There is an enormous amount of confusion between price and value; this problem was resolved a couple of centuries ago. I’m sure someone with a recent college degree in economics can tell me who finally solved it, but for a long time there was great debate over whether price and value were the same thing, kind of like there still is a debate in physics about whether gravitational and inertial mass are the same thing.
First, if money is exchanged by spending time and possibly additionally happiness or opportunity cost or whatever dimensions you may wish to add to your cost vector, you can see exactly how much extra stuff is worth. Conversely, employers exchange stuff for employee time.
Second, whether you are willing to make the exchange comes down to your marginal value (loss) of doing work, that is, utility you’re giving away, versus the marginal value of happiness of an extra ice cream cone, say, that is, utility you’re getting in exchange. At one end, if you’re working very little, your marginal time is not worth much to you, it is cheap, so you don’t mind working. At the other end, you’re already working a lot overtime, so it costs more. Conversely, basic needs are very valuable to you. You will pay a lot for indoor plumbing (which is surprisingly cheap) or the first glass of water in the desert, but the value you are willing to pay for a luxury item like a $50,000 dollar wrist watch is less.
Now make a ranking ladder. You will have something like: 100 hours of spare time in a week, 99 hours of spare time, etc….. 0 hours of spare time.
Conversely, you will also have daily dose of lentil soup, you will have luxury food, an xbox, the fifth bed room, etc. Now all you have to do is rank them according to what you can afford. For instance, you may rank having an xbox above having 80 hours of spare time but below have 60 hours of spare time. In other words, you’re willing to work up to 20 hours more to get the xbox.
Admittedly this is one-dimensional, but as I said, you can make it multidimensional including aspects such as pride in work, fun, … on top of the price. To make things simple, simple market economics only calculate one price. This one price obviously carries less information than an entire price vector. This is probably the main reason the economy is so hard to understand and control(*), anyway…
If we compare how we each individually rank our ladders, it will be found that those of us who are very frugal value over time very highly over say red meat dinners. On the multidimensional ladder we may value the chopping our own wood and displaying another skill over working extra hours at the same skill.
(*) It would not be an entirely stupid idea to carry several, at least two, prices on market goods. It would as far as I can intuitively see not be impossible either. With two prices there would be more information carried and possibly one price signal could be used as a predictor of an alternative quality such as inflation, pollution credits, etc.
Now, money is the value that is attached to something in the aggregate when we bring all our individual ladders together and negotiate who gets what: sparetime or extra ice cream. This, by definition is the price. Price is the average value attached to something by all people, but technically the price is the rung that the last person is willing to sell something for or buy something at. (In the real world there’s a spread – we’re getting into the finer details of trading now, but I digress). Price is virtual but objective. Value is real but subjective. Make sense?
The price may significantly differ from the value you attach to it; particularly if your values are far from the mainstream. If the price is higher than the value you attach, you aren’t buying and vice versa. For instance, today spare time is very cheap, and hence I have been buying a lot of that, enough to retire. Many people do not value spare time to the same degree that I do and instead desire big screen TVs and $50 dinners.
To further complicate matters, ladders do are not constant in time. One dollar today is not the same as one dollar tomorrow. In general, one dollar today is always better. If you start trading with future ladders through the use of debt contracts, you easily develop the concept of interest rates, e.g. I’ll trade my $100 today for your $105 dollars next year, the interest rate is thus 5%.
The fact that interest rates are larger than 0 suggests that some want to spend money now that they don’t have and some people have money now that they don’t wish to spend and thus a deal is made. Realistically such deals are made very fast and thus compared to the the amount of nominal wealth out there, the number of circulating money in the form of cash is really small.
Sure, all money is eventually spent by someone. The key to understanding this is not that it will be spent, but WHEN it will be spent and WHO will spend it. People hold money simply because they do not wish to spend it now; and they get paid by other people who do wish to spend it now. I tell you, thus getting paid can be a powerful motivator for for never spending it!
I hope this made the concept of value, price, and spending money a little more clear.
Originally posted 2009-05-01 23:37:05.