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.

4 thoughts on “The Point of Exchange Is To Increase Utility

  1. Of course this excellent point will be misunderstood by those who approve of such measures. Their focus will go immediately to the notion of increased wealth. All they see is that pile of gold coins that Scrooge McDuck is reveling in. And then they feel (emphasis on feel) that this urge to increase wealth is sinful and they need to step in and force some of that wealth to be redistributed.



  2. Forgive my ignorance, but if we can say that “value is subjective” then can we also say that “wealth is subjective” too? I typically think of wealth as an objective measure of material goods/resources, but maybe that’s the wrong way to look at it.


    • Wealth is based on subjective valuations of an individual’s or company’s assets and liabilities. For example, you can get an appraisal to estimate the value of real or chattel property, but you won’t really know what it is worth until you sell it.

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    • No, I think you’re right. Keeping my above example going, pork is a good I can consume. If I were to buy it, my wealth would increase. But I don’t value (the subjective aspect of it) it. So, instead I increase my wealth by buying other things.

      Make sense?


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