 Value theory within economics represents all theories that try to define what economic value is, where it comes from, why goods and services are priced the way they are and how to calculate some form of objective price if such a thing exists. In this video we'll be looking at two major paradigms to the theory of economic value, the standard extrinsic paradigm based around the idea of utility and the alternative non-linear paradigm of intrinsic value. The theory of extrinsic value, also called the subjective theory of value, is a theory which advances the idea that the value of a good is determined by the importance an acting individual places on a good for the achievement of his or her desired ends, what is called utility. The theory of extrinsic value posits that value cannot be measured or observed directly, so instead economists derived a way to infer underlining relative utilities from observing choices called revealed preferences. The economist Alfred Marshall put it like this, utility is taken to be correlative to desire or want, it has been already argued that desires cannot be measured directly but only indirectly by the outward phenomena to which they give rise and that in those cases with which economists is chiefly concerned the measurement is found in the price which a person is willing to pay for the fulfillment or satisfaction of his desire. An important component to this theory is what is called consistent choice, once an agent's preference have been revealed they are not allowed to change unless the properties of the good they are evaluating changes. If I prefer an apple to an orange now I cannot change my preference unless some properties of the goods changes but if all the properties stay the same and instead we add a banana to this set of choices and then I make the choice again I'm not allowed to choose the orange this time. Because in both cases I did not choose the banana it is considered not part of the optimization equation and thus cannot alter my choices. The banana is exogenous to the equation it is part of the context and within this model the context cannot alter what happens in the equation. What all of this is saying is that the value of something is in the properties of that entity and people's perception of them and you are not allowed to change your evaluation of it unless its properties change. If you suddenly notice that the apple has a little blemish on it then its properties have changed and you can change your evaluation of it and choose another option that's considered rational. Put more formally if an agent chooses x over y then whenever x and y are available she will always choose x over y. What this makes explicit is that the context cannot change the evaluation of things. Within this model the context cannot add or subtract any value as long as this condition of consistent choice holds we can then model agent's behavior in terms of an optimization over a set of choices and we will get a closed form solution. In our previous example because the banana should not have affected my choices we can abstract away from the particular context within which the choice is being made assuming that this context does not add or subtract any value to the properties of the good under evaluation and thus we don't need it in our model. Because utility is always defined through revealed preference it always exists with respect to someone or some organization. Objective value is then defined through the interplay between people's utility functions that is to say the interaction between producers and consumers trying to maximize their utility creates what is called a market and the market defines the economic value of something what we call its price. The benefits of this model to value are many, most importantly it gives us a very simple way to objectively evaluate something. This extrinsic value model gives us a very compact clean and robust mechanism for objectively evaluating things. Another important part of this idea of the market as defining price and value is the law of large numbers. It is assumed that the more people we have in this market the more information we're bringing into the equation and thus the greater the interplay between all these different subjective utility functions that will end up approximating some kind of real evaluation of the good and this is a central idea in the efficient markets hypothesis. The more people in the market and the more competitive they are the more information we will have and the closer we will approximate some kind of objective evaluation. This whole framework of extrinsic value theory is critical to achieving abstract mathematical models of markets as equilibrium points which is of course central to the whole enterprise of standard economics. Utility always defines value in relation to someone thus within this model something can't have value independent from someone desiring it which is essentially the definition of extrinsic value. When value is defined by the interaction between different well-defined utility functions this means that the thing does not have any intrinsic value. Thus the value of an entity cannot be dependent upon something else it cannot be dependent upon the context as we illustrated with our banana example previously. And this is where the theory and the data diverge. Many experiments from behavioral economics will tell us that value does in fact change depending upon the context. Not only this but value may in fact sometimes be fully defined by the context which is way outside the model that we have here. For example the value of a color is dependent upon what color is placed next to it. The perceived value of a product in a magazine is dependent upon other products in that magazine that they were never going to purchase but the price and quality of those other products did create the context for their evaluation of the item that they did purchase. With hyperbolic discounting our preferences for different payoffs is dependent upon the context of time. This phenomena that value is not just dependent upon the properties of something in isolation but also upon its context is everywhere and very intuitive to us. But incorporating context as a defining factor into value would lead us to a whole new paradigm called intrinsic value where the value of something can be at least partially independent from the value ascribed to it by some agent in isolation. With intrinsic value theory the change in value may derive from the items relations to other things and thus dependent upon those other things what we call the context. Thus this context can in fact have some value and it can add or subtract value to any individual item within that context. Allowing for this empirical fact will give us a very different model where value and preferences are dynamically changing depending upon the connections and context. Within this intrinsic value paradigm value is in how things are contextualized culturally socially environmentally and technologically and we'll take some examples of this to try and solidify it. I want to be a lawyer because it is a socially respected job. The job is giving me access to a culturally respected identity. In other words through the job I am gaining access to cultural capital. Every time another person joins this culture and believes that my job as a lawyer has prestige the value of my job goes up not because it got any better or I got paid any more but because the network that I'm getting value from has grown. I choose to wear a suit to work because that's what everyone else at my workplace does. The thing that is the suit is giving me access to social capital derived from being part of this in group. I buy a tablet computer because it will give me access to the internet. The value of these things is really in the fact that they give one access to a network that has value as a whole the internet, society, my culture, the natural environment etc. In all these examples the value is actually in the integrity of the entire network not a property of the thing. Every time another person joins Facebook it makes my account with Facebook more valuable. My account has not changed but the network's value has and because the value of my account is in its access to that network its value has gone up. This is what we call the network effect where the value comes from the network. The network is just another word for the context a set of connections that adds or subtracts value to the item. If things then have value in their connections the inverse is also true. By disconnecting them we will reduce their value. Many of the jobs that are considered undesirable are so because they only give economic value. Cleaning the street is such an activity. It has very low social status. It has no enduring value as it will be rubbish again tomorrow and you'll have to do it again. You will also have to live with the fact that some machine could probably do your job better than you. All of these reduce the psychological or what we might call cultural capital received from the activity and due to this we will have to pay people a financial reward that is the only remuneration of value that they will get from this activity because they are disconnected from other networks that might add value to the activity. Because the value is in the connections it is both in your access to the network and the integrity of the network. If we were to disintegrate the internet by disconnecting servers or cables the value of all the devices connected would go down or if we believe the organization we form part of is without integrity the value to us of our social status within it will also be devalued and as we'll be discussing later the value of the whole system is often an emergent phenomena which requires all the parts to be working together in an integrated fashion out of this we get the emergent value of the whole system when we disintegrate the system this emergent value no longer exists and the value of all the components in the system is reduced this intrinsic conception of value is what we call well-being well-being is a very complex phenomena the value that it represents is a distributed one well-being is not the property of a thing it is what emerges out of forming part of having access to many different services ecosystem services industrial services social cultural etc but it is also in contributing to these systems co-creating value within them the value that emerges is a complex interaction of different forms of capital the value of something is not just contingent on its context within space but also its context within time the standard model is very much a static one time doesn't inherently change the value of things in the static model value just exists and people want it if they get it they will be happy it is assumed that agents will always try and achieve it at the lowest possible expense of resources and thus within this model there is no value in the process of achieving it but this is in contrast to empirical data where we often see that the value of the thing is created during the process that people go through in trying to achieve it for example in experiments that have been done with participants building things like Lego toys or origami figures the participants who engaged in this process valued those things more than those who did not engage in the process and those who had harder tasks valued the end product even more in experiments it turns out that people have to be paid more to do repetitive tasks that have no lasting outcome as soon as you add some elements of endurance to the finished product so that they feel like they are part of an enduring process this gives meaning to what they're doing and they will be more motivated being prepared to work at a lower cost this is an example of cultural capital it gives us a sense of direction and self-realization that adds value to what we're doing in cultural capital value is in fulfilling some motivation and this motivation plays out over time it is a process and the value of things is contextualized by that process the sense of achievement one gets when one goes through the full process of creating something might be an example of an emergent phenomena the integrity of that whole process adds some value to it in contrast when we divide the process up through specialization asking a worker to do repetitive tasks on a production line they become alienated from the end product and receive no value from it what I'm trying to illustrate here is that as with our previous example where value was added by the integrity of the context in space the same is true of time where the value is in the continuity of the process and that emergent phenomena adds value to any component within it like all emergent phenomena this is nonlinear the whole is greater than the sum of its constituent parts by performing or maintaining that whole process we get that emergent value value is added by the integrity of the network our standard theory of value was formalized within the context of the industrial age where the mass production of discrete tangible products was at the center of economic activity these discrete products could be easily given a homogeneous quantified price due to a lack of information this model of the market was an ideal mechanism for defining an objective value in the form of a single price metric today a number of different factors are converging to put stress on this traditional paradigm to value they include most of the major trends that we previously highlighted serviceization information technology the knowledge economy sustainability information technology is making it ever more explicit that the value is in the network of connections such as the internet or social networks in an interconnected world it is increasingly explicit that access and connections are what people want instead of the ownership of discrete tangible products information technology in the form of big data is giving us quantifiable values to all sorts of things that we never had previously how many people follow you on Twitter which is social capital how environmentally friendly a product is and how much people are prepared to pay for that which is ecological capital in big data we have the capacity to reveal the value of things and we're not just talking about aggregate values we may soon have individual personalized values associated with different individual goods and services Amazon the online retailer already uses sophisticated algorithms to adjust the price of products for different customers depending on information they have about your profile what device you're using what time of day it is and so on they may adjust the price accordingly we talk previously about serviceization we don't sell you a single product we sell you access to a service and that service is really a network that aggregates many different things in order to deliver a complex form of value to the right person in the right context added to this is the knowledge economy which requires a new skill set of intelligence self motivation meaning context creation all of which can't really be brought about with reference to extrinsic value they require the harnessing of motivations through intrinsic value in this module we've outlined two paradigms to economic value one extrinsic that is defined in terms of the value that an agent ascribes to an entity due to its properties in isolation what is called utility within this formalization value is a homogeneous variable it is derived from a single source the properties of the good or service and made manifest within prices that represent the interplay between different people's utility functions we've talked about an alternative formalization of value called intrinsic value that emerges out of the network connections that the entity is embedded within and this value changes depending on the context within this model value is heterogeneous it is derived from a network of interacting social cultural industrial and ecological capital we should maybe think about these two models as tools in our theoretical toolbox to be used when appropriate they both have their advantages and disadvantages that will make them applicable in different circumstances extrinsic models will often give us nice clean closed form solutions but we can't always use them as extrinsic models will run into the problem of market failures due to the fact that markets can't define intrinsic value the intrinsic model to value doesn't suffer market failures and it is much more representative of empirical data but it is also much more complex in many cases we don't really have the models to fully define it in order to instantiate them we're likely gonna need lots of data and again we often don't have this but with the rise of big data and advanced analytics it's very likely that we will increasingly have this in the future