 Since the study of economics began, one of the most perplexing questions on all of the minds of thinkers was how is a good actually worth something. At the time of the classical economists like Adam Smith and David Ricardo, the most widely used example for the seemingly nonsensical formation of prices was the difference in price between water and diamonds. Every human being needs water to live. It is completely essential to life, even more so than food. So why does nearly a whole week's worth of this vital resource only cost £2.10 from Tesco even coming in a convenient plastic bottle so you don't have to drink directly out of a stream when a standard white gold and diamond-encrusted wedding ring from Goldsmiths cost £2,250? That's the same price of over 1,000 weeks worth of water or almost 20 years. You can meet one of your most important survival needs across two decades for the same price as some shiny rocks to go on your finger which you could lose forever at any time and that don't literally keep you alive like water does. On paper this seems to make no sense doesn't it? Well humans don't live on paper, we live on earth. So in all of this confusion nobody had a clear answer but the one that people most often gravitated to was the labour theory of value. This theory says that goods have value because a worker put their labour into it, that a diamond in the ground isn't objectively worth anything until a worker pulls it out, another transports it, another refines it, another cuts it and then another sells it. This process is known as the division of labour and it is incredibly crucial but we can see it still doesn't explain the high price of the diamond as there's no way that this process is objectively equivalent in labour to 20 years of survival in the form of water. Well if you watched my previous video in this series where I laid out the brief history of the Austrian School of Economics you'll remember I went to great lengths to praise Carl Menger due to him founding the school in 1871 with his publication of Principles of Economics in which he finally put the contradictions and confusion to rest with a world changing realisation. All value is in fact subjective and is determined by the individual. It is impossible to place an objective, definitive and undeniable value on any single thing because no two people will perceive every possible good at the exact same level of value. Everything means something different to everyone. Think of the term beauty is in the eye of the beholder and change to value is in the eye of the beholder. There is no objective measurement of beauty because everyone views it at least slightly differently and as such there is no objective measure of value. Not the labour that went into a good, not the intrinsic human usefulness of it, not the costs incurred in production, it is simply impossible to objectively define because it grants different utility in its use to different people. And that is the ultimate source of value. Individual utility. But prices obviously still exist so if there is no objective measurement of value why are there literal price tags on goods that you have to pay in order to receive them? The subjective theory of value does not say that prices are just the work of fiction. Prices and value do exist, it just only exists on an individual level until all of the possible values of a good congregate together in a marketplace and get matched up with all the possible amounts of goods that can be provided at various prices through which the amount between the producer and consumer of a good is met. What I just described there is the process of supply and demand and I'm sure you've all heard of it. When the largest amount of people decide on a particular value for a good and the producer can supply the amount required to fulfil this demand, you've reached the equilibrium price. There are other factors involved such as elasticity of demand and economies of scale but we don't need those for this video. Every individual's subjective valuation of a good is their individual demand. Every individual's demand scale on a group of goods is guaranteed to be different and the market system works by satisfying the most amount of people's values at the lowest possible price. Taking an aggregate demand curve by adding up all the valuations in an economy is not an objective measure of value because demand is also affected by the available supply. You can't have an objective standard of value that is constantly subject to the change of people's personal valuations, that's simply impossible. The market equilibrium price is not meant to be viewed as a good's objective value as such a thing does not exist. It is simply the most efficient price at the given time depending on the technological limitations of the producers and the current demand of the consumers. The labour theory of value cannot truly reconcile itself with supply and demand and price formation as a constantly shifting level of value cannot be called objective precisely because the aggregate value level is simply just the most widely appealing price among a collective of subjective valuations. And within an individual's value scales not even the same good is held at equal value twice. Another concept pioneered by MENGA called marginal utility demonstrates how an increasing lack of scarcity makes a good less valuable. Making utility to mean usefulness or happiness, let's say you come across a bar of chocolate for a mere 50 pence. That sounds like a great deal and you really fancy some chocolate at the moment so you buy it. Once you've eaten that bar of chocolate, how likely are you to go straight back for a second? Obviously, some people are absolute chocolate fiends and will keep going back until the sunset but I'm willing to bet most people wouldn't even go back a single time. The consumption of one bar of chocolate has satisfied your utility, your human wants for now. The amount of personal utility decreases with every additional good consumed until it provides no more utility for you or at the very least any utility gained is not worth the disutility in return which could be the amount of money you've spent or the amount of weight you've gained in your chocolate binge. The real equilibrium price in an economy is the price where the most utility is achieved across the board. At a forced higher rate of supply, the producer begins to take on higher disutility as their marginal revenue begins to decline and at a forced lower supply which creates a higher price due to higher demand, fewer consumers could obtain the good as the disutility of cost overtakes the utility of consumption. Now let's think back to the diamond water paradox. After you drink a litre of water you will not be keen to start chugging down another litre and because you know that water will be easily accessible the next time you need it, you're not in a rush to enter a bidding war for it. It's precisely the fact that you can't pick up six packs of diamond rings at Tesco that makes them so expensive. Their relative scarcity is beyond comparison and while water fulfills a human need diamonds fulfill a human want. The monetary sum of all of the water in the world would be an astronomical figure totaling a much higher amount than all of the total diamonds in the world, even if one diamond ring can buy you 20 years of water. Diamonds are incredibly scarce and this scarcity plays on our subjective valuations to drive its value higher and if you're thinking to yourself there's no way I would ever pay that much for a ring, detach from yourself for a moment and imagine how many people you personally know that would, especially if they had the means of their disposal. Say's law can also come into place here. If you imagine that the price of diamond rings fell low enough their supply could create its own demand as you can essentially give away anything to anyone if the price is low enough regardless of the personal utility one might receive from a good. The available supply of a good is determined in part by the scarcity of its compounding resources. Air is not a scarce resource because outside of extremely exceptional circumstances like on Mount Everest where it's very thin you do not need to sacrifice one end in its use i.e. you don't need to give up breathing to light a fire even though they both require the consumption of air. We'll go into this more in a later video on opportunity cost. So then if you've done any conventional economic study at school you'll probably realise that you might already know most of this stuff except it may be worded a bit differently. That's because subjective value, marginal utility and price determination are the main areas of the Austrian school that have been completely adopted into the mainstream economic zeitgeist but have been done so entirely without credit and without any consideration to the continuing ideas of the Austrian school that came from this. It's convenient for the economic powers that be to adopt the subjective nature of value because it already fits into the basic models of supply and demand, economies of scale, division of labour and such that they were already using. These models were first conceptualised by the classical economists but they half-heartedly rested them upon an inconclusive labour theory of value. So Menge's marginal revolution was the missing piece of this puzzle. However it's very depressing to realise the innumerable implications that subjective value has to the macroeconomy that the Austrian school has realised but the mainstream has ignored because it's simply inconvenient to their status quo. The chief example I have in mind here is the Austrian business cycle theory, another upcoming topic. When we get into it you'll see that this Austrian theory of value and prices inevitably lead to the conclusion that supply and demand, time preference and value assessment all apply to money and credit just as much as they apply to goods. And if that's the case, the very existence of central banks and any form of government currency manipulation cannot be justified and will inevitably interrupt and falsify the market process, causing it to repeatedly build bubbles and inevitably burst into recessions. Menge started a new chain of impeccable logic which has largely gone ignored except for the first link of the chain because that particular link just happened to fit into the pre-existing chain, the chain which forms the whip of statist economic tyranny. So at around the same point in time as Menge was revolutionising the concept of value away from the fruitless pursuit of objectivity, Karl Marx grabbed the labour theory of value with both hands and used it to create his theory of capitalist exploitation. Marx's interpretation is very complicated, the least of reasons among them being that he contradicts himself at many times and changes definitions almost at will, seemingly whenever he hits a logical snag to make a quick workaround. So while I won't intend this segment to be a refutation of his theories, it's at least a start. Assuming the LTV to be true and the use of labour time being the creator of a goods intrinsic value separate from its market price, Marx states that any good traded for a good of lesser labour value is an objectively unequal transaction and the person selling short in this exchange is being exploited out of their labour. I tackled this towards the end of my video debunking arguments against the statement taxation is theft, but I'll reiterate it here. In the Marxist theory of exploitation, if you make a chair for four hours and your labour is worth, in air quotes, £10 an hour by some objective standard, the chair must cost at least £40 and you must be paid exactly £40. If you are instead paid £30 and the chair sells for £40, that missing £10 is called your surplus value, which the evil greedy bourgeois capitalist pig has stolen from you and taken as profit, despite the fact that you agreed to receive this hourly rate and you can't be consensually stolen from because that's obviously an oxymoron. But deeper than this, what happens if there is not enough demand for a £30 chair and the chair in fact doesn't sell? Rather than making a £10 profit, this evil greedy bourgeois capitalist pig has instead taken a £30 loss, losing triple the value that he otherwise stood to gain. The risk to reward ratio here is 3 to 1, which seems a terrible proposition for the capitalist, but how would you know? You still have that £30 in your back pocket. If you directly flip this logic of exploitation, you getting paid a wage for a good that doesn't sell is actually you exploiting the capitalist and that makes you the evil one. You've engaged in a transaction weighted three times in your favour. Far more unequal than when you made a chair and the capitalist made a £10 profit. But of course this all obfuscates other factors of Marx's theory such as the nature of capital, distinctions of value types and price and so on. To keep it concise, Marxism views the formation of value and prices through a skewed lens by asserting its moral stance long before its economic one, and essentially ends up assuming that market prices are abstract and meaningless, but like an atom has a definitive makeup of protons, electrons and neutrons, a good has some sort of intrinsic and scientific bearer of value, which is labour time. There is of course immense importance in moral discussion and I do my fair share of it too, but the horrendous economic track record of socialism makes a lot of sense when you consider its introductory assumptions, however let's not also forget the condition of its moral track record as well. So to summarise this video, fundamentally, value is in the eye of the beholder. Markets and their process of finding prices are always the best way to realise the collective values of a society and it enables equilibrium production by fully realising individual utility through supply, demand and the many factors which go into those two behemoths of human interaction in order to continually satisfy the greatest possible utility through competition and cooperation. This is another thing that will be continued in its own video on what is certainly the biggest nail in the coffin for socialism, the economic calculation problem. The view behind socialist economics, which inherently see prices as not very important and certainly not comparable to labour and surpluses is a catastrophic misalignment of priorities and is what dooms socialism to always fail no matter how many times it's tried. I'm not too sure which topic I'll tackle next in this series, so at least that can be a nice surprise for you when it comes out, but I doubt it will be the economic calculation problem just yet, so I'm sorry if that little teaser got you quite excited for it. But for now, take it easy.