Austrian view to utility, satisfaction and value

Christopher Pang

What you pay is what you get?

In microeconomics, the law of marginal utility is essential for modern economists to attempt to quantify consumer satisfaction. Utility is a measure of relative satisfaction, modeled to be affected by consumption of goods and services, evaluating decisions to deploy scarce resources (time and money) between leisure and work, between investing, saving and spending. Economists today try to measure utility using prices, based on the simple fact that prices are effectively the amount a person is willing to pay for the fulfillment or satisfaction of his desire. Can satisfaction really be quantified using prices we pay?

The value of different goods and services does not depend on the market price or the intrinsic value of the things but the subjective valuation of the individual making the evaluation to exchange. All economic activities take place because an individual has a valuation ranking system and it differs from the other individual he is exchanging with, otherwise known as the subjective theory of value in Austrian economics. It is the difference between people’s perceived value that trade/exchange exists.

Carl Menger, one of the earliest Austrian economists, argued that price cannot be a measurement of utility. Individuals should rank all possible uses of their money and then use marginal utility to decide the trade offs. In the water diamond paradox, also known as paradox of value, marginalists try to explain that it is not the total usefulness of diamonds or water that matter but the usefulness of each unit of water or diamonds. If you had to choose between a diamond and a bottle of water, it is likely you would pick diamond. Marginalists then argued that the price of something is determined by its scarcity rather than its usefulness. If it happens you are stuck in a desert where diamonds and water is just as scarce, what is the likelihood of you picking the water over the diamond? Thus the most critical factor in determining the decision for exchange is not the scarcity but the perceived satisfaction.

In a simple real life example, I would only be willing to pay SGD8 for a pint of beer. Under normal circumstances, I would seek a pub/bar/restaurant which meets my reservation price, defined as the highest price a buyer would pay for a good or service. However last week I paid a premium of SGD10 over my reservation price last week, not once but a total of three times because of a guest appearance by singer songwriter from Hong Kong, Robynn Yip. From the economist’s perspective, my willingness to pay SGD18 for a beer last week suggests my valuation of the beer is SGD18. The economist would then conclude that SGD18 is the equilibrium price because I was willing to part with it last week.

Would I pay SGD18 for the same beer this week? Obviously I would not because the value of the beer means nothing to me. The economist does not know why I valued the beer last week more than this week. What is the cost of the beer? It is not the SGD18 I paid but the next best alternative I could use the SGD18 to derive satisfaction, otherwise known as opportunity cost. The economist cannot conclude I derived SGD18 of satisfaction because the value to me has to be more than the SGD18, in order for me to sacrifice the SGD18. I do not know how much more, let alone the economist. The economist would not know unless I pay that higher price for that beer with the exact same conditions. The only conclusion the economist can draw from his observation is that I ranked that beer at Timbre (hearing/watching Robynn live) higher than any other alternative I can use that SGD18 for at that moment(s) in time.

If a rich man and a poor man are making a decision to purchase a fast food meal; the rich man makes the purchase and the poor man decides not to. To the economist, it looks like the rich man values the meal more than the poor man. The opportunity cost to the rich man is probably next to nothing whereas to the poor man, it could mean a tin of milk for his baby, or groceries for the week. When two men give the same thing, the same thing is not the same to the two men. The only thing we can observe is that the rich man values the meal higher than any other alternatives he can use his SGD6 for but the poor man values his alternatives more than the meal.

Economists today attempt to predict the future by observing past economic activity, then running empirical tests, using historical data to create correlation studies, formulas and indifference curves to forecast the future. Is it really possible to do this? Would I buy the same beer today at Timbre? Can consumer behaviour really be aggregated? Does everyone have the same value judgment of goods and services? Does everyone purchase the iPhone solely for games? The answer to all of the above questions is no. Everyone has a different value ranking system at different times because value is subjective and cannot be accurately measured based on prices we paid. No one will know what you value most at that moment except yourself. What you value today might not be the same as what you value tomorrow.