Saturday, March 12, 2005

Economics Lesson No. 2: Wealth, Worth, Prices, Capitalism and Competition

So what is wealth anyway, if dollars are only paper? (See Economics Lesson No. 1) How do you evaluate something's "worth?" And while we're at it, what is capitalism?

My father Edward C. Harwood was an economist who created the American Institute for Economic Research in Boston in 1933, moving it to Great Barrington, Massachusetts in 1946. When he gave his speeches, he was always very clear about the basics. For example:

First, what is wealth? Wealth is stored value, as contrasted to spent value. Most often, we measure wealth in terms of the dollars we have saved or invested and of the dollar selling price of the things we have acquired. Now, when you think about it, the value to each of us at any given moment of any particular amount of wealth is probably going to be the equivalent of the time, skill and intensity of the work it would take to earn enough dollars to pay for it. Following this to its logical conclusion, wealth is therefore essentially nothing more than stored work.

Thus in short, we represent the value of a dollar as the work required of us to obtain one. Then how do we go about evaluating something else's worth in dollars, using our own work as a measuring stick?

Here's an example. Imagine that you are walking about in the hills of Berkshire County on a nice September day. You come upon some apples on a tree. For nothing more than the effort it takes you to reach up your hand, you can pick one of them to take home or eat on the spot. Assuming this apple tree is not on someone else's private property, this apple is "free," other than the little effort expended to pick it. You didn't have to pull out one extra penny to give to anyone. This apple is cheap.

Now imagine that you are walking through a market on a small New England street. There are stands of fruit of all kinds. That same apple is sitting on one of those stands. Rather than pick it up and try to get away with consuming it for free, you will probably pull a few cents out of your pocket and give them to the person who bought the land and seed, planted the tree, picked the apple, bundled it up, transported it to market, rented a stall and displayed it on tables (with decorative leaves) just so that you could share in the pleasure of feeling the juice run down your chin.

What I'm getting at is that the apple, in truth - and this is counterintuitive - is worth only the time and effort it takes for you to pick it, chew it up and throw out the core. It's "intrinsic value," in other words, is much less than you would think. What you are actually paying for is the merchant's services: his time, his labor, and his cost to obtain the tree seeds, to tend the trees, to buy a truck to take them to town and to put them so nicely on display.



So how do buyers and sellers determine the value of their work in dollars?

Because there is probably more than one apple seller at the market that day, the sellers have two worries. They cannot just ask for any amount in exchange for the apple, because either the buyer may decide he'd rather work himself, go out in the fields and pick his own apple, or the merchant next table over may accept a few pennies less, just to get the sale. This sounds like a game, and in fact it is, because the two or more sellers will take more and more pennies off, right down precisely to the point where it barely pays them to bring the apples to market at all.

In a sense, the winner is the buyer, because as long as no one is colluding and the game is played fairly (more about that later), he doesn't have to worry about being "ripped off," given that the bargaining process will ensure that the price of his apple is about right relative to the cost to bring it to market. The buyer also knows that he can do the work himself; therefore, if he doesn't want to pay whatever that price is, there will be no apples next time, and that's just the way the cookie crumbles.

If that happens, that means there will be no advantage to having apples brought to a market. On the other hand, you may have been smart enough to note that in all cases where a sale is completed on a voluntary and fair basis, both the buyers and the sellers are the winners, because both sides have gotten what they wanted to make their life better. Not only that, but the market even determines what the fair price of an apple will be on that particular day, both for the buyer and the seller. Everyone's happy. That in a nutshell is the beauty of capitalism and its underpinnings, competition.

Now we must move on to the dangers of a "floating" dollar, and why our evaluation of our own work is a pretty primitive and unsound measuring stick for a dollar's worth.

1 Comments:

Blogger Bill said...

I recently learned a lot about the apple from Michael Pollan's book The Botany of Desire.

There's a common error in the apple analogy you make, which is the belief that apple seeds produce trees with edible apples. Apples you buy at any market are grown from grafted trees, not from seed. Some very small fraction of trees grown from seed actually produce sweet apples, and once one is discovered the tree becomes the source of all future apples of that variety.

I'm not pointing this out to be picky--there's an economics tie-in. Remember Johnny Appleseed from grade school stories? He did plant apple seeds all over the frontier, but it wasn't for fun. He owned the land wherever he planted, and he sold apples and trees to local settlers. The apples, grown from seed, were mostly sour crab apples used for cider (the alcoholic kind).

So the economic value of an apple at market is related to scarcity--you never would find a good eating apple just by happening upon a tree on public land. It takes skill, labor and other resources to make apples that taste good.

Pollan points out another channel of value being exchanged: the apple itself, specifically its genes, gains from this relationship with humans. We go to all sorts of trouble to ensure the survival of particular genes, in effect imposing Darwinian artificial selection on the species.

And that's just apples. The section on tulips is full of economics issues related to the Dutch tulip market crash in the 1600's.

7:34 AM  

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