of the people.
But there is a more rare circumstance, that could arise. What if being a shoemaker was such a specialized occupation that nobody else could figure out how to do it? What if the shoemaker was the only one that knew how to make shoes? This lone shoemaker would own a monopoly. He would own the entire supply. Without competition, this shoemaker does not have to worry about making the price cheap, so he could raise it. He would charge more and more for shoes, and consumers would have to pay it, right? Or would they?
What if that price exceeded what they are willing to pay? What if the shoemaker puts a price on his shoes which is higher than what people value them at? Once again, a price is merely a guess of what people value things at. And every single person values things at different rates. What if the people would rather go shoeless? What if they are all living in poverty, and would rather spend money on food instead of shoes? What if somebody created mats and pathways to walk on that were soft and eliminated the very need to have shoes? People become innovative when they are pushed into a corner. People find ways to avoid paying prices higher than what they believe the value is. In addition to this, there will be many people who will see the money that the shoemaker is making, and want to join the action. There would be people who devote their time to learning the art so that they could become a competitor.
In this way, the force of the market actively works against monopolies. The desires of individuals to increase their own prosperity is the very tool that can stop a monopoly from endlessly controlling a market.
But for the time being, let's ignore the inevitable competition, and assume that the shoemaker remains a monopoly. There is another possible outcome. The government of this group of people may see the overpriced shoes, and see that people can no longer afford them. Perhaps the government assumes that people still want to buy shoes, but simply cannot afford them. This is a broad assumption because it neglects any individual who chooses not to wear shoes. Immediately we are heading in the wrong direction by disregarding the preferences of the people. Nevertheless, if the government chooses to intervene there are two options: financial aid or control of the monopoly. Let's investigate both of these options.
With financial aid, the government decides to help the people pay for the overpriced shoes. They would offer money to pay for some or all of the cost. But before we celebrate we need to know where the government got the money to do this. A government does not have money of its own. All money used by the government came from its citizens. Most frequently it is taken in the form of taxes. If this were the case in our figurative town, the government would tax its people, then it would use that tax money to purchase the overpriced shoes for them. It forces the people to pay for overpriced shoes without addressing the fact of why they are overpriced in the first place. The flaw in this logic is obvious, but it gets worse.
Once this system is in place the shoemaker can still raise prices. Now that the citizens do not buy directly from the shoemaker they are unaware of how expensive the shoes are. But as the price increases, the government has to spend more to keep buying them. The only option is to tax its citizens more to help pay for the rising cost of the shoes. This cycle repeats endlessly. This trend is known as the Tragedy Of The Commons. And it is exactly what is happening in the realm of college tuition in the United States today. The more public funds that are available to private industries, the more those private industries will raise their prices. It is a black hole of growing prices and therefore growing taxes.
Now that we can see the flaw in that form of intervention, we can look into the second form: government control of the monopoly. In this case, the government employs the shoemaker, and they set his pay rate. They can manipulate the price in order to keep it low. It may seem like a better option at first. In fact, this is the very argument of the current socialist liberal movement in the United States. But it has a fatal flaw that is unavoidable. A government has no metric for determining value.
The government exists outside of the free market system. Remember that the seller of the product is guessing the amount of value he or she believes the consumers will pay. It is a system that is constantly in flux depending on competition and general interest in the product. If the interest in the product drops, then the seller must drop the price or provide other incentives to gain back the consumers. The seller has to sell in order to survive. In free market capitalism, the seller is forced to innovate and provide for the needs of the people.
And here lies the tragedy. While all transactions within free market capitalism are voluntary, the transactions among the government and its people are not. A tax is not voluntary. A citizen cannot refuse to pay a tax without consequences. It can be considered a non-consensual transaction. Because this is a forced transaction, it disregards the individual's opinion of the value of the product in question. There is no way to bargain or meet the needs of the people. The government has no choice but to set an arbitrary price, regardless of the preferences of the people. It is incapable of defining value and is restricted to only defining a price.
Since this is the case, we can assume that the government would avoid spending more than it receives in taxes. It would have several things to consider. First, it would have to find a version of the product that could be paid for reasonably. But as a fail safe against a budget deficit, the government would have to tax the people slightly more than what is needed to cover the cost. There are always variables, and it is a necessary evil if we give control to the governing powers. A government also segments assignments to different departments and committees. It would ask the department or committee how much funding they need to fulfill the service to the citizens. To which, these departments would also not want to risk budget deficiencies so they will also overestimate the costs.
This is a small problem that becomes compounded over and over again. It is a fault that even the most benevolent politicians cannot avoid. Not only does government set an arbitrary price, but they also overestimate the cost on purpose, and then transfer these costs to the taxpayers. No matter how good the intentions are, the prices we pay in taxes will inevitably be higher than the prices set by free market capitalism.
You are also adding a middle man to the equation. There are new administrative costs and employees to compensate. We know that the prices set are already higher, we now run into an additional problem. The more people involved as “middle men”, the more possibilities there are for corruption. Politicians who seek wealth and power can easily do this. The more responsibility that is given to a government, the more ways that it can be corrupted. There is nothing stopping politicians from setting higher costs of products and taxing citizens to cover it. Because again, we cannot argue with a tax.
The natural human desire is to increase one’s own wealth. A business owner does this in the free market by providing a product to consumers who want it (in order for the consumers to increase their own wealth as well.) But a politician increases their wealth from public funds, which are paid for by taxpayers in a transaction that they may deem as non-consensual.
In a consensual, voluntary, mutual transaction, both parties receive something that betters their situation. But if one of the two parties believe that the thing they are receiving is of less “value” than what they are giving away, it does not increase the wealth of both. It does not create mutual increased wealth. It is merely a transfer of wealth from one person to another. The general wealth of the people as a whole has not gone up. On top of this, a middle man has been added to the transaction who will pocket some of the wealth on the way to the person who really needs it. Not only does it fail to increase wealth, but it actually loses wealth in the process. It literally makes the citizens poorer in the long run.
Perhaps it is easier to view it as two separate pots of money. In one, you have all of the money amongst the private sector (citizens and their businesses), and the other is all of the money in the public sector (politicians and their departments). The private sector determines prices through what consumers value them at. While the public sector is forced to overestimate and pass the increased cost to the citizen. In the private sector, a business has to meet the demands of consumers for their survival, while the public sector is not held by any such standards because they are the ones dictating prices. The more money inside the public sector pot, the less money will be among the citizens. In essence, the larger you make a government budget, the poorer the citizens will be.
And now we come to another far more sinister problem that can arise. The public and private sectors can collude with each other in what is called Crony Capitalism. This happens in three main ways: subsidies, tax breaks, and bailouts. All of these throw a wrench into the free market system. It skews the markets ability to let consumers determine value.
A subsidy is the use of taxpayer money to a certain company or an entire industry. In effect, this business or industry has extra money that they would not normally have through the free market. Once this has happened they have an advantage over their competition. They can do several things. First, they can drop prices lower than they would normally be able to do, and possibly lower than all of their competition. This creates an unnaturally low-cost product and lends itself to that business or industry to monopolize. But the tragedy is that they are using taxpayer money to do so. And once they have the market cornered they can raise prices. Because they get an extra amount of taxpayer money, it makes it harder for new competition to even begin to try to contend with them.
Or, if an entire industry is receiving a subsidy, the producers can afford to take larger risks. They know that they have a base income no matter what, so they can slowly raise prices because they can afford to lose sales. With unnaturally high prices they gain more revenue while selling less of the goods and services. This leaves consumers paying a higher price while also paying for the subsidy through taxes.
But a subsidy cannot kill the free market. There is always innovation and ways to create entirely new products and industries that bypass the one receiving the subsidy. You cannot underestimate human ingenuity. But subsidies create an unnecessary hurdle that must be overcome if we want to see true competition.
Tax breaks sound great at first. But the effect is similar to a subsidy. It gives an advantage to a certain business or industry and hinders the competition. The additional problem with giving tax breaks is that the government still likes to provide a lot of services that require money, and giving a tax break is cutting off a “revenue” stream. If they want to avoid a budget deficit the government must raise taxes on other businesses or citizens. In either case of a subsidy or a tax break, they both use taxpayer money to fund what could become monopolies.
A bail out is straightforward. When the free market has determined that a product or service has become all but obsolete, the producers have to drop the price as much as they can to continue selling. But they eventually reach a point that the price is so low and the sales drop so much that they cannot even afford to produce the product or service any longer. The consumers have moved on to other things. But sometimes even after our buying habits have moved on, we deny it. We do not like to see a business or industry die, even though our spending habits caused the death. So we allow the government to bail out the business. They receive a lump sum of money from our tax dollars to artificially keep them operating. This discourages innovation and uses our money on things that we have deemed unnecessary. This results in a loss of wealth for the consumers.
It is important to understand that wealth is not money. Money is merely the means that we use to exchange wealth. Wealth is the products and services that we provide each other, which increase our standard of living. When we work jobs we are producing something of value to those around us. If the job we are doing is not producing something of value, then the work is not contributing to the wealth of people. In the private sector (excluding subsidies, tax breaks and bailouts) we must produce things that people value enough to buy in order to survive. But in the public sector, it is not necessary to produce anything of value to the consumer. They always talk about doing so, but their salaries are not dependent on it. Obviously, they still have to consume, and in doing so they spend money, but they don't have to produce wealth. And though they don't have to produce, we are still forced to pay them. This results in a net loss of wealth as a whole.
At their very best, government funded projects are a Zero Sum Game. The best scenario we can hope for is that wealth is moved from group A to group B with no additional wealth created. It is simply transferred. But that being the best case, it can only get worse as the corruption and cronyism actually destroy wealth.
If a thief comes into your house and steals your things it is obvious that no new wealth has been created. But the thief has a use for the items. The wealth has been transferred to the thief. We generally agree that this is a crime, and rightly so. But would it not be even more of a crime if wealth was actually destroyed in the process? This then, makes it much worse than a thief, for the government can list the many wonderful sounding things that they will use the money for, but are under no obligation to do so because they exist outside the free market. They cannot determine value, and overestimate prices on purpose. And this is done without our consent.
o in conclusion, we can determine that consumers decide value on their own accord, and producers attempt to assign prices to match them. We can also determine that wealth is only created through mutually beneficial and voluntary transactions. If one of the two parties does not agree to the transaction than it is not voluntary and it is merely a forced transfer of wealth without new wealth being created (a crime). Mutually beneficial voluntary transactions will always create new wealth and must be encouraged as much as possible. This is the way we can help one another and grow in prosperity.