The Point of Exchange Is To Increase Utility

Don Boudreaux’s Quote of the Day at Cafe Hayek got me thinking on value.  The quote, from the indispensable Armen Alchian, is excellent in its own right, but Don’s follow-up comments are where I want to focus.  Don says:

Tom Palmer often recalls how, many years ago, he – a young man of very modest means – was bidding to buy a rare book.  Another of the bidders for this same book was Charles Koch, already a very wealthy man.  Tom won the bidding.  Alchian’s insight [quoted in the paragraph] above helps to explain why.

One of the more common justifications we hear regarding price floors for wealthy people (for example, minimum wage or tariffs), is “they’re wealthy so they can afford it.” However, this justification misses the point of exchange.  The point of exchange is to increase one’s utility, not to buy whatever one can afford.  One isn’t going to buy something, even if he can afford it, if it does him no service.

I use as an example myself.  I thank God that I have been able to make good money for someone of my age and skill.  When I go to the grocery store, I buy many kinds of things, but I do not buy pork.  Why not?  I can afford it.  My bi-weekly grocery bill rarely exceeds $60, and adding on a few extra dollars for pork products wouldn’t bankrupt me at all.  The reason I don’t is because I don’t like pork that much.  I’ll eat bacon from time to time, but that’s really it.  Buying pork would make me worse off because the dollars I spent on pork (something which brings me little pleasure) I could have spent on something that would have brought me more pleasure, like baseball tickets.

The situation is the same as in the story Don recounts between Charles Koch and Tom Palmer.  Both were bidding on a book and it eventually reached the point where Koch’s value gained from the book was lower than the price he had to pay.  In economic terms, his marginal cost exceeded his marginal benefit.  Conversely, the price was spot on for Tom, where the value gained from the book was equal or greater than the price he had to pay (in other words, his marginal benefit was equal to or greater than his marginal cost).

It is this simple concept that rests nearly all of economic and social thought.  It is why taxes are effective at altering behavior.  It is why minimum wage leads to lower employment.  It is why the Demand Curve slopes down (and the Supply Curve slopes up).  When the assumption is made that higher taxes/mandated wages/etc won’t change behavior because “they can afford it,” there is a fundamental misunderstanding on how people operate and why such schemes are ultimately doomed to fail.