 My topic for this morning is markets and prices. So before we hop in, I just kind of wanna think a little bit about what we want the economy to do, in a sense. And I think that Dr. Murphy did very well, saying that when we think about human action, what it's really all about is me as an individual, applying the resources I have at my disposal to accomplish my most important goals. So I have these various purposes in mind. Some are more important than others. I have various means at my disposal. I apply those means to attain my most important ends. And I think it's fair to say that when we are involved in a social economy, like we are involved with other people, that we'd like the economy to allow us as individuals to achieve our most important ends. So that that way I'm not just bound by the resources that I individually have in my pockets or in my house, but that if there's something say that you have, they'll be very valuable to me and I have something that would be very valuable to you. We now have the opportunity to exchange these things so that each of us can fulfill a more important goal than we could if we were totally isolated. So I think ultimately the goal of the economy is for us to use all of the resources available in our society to attain a maximum value in the eyes of us as the people using these resources. So I'm gonna suggest that the market and the pricing system that coordinates our behavior in such a way that we do actually do that. That is we do actually apply resources to the most important goals. Now first we have to kind of establish what do I mean by most important goals? Building on what Dr. Murphy said, remember that value is subjective. So we can think about something very simple like a box of chocolates. What is a box of chocolates really worth? Well, it depends who you ask. If you're say someone like me or I have a wife who likes chocolate, to me a box of chocolates is very valuable because I can then take it and give it as a gift to my wife and that makes her happy and that makes me happy and my life is much better. And other people may say, and the box of chocolates is worthless, it's not really good for your health, there's all the sugar and fat and various other things in it. It's just, it's on the whole, not good. Well, different people have these opinions and if as economists what I'm interested in is people's behavior, then I just have to accept, right? The value is subjective. Different people will disagree about the value of different things. And so value is then in a sense personal. That's what I mean by being subjective. Now we'd also add to this that how useful a particular box of chocolates is saying, on the way that I established this is by thinking about the order of different potential uses. So I'll just introduce, say, three different possible uses for a box of chocolates. So the most important thing that I might be able to do with a box of chocolates is I give it to my wife as a gift. I think she might be listening in on this, so I have to say that first. The second most important thing might be that I eat it myself because I also, it ends up really like chocolate. So that may be the second most important thing to me. A third most important thing is that I also have a couple of boys and I know my kids like chocolate because I'm not a very good father, so I give it to them anyway. So I give them chocolate and that makes them happy and it makes my life a little bit better for the few minutes before the caffeine kicks in. So I have these three different goals. One, giving a box of chocolates to my wife. Another, eating a box of chocolates for myself. Another, giving a box of chocolates to my children. And so here we can see I've established an order of different uses. And this would be the order in which I'd say rank their usefulness. First is the most useful thing I can do. Second is the second most useful thing. Third is the third most useful thing. Now, we as Austrians have a very specific technical name for what I just said. We'd say that utility, utility is really just a word for usefulness, is ordinal. That is it's all about an ordering of various uses. So usefulness is ordinal. I have one use is more important than another. That one is less important than some but more important than another still. Now this is important because a lot of economists in other approaches would say that no, utility is more cardinal and which means we can assign a specific number to it. So I can say that, oh, giving a box of chocolates for my wife is worth 15, having one for myself might be worth something like 12, giving one to my children is worth three, something like that. But what we find is that when we really think about people's decisions, we don't have to come up with these cardinal numbers at all. What really matters is the order in which these things are presented. If I have one box of chocolates, what am I going to do with it? It doesn't matter whether the numbers are 12, 7 and 3 or anything like that. What matters is what is the most important thing. So the order is sufficient for me to explain behavior. I'd also suggest that this cardinal approach is probably wrong. You ask most people, what is the value to you? They might give you a dollar figure in terms of what they're willing to pay for the thing. But they're not going to give you some kind of value of happiness. Oh, okay, it's worth 12 happiness units or utils as economists might call it. Okay, so the ordinal approach is perfectly sufficient and will get us where we need to go. Next, I want to touch on the law of diminishing marginal utility. This is something that Dr. Murphy did very well presenting, so I'll present it again. And the reason that it's important is that it helps us explain really why some of the very early economists, people like Adam Smith in the late 1700s, got price theory very wrong. Because what ended up happening, we're going to show that usefulness in the end underlies pricing in the market system. And this is totally divorced from the approach that Adam Smith took. Adam Smith, he was looking at prices, he wanted to explain them, and he said, well, we have this problem. Do we know that water is very useful? Without water, I die. On the other hand, diamonds are basically useless. He was a good Scottish Presbyterian. Diamonds are frippery, they're basically worthless. But at the same time, when we look at the market, here I am in Scotland, water falls out of the sky on a regular basis, nobody is willing to pay for it. So it has a value of zero on the market in terms of prices. But at the same time, people are willing to pay huge amounts of money for a diamond. So he said, you can't have anything to do with usefulness then if something that's vital for survival were unwilling to pay for, while at the same time, something that's a frippery we're willing to pay a lot for. So there must be a separation according to Adam Smith between the exchange value or the price and its use value that is what I would actually use the painful. The law of diminishing marginal utility was essential in solving this paradox. And in fact, coming up with the answer that yes, it is usefulness that matters. So what usefulness exactly? Now, before I lay it out, let's just give some of the technical conditions. We talk about the law of diminishing marginal utility. First, we have to say we're dealing with homogeneous goods. What that means is that we have two different units of the good, so they could be exchanged with one another if they can fulfill the same purposes. So if I'm thinking about that box of chocolates again, for me to say that these two boxes of chocolate are homogeneous, means that they are equally able to satisfy the same list of goals. So I could give this one to my wife and she'd be fine. I give this one to my wife. It works just as well. It doesn't necessarily mean that the contents of the box of chocolate are exactly identical, just that it satisfies the same set of goals. So we have homogeneous goods. As long as we have that, but we can say with great confidence, as Dr. Murphy mentioned, that each unit in a larger stock has a lower value than each unit in a smaller stock. Now the reason for that is we can think, suppose that I don't have any boxes of chocolate, I would naturally be very sad, especially because my wife is very sad. But then you give me that one box of chocolate and suddenly my life has improved immensely. I can fulfill that most important goal. Now on the other hand, if you give me three boxes of chocolate, my life has still improved immensely. That's true. But each of these units isn't quite so important to me as that one when I only had one. Now the reason why? Let's imagine what happens if I lose a unit. If I only have one to start with and I lose it. Now I don't have a gift to give to my wife. And then I hear again about how I never get her gifts. I'm very dissatisfied with that situation. On the other hand, if I have three boxes of chocolate and one of them vanishes, I put them in the trunk of my van, the sun heats it up and it totally melts and is worthless for any use. I throw that box away. Then what has happened? Well, we know my use is most important, give the gift to my wife. I'm still gonna do that. I have two boxes of chocolate. Second most important, eat one myself. I'm still gonna do that. I have a second box of chocolate. The least important thing would be giving that I'm boxed to my children. Well, that's what I'm gonna give up. So that one box, when I lost it, made me lose something really important that is the gift for my wife. Whereas that third box made me lose something that is important but not as important as a gift for my wife. If we apply this to things like diamonds and water, if we're thinking about Scotland, I live in Northern Ohio, which has whether or not I'm like Scotland or water falls out of the sky on a regular basis, it pools in my backyard, plenty of water. Well, I have so much of it. Any particular unit, any say eight ounce glass, isn't that valuable to me? Now it's true, if I didn't have any water, if I was in the middle of the Sahara and somebody offered me an eight ounce of glass, that's very, very important. So we can then see why water in places like Scotland or Northern Ohio would be basically worthless in exchange. Having that one additional unit, which is the unit I would be buying in exchange, it's not that valuable to me. On the other hand, having an additional diamond, which are not very common in Northern Scotland or in Ohio for that matter. Well, in that case, having an additional unit might be very useful. At this point, I believe my wife owns exactly one diamond. And I think she'd be very happy with another diamond. I've not yet been willing to buy it, but it would be very valuable, certainly more valuable than an additional glass of water, which we can easily have thousands of where I live. So we have the law of diminishing marginal utility, which tells us then that if we have a larger stock, each individual unit of that stock isn't that valuable, compared to if we have a smaller stock. Now, following from this would be that that first unit we receive is more important than the second unit we receive. The first unit we receive goes to the most important thing, that first box of chocolates goes toward giving my wife a gift. Second box of chocolates goes toward a second more important thing, in this case, meeting myself. So it's the law of diminishing marginal utility as Austrians would present it. Now, this is different from the way you might hear it in say a conventional economics classroom, where there they might say open up the box of chocolates, have a student come to the front, say, okay, eat this piece of chocolate, student eats it and say, okay, how much happiness did that add to your life? Oh, 10, come up with some number. Okay, we give them a second piece of chocolate. How much happiness did that add to your life? Eight? Okay, I give them a third piece of chocolate. How much did that add? Until eventually they're eating the whole box, they're feeling sick, and they're saying, oh, I'm actually getting less happy the more that I eat. So we might think of this way of proving the love diminishing marginal utility, but this is notably not the Austrian way of thinking of it. It is not just that psychologically that we react in this way to getting more of the thing, it's that we have a list of uses and logically we're going to fulfill the most important use first with any unit that we get of the good and we'll move down that list as we get more units of that good. So it's not just a psychological thing. I actually did read a case where somebody did this, this psychological approach, and they gave the student pieces of chocolate and they never decreased. They apparently were just a chocolate lover. They could just eat an entire box of chocolates and it was a 10 every time. As far as Austrians are concerned, this would not disprove the love diminishing marginal utility because it's all about this list of usefulness, not about psychologically, how does it affect your sense of wellbeing or happiness? Are you satisfying a more or less important use? Now last point before we really get into price determination. It's just pointing out that we can rank not just say the first box of chocolates versus the second box of chocolates and the third, we can rank different goods on a preference scale. One of the things that I hear people say all the time that really irritates me is that you can't compare apples and oranges. Have you ever been to a grocery store? Have you ever decided, gee, I think I'm going to buy apples rather than oranges? If so, you've compared apples and oranges. You've decided this is in fact going to be more satisfying for the various goods I have, whether it be maintaining my budget or cooking apple pie or what have you, then the oranges would be, right? We can compare apples and oranges, which means then, when we think about our preference scale, we don't just put in say different ranks for first, second, third box of chocolate, we can also compare that with say first, second, third bag of apples or we could compare that with say $10, $9, $8, 10 I'd certainly prefer to nine, nine I'd prefer to eight and so on. If you have the opposite preference, rather of $8 than 10, talk to me afterward, we can solve that problem for you, right? But we prefer more money to less and we can compare, right? Money and oranges or money in boxes of chocolates. In fact, we know we do this all the time, right? Every time I go into the grocery store and I look in the candy aisle, which happens more often than it should, right? And I see, okay, it's $10 for this box of chocolates. What's really happening is that the grocery store is asking me, right? Which is more important to you, right? This box of chocolates we're offering to give you or the $10 you have sitting in your pocket. I'm being asked to compare money versus this particular good. And this then feeds directly into price determination. How do prices get determined? Well, in the end, what a price really is, right? It's just an exchange ratio, right? Between a sum of money and a good that is being exchanged for that money. So thinking again about that box of chocolates for $10. If I go and I say, yes, $10 for a box of chocolates, I'm willing to do that. My wife will be very appreciative. I'm willing to give up $10 for that box of chocolates. That is implying that to me, that that box of chocolates is more important to me than $10. So when I look at my ranking of values from most important to least important, that somewhere $10 is below that first box of chocolates. Right, so there's an inequality there. At the same time, the seller, in this case the grocery store, by offering to sell me this box of chocolates for $10 is indicating that they would rather have my $10 than their box of chocolates. So there's what we call a double inequality of value. That is, on my side of things, I consider this particular box of chocolates to be more valuable than the money I'm giving up. On the side of the seller, they consider that quantity of money to be more valuable than the box of chocolates that they're giving up. Now it ends up as a very important point. Because when you go back to the Smithian way of thinking about things, what then does exchange mean? And often we saw amongst the classical economists this idea that if we are exchanging $10 for a box of chocolate, it indicates there's an equality of value between the two. One of the projects I'm undertaking at the moment, because I have very poor judgment, is that I'm reading Marx's capital. This is the third time I've attempted, I've given up at least twice before. But this time I said, I'm going to go, I'm going to read Marx's Das Kapital and find out where he makes his mistakes. I found the first major mistake on page four. So it didn't take long, unfortunately, and that I guess provided some energy to continue with the project. And the mistake he made was exactly the one I just mentioned. He said, if we exchange a certain amount of gold, gold being the currency at the time, for a particular good, I think he was talking about thread or yarn or something like that, that indicates there's an equality of value between these two. And then he reasons further and says, well, what then is equal? Well, it must be labor. And then we end up with everything that we know is communist theory. But that point that he makes about this equality of value is exactly wrong. It's exactly wrong. Because when I pay $10 for that box of chocolate, what I'm really saying, again, is the box of chocolate's worth more to me than $10. They're not equal. Similarly, on the seller's side, what they're really saying is the box of chocolate is worth less to them than the $10. Again, they're not equal, because there is no equality of value whatsoever. In fact, we need the inequality of value for the exchange to happen. All right. So then taking this in mind, the way we would think then about say things like price determination, we have these exchanges, an exchange the buyer is indicating that they value the good more than the money they're asked to give up. The seller's indicating they value the money more than the good that they're giving up. So what is going to determine prices? We can imagine then in my value scale, I have my first unit, that gift that I'm giving to my wife, my second unit, we know it's somewhere below the first. I'm going to say it's also below $10. So when I see that $10 price tag, I'm willing to buy the gift for my wife, that box of chocolates, but I'm not really willing to buy one for myself. And down further, it'll be some price like $8 down further that I'm unit for my boys, right? Down further, something like $3. And so what does this then indicate? I'm willing to give up $10 because it's less important to get that gift for my wife. So $10, I'll buy one unit of the good. If instead when I walked into the grocery store, the price had been something like $8, I walk in there saying we'll sell you these things for $8 a piece. I say, well, I was willing to make 10 for my wife. So certainly I'm going to buy that one for eight. That's a great deal. Not only that, but the second unit, the one for myself is also worth more than $8. Let's all go ahead and I'll buy two units. Maybe they offer me a really low price. They're selling them for a dollar a piece, something like that. In that case, I might be willing to buy not just the first and second, but also the third, right? To buy this gift for my children. I said they can have chocolate as well. Okay. So we end up then with what I just described is really the law of demand. It indicates that all else equal, the lower the price is, the more units I'm willing to buy. And the reason is really just because we know that that first unit is going to satisfy the most important goal. So I'm willing to pay more for that first unit than I would be a second unit. For me to be convinced to buy that second unit, you have to drop the price enough for I'm willing to do it. At the same time, third unit, you have to drop the price even more and on down we go. This is the law of demand. It ends up we can also reverse everything we've done to come up with the law of supply. So now we imagine, say that I have a bunch of boxes of chocolates, say three of them, and somebody's thinking about trying to buy them from me. So we know, because I have a lot of them, that last unit, the one that I would feed to my boys, isn't worth that much to me. If they offer me say six or seven dollars, that's a six dollars, I'm willing to sell it too long. Now for them to convince me to sell them, the gift that I would give to my wife, they have to offer me substantially more. So we then end up with the relationship that to convince me to sell more of the good, you have to offer me a higher price. Or stated then as the law of supply, the higher the prices that offered, all else equal, the greater quantity is going to be offered for sale by suppliers. Okay, so demand we have this inverse relationship between the level of prices and the quantity that people are willing to buy, high prices, people don't buy much, low prices, people will buy more. Supply on the other hand, we have a direct relationship at higher prices, our suppliers are willing to sell more of the good. So then how do we end up with prices in the economy that we have? Well, I'd suggest that there are really three possibilities when we're first putting a price tag on an item. One possibility is that we price in a sense too low. So we price really low. So we say, I don't really want to sell much of this good. I'll get rid of it for say $3 or something like that. But this attracts a huge number of buyers. So lots of buyers want to buy lots of the good. So what do I see? I see immediately, I sell out of this good, people comes ahead, do you have any more chocolate? No, no, we're sold out. Now in the economy as we run it in the United States, we know that we don't have much negotiation with most of our sellers. I don't go into the grocery store and say, let's talk down or talk up prices that are posted. We just kind of accept the posted price. But it's very believable that the supplier is going to see that they're regularly selling out of boxes of chocolate and say, well, might be worthwhile for me to both stock more of this good and also charge a higher price. I'm only gonna stock more if I can charge a higher price. I'm selling out so quickly, looks like I can get away with it. People really want this good. So if we price in such a way that the quality demanded is far beyond what is supplied by suppliers, there's going to be a natural tendency for prices to rise from that point. Or we can imagine exactly the opposite. We could say, perhaps the store is very optimistic about the quantity they can sell. They say, we're willing to sell a lot as long as the price is really high, say $20 per box. And then they see that it just kind of sits there. They're on the shelf, these boxes of chocolate, nobody's buying them because the price is simply too high. At this point, the supplier may say, well, I would like to sell at least some. So if I lower the price, maybe I'm going to attract more potential buyers. So we put things on sale, clearance, these types of things. We lower the price, either temporarily or permanently. And that does in fact, convince some people to go ahead and buy. If you're not asking me to give up as much, then the use that I'm fulfilling doesn't have to be as important for me to go ahead and pay the price. And so in that case, we have these very high prices where we have lots being offered for sale, not so much being bought. But there'd be a tendency for these prices to fall. Now, the last possibility would be that maybe we price in such a way that the quantity that is being offered for sale is basically equal to the quantity that is being purchased. In this case, all of our buyers and sellers are perfectly satisfied. We don't have these lines of people waiting for chocolate that isn't there on the shelf. Nor do we have chocolate on the shelf going unsold. We have what we would call an equilibrium. That is where we would expect this to maintain stability. There's no natural reason that things would have to change from this point. And in the end, this is where we'd expect prices would come from. That there is this process of demand and supply interacting over time as we discover the prices that will lead us toward that stable point. The last point I wanna turn to, we really need to talk about it because it's very easy to say, well, this all sounds well and good for things that I as a consumer get direct value out of. I like to give gifts of chocolate to my wife. I like to eat it myself. My kids like to eat it and I like to give that gift to them as well. But what about things that are not directly useful? What about things like cocoa beans? I've never eaten a cocoa bean and I suspect it would not be a pleasant experience for me. I think it would probably be overly bitter for me. And so I really wouldn't value this directly. So how then do we end up with prices for cocoa beans? Because we know that they have prices and we know that machines that we use to process chocolate and like also have prices, though it's not something I'd want to buy to put on display in my house or anything like that. It doesn't have a direct use that is satisfying my ends directly. And so how is it that we end up with these prices? Now here, Austrians appealed what we call the theory of imputation, which suggests that the price of something like cocoa beans or these various machines needed to process cocoa beans and chocolate, that price ultimately comes from the demand for the end good. In this case, the demand for chocolate. So we know that cocoa beans have a number of uses. We can grind them up, turn them into chocolate bars or boxes of chocolate. We could also turn it into say hot chocolate mixes which are also valuable. We could turn it just into cocoa powder which I may buy so I can put it in cakes or something like that. And so we have these various uses for cocoa beans and each of these uses has some price based on the direct use that consumers expect to get out of the thing. So then I as an entrepreneur would look at these various prices. Let's say okay, if I can sell this box of chocolates for $10, that's going to limit what I'm willing to pay for cocoa beans for the machinery that I need to process these cocoa beans into chocolate and the like. So the value of these various factors of production, my workers, the materials, the capital, the land that I build my factory on is going to be limited by the price that I expect to earn. And not only is it limited by it but once we have a competitive process. So we have lots of different entrepreneurs out there. Some are making cocoa powder, some are making chocolates, some are making other things but using the same materials. Now the bidding process is going to be such that whoever thinks they can get the most value out of this resource is going to be willing to pay the most for it. So as a result, the price is then going to approach what is the value of that particular good in that use by looking at the final good. Now here we can note that there should then be some kind of connection between what is the price of the final good and what is the end cost of production. So if we expect our consumers are going to pay something like $10 for that box of chocolates then I'm willing to pay $10 adding up all of the resources minus a little bit for the amount of profit that would be reasonable. So I might say be willing to pay $9 or something like that for all of these materials. So then I entered into this competitive process and if this is the most valuable use of those resources then we'd expect the prices to get bid up to something close to $9 which means the resources would not go toward things that are less valuable than that $9. So then we'd end up resources are going toward the uses where people are willing to pay the most but what I'm willing to pay is really based on how valuable this thing is to me in terms of the goals that it helps me to pursue. Now there is kind of an opposite way of thinking of this which I would suggest is certainly fallacious is to think of what we call the cost of production theories which I think Dr. Murphy did allude to. And so the cost of production theory would suggest the way that prices appear on markets for goods is that producers produce the thing, find out what their costs are and then add some kind of return to it. In practice it may often feel this way but in the end we would know that this would not actually sustainably explain prices. The reason being we can imagine cases but probably my favorite case is the glass sword. And yeah, Pawn Stars if you've not watched it it's a great show about economics. It stops being great after about a season. But it's people that run this pawn shop, people come in offering to sell them weird things and this one person came in and said, well I made this glass sword as far as I know it's the only one in existence. So one would think in terms of diminishing marginal utility it should be very high except it ends up that even the most important use for a glass sword isn't very important compared to most things. So I'm willing to sell you this glass sword and the pawn broker just turned him down so there's no way that I'm gonna be able to resell this thing because he understood that in the end it's really the consumer's value that determines the price you can charge. So it doesn't matter how much money, how much time, how much effort you pour into producing this glass sword you're not going to be able to charge cost plus to a consumer if they don't want the glass sword that doesn't help them satisfy their goals. And so while we may see a connection if you have resources that help you satisfy really important goals those resources will go for a fairly high price. The reason is that entrepreneurs are bidding up the prices of those resources because it's going to command a high price for the product. It's not the other way around that the valuable resources then lead to high prices for the good. Okay, so then we can see just kind of taking a look back. In the end it's really our uses for the various consumer goods to determine the prices of those consumer goods. It's the prices of those consumer goods then determine what entrepreneurs are willing to pay for the factors of production. And thereby we end up with factors of production going toward wherever they're going to be most useful that is most profitable for the entrepreneur. So in the end we end up in this economy through the pricing system with resources going toward the places where they will achieve the maximum value in the eyes of consumers. Thank you very much. Thank you.