 I want to give a lecture here for the next 45 minutes on subjective value and market prices. And I just want to give you some of the motivations behind this. On the one hand, Austrians are very unique amongst economists. And I'll give you a snapshot of this at the very end of the lecture, because we actually do believe that value is fundamentally subjective. And I'll tell you in this lecture what that means. And the second reason why this is such an important lecture goes back to the reason of why we have prices and what prices function in the economy. So if you just think about your lives, your lives are fairly simple for the most part, because when you go out to do your buying decisions or whatever activity you want to do, you look at the market prices that exist. T-shirts cost $10 and sweaters cost $20. And you're fairly able in pretty short order to determine how many T-shirts you want to buy or how many sweaters you want to buy so on and so forth. And prices are really what enable this ease of computation and this ease of life to happen. They summarize, as we'll show here as the lecture progresses, a whole body of knowledge into one number that you can look at and then compare with other numbers, other prices, to make our buying decisions. But before we just look at prices or before we even accept prices as existing, we need to have a theory for why prices are formed. What are the factors that affect prices or what are the different ways that prices would change in the economy? What are the factors that would change them? And this is again, one of the strong parts in Austrian economics in that we have a very causal realist, a very realistic explanation for why prices form in the economy, the functions that they serve and the things that will change them. So Professor Salerno touched on this in his previous lecture, but I want to go over it again quickly because it's so germane to the topic. Before we can talk about prices on goods, we need to understand exactly what we're talking about what economic goods are. And again, Karl Manger, one of his great contributions in his Principles of Economics was to outline the criteria that define an economic good and these are the criteria that must be met before we can consider a good to be economic in nature and before we can economize on it and before we can value it and exchange it and determine a price on it. So just to quickly list through the different criteria, first of all, there must be something out there that satisfies a need and this is very important. The need of course is something that we need. You perceive yourself to be in a state of discomfort or you're not entirely happy about something and you have a need to make your life better and the thing out there is going to be something that would satisfy that need. Maybe you're thirsty, for example, and you see water as being something that would satisfy your need to alleviate thirst. And of course, a causal connection needs to be made with that need. So the water in that example is the thing that's going to satisfy your thirst. And thirdly, you have knowledge of this connection. You know that water will alleviate thirst or that close alleviate nudity or I don't know why I thought of that example. They say when you're public speaking you imagine the audience is naked. I'm not doing that right now by the way. Luckily I'm behind a podium, so. And then finally, somebody has to have command over that good or that thing that will satisfy that need and that they know has a causal relationship with the desire, the need that they need satisfied. And so we get into property rights here, defining who owns what and who has a command over what different type of resources. So that's the background. We need these goods, these things out there to satisfy these criteria before we could consider them to be economic goods, subject to valuation and exchange and the price formation process. Now, Austrians have a very specific, a very clearly defined theory of value which we call the subjective theory of value. And the theory goes something like this. Things exist out there, goods exist out there but we only value them according to our needs and our needs exist only in our mind. And so if the need only exists in our mind the value that we attach to a good must be exclusively a product of our mind as well. The goods, the economic goods objectively exist. I mean, this is a podium and you're sitting on chairs and we have lights in this room and those are all economic goods. They all satisfy the previous four criteria that we looked at. But the need that each one of those goods is satisfying at any given moment exists only in our minds and so the value we attach to those goods is only within our mind as well. And if the value only exists in our mind and since you're the only person who understands and knows what you're thinking there's no way that we can compare these values interpersonally. In other words, you see a chair and you value it according to the need that you have to take a load off and sit down. And that value that you attach to the chair and serving that need or satisfying that need you cannot compare to somebody else. Like person over here might not be tired and they see the chair and they don't value it because they don't really want to sit down. Person over here has been walking all day long and they're very tired and they really want to sit down and so they value the chair very highly. But we can't really compare the two values in these people's minds. Only they know how much they value the chairs. So there's no interpersonal value comparisons. The other factor is that since the value is only created or it's only a product of your mind and it only exists as regards to a good satisfying and specific need, as your conditions change the value that you associate with certain goods will change as well. So we do not have constancy of value over time. And as an example of that, you can imagine that in the morning you wake up and you're very hungry so you go out and you get breakfast and of course since you were hungry you placed a very high value on food. But then immediately after you ate once your hunger is satiated you no longer value food so highly because you're full and you don't need food anymore. Or sleep of course in the evening when you're tired you value sleep very highly because you're very tired and you need it. And sleep is the action which will alleviate your discomfort of being tired. But then when you wake up in the morning, well if you rest well when you wake up in the morning you're no longer tired and you no longer face place a very high value on sleep because you've obviously just alleviated the discomfort of you being tired by sleeping for the evening. So we don't have a constancy of value. It's constantly changing. We can't say that you will always value this good at this high level or this lower level or anything like that. Or to put it in other terms, we can't come up with concrete relationships between the value you place on something and how much of a good you will consume. Example, price of gas falls by 10%. And maybe you respond by consuming 20 gallons more gas per month. But that would be something that you do this month and it's not necessarily something that you would do every month. So we cannot say that there's a constancy between the changes in the value of a good that you have and the amount that you'll actually consume or the amount that you would want to consume. Now when we talk about the subjective theory of value, the value that we're talking about we express it in terms of what we call utility. A good will only have value according to how useful it is for you to alleviate the discomfort that you have. Or in other words, a good is only valuable according to how useful it is to make you better than you were before. This is what we mean or economists mean by the concept of utility. So utility is almost synonymous with usefulness. And within utility, which is the way that we describe the value or allude to the value that a good will have, we have two laws. The first is what we call non-saciation, which is the law that you would always prefer to have more of a certain good to less of a certain good. And here, when I talk about stocks of goods, I mean homogenous goods, like you would prefer to have five bottles of water available to you, then four bottles of water, then three bottles of water, so on and so forth. And if you think about why this is, it comes because the more of a unit of a good that you have, the greater amount of needs will be able to be satisfied. And since you value satisfying needs or alleviating your discomfort, you would always prefer to have more discomfort alleviated than less discomfort. You would always prefer to be happier than less happy. And the more of a good you have available to you, the more of those wants you can satisfy and the happier you'll actually be. An objection commonly arises, and maybe you're thinking about it right now. What would happen if, you know, surely five bottles of water is nice, but if I had a thousand bottles of water, I probably wouldn't be all that happy with that. I mean, what am I gonna do with a thousand bottles of water? And there's a couple of different ways that you can address this objection. The first is to say, well, if you had that many bottles of water, they probably wouldn't be an economic good anymore because you wouldn't have a need that a thousand bottles of water satisfies. Like, you have a need for quenching your thirst and cooling yourself off, and I don't know, you like the taste of water or something like that. And five bottles of water satisfies that need, but having a thousand bottles of water is not necessary because once you consume a couple, you no longer have the need that you need to alleviate it. So we would no longer be dealing with a case of economic goods. Or alternatively, you could say, yes, you would prefer to have a thousand bottles of water because even if they don't satisfy a need directly for yourself, you could always trade them away to somebody else, exchange them to somebody else in order to obtain something that you want of more higher value, and that's something that I'll get to a little bit later on in this lecture. The second law of utility is what we call the law of diminishing marginal utility, and this is one of the great contributions that Professor Salerno would have alluded to in the marginal revolution of 1871. So the law of diminishing marginal utility says that for any given stock of goods that we have, bottles of water, the value we place on each subsequent unit of that good will be less than the one before it. Example. Say you have four bottles of water in front of you. The first bottle of water that you consume will be consumed to satisfy your most pressing need or your most urgent need or your most highly valued need. You're thirsty, and thirst, quenching thirst, and staying hydrated is pretty important. So of these four bottles, you pick up your first one and you drink it, and that's the need that it satisfies. That's a very highly valued end because if you don't drink water, you die eventually, I guess. The second bottle of water that you consume, you pick it up and it satisfies a less pressing need, a less urgent need. So after you've satisfied your need to quench your thirst, the next pressing need is, let's see, refreshment. You're no longer really thirsty, but you want to be refreshed. So you drink the second bottle of water, fantastic. And then you've got the third bottle of water in the stock, and you pick that up and you drink it. And the reason why you've drunk that bottle, drunk, drank. Drunk did, you know. Once you consume that bottle of water, it satisfies the third most pressing end that you would have or the third most highly valued end that you have. So maybe you just like the flavor of water, the taste of it, or it's, I don't know, it's gluten-free and you're on a diet and that's why you're consuming it. And then as you continue going down through your stock of goods, the stock of good, each subsequent unit that you use serves a less valuable, less urgent need than the one before it. And so the value as you go down, the units of goods, has to become lesser and lesser and lesser, or in other words, diminish. Finally, when you get to the fourth bottle of water, it's like, I don't know, you're socially awkward and you're just looking for something to bide your time while you're talking to people. And it doesn't go away as you get older, it's just the drink changes, I guess. And so the two of these laws taken together are how Austrian economists talk about the utility that we get from consuming different goods. And then you can put this in the context of changing the size of the stock of goods you have available to you. So in my example, I had four bottles of water. What would happen if I added a fifth bottle of water to it? Well, first of all, from the first law of utility, I know that I would be happier or more satisfied than I would be if I only had four bottles of water. The reason why is because that new fifth bottle would be able or would allow me to satisfy a new need, and so once that want is satisfied, I'd be happier than I was before. So maybe the fifth bottle of water, now I'm not thirsty and I'm refreshed and I've got my tool against social awkwardness. And now I'm looking at just giving it to a friend and helping somebody out or charity or something like that. And that's less important to me than the other four needs, but it's something so I'm happier as a result. Of course, the change in my happiness is what diminishing marginal utility is telling us. So my change in happiness from having that fifth bottle will be a little bit less than it was from each of the preceding four bottles, but it's still positive, it's still something. And as I keep adding stocks, units of water, bottles of water to my stock of water, my utility will continue increasing, I'll be happier, but at a diminishing rate, each subsequent unit will make me less happier than the one before it. So we use utility to measure the usefulness or to describe the usefulness that a good has in satisfying your wants, and utility abides by these two rules or they're two laws that we can always depend on. So what do we do with it? Well in Austrian economics, we use what we call a value scale to describe the goods that we have and how useful they are to us. And the value scale has a couple, not oddities, particulars to it that are important. So the first is, as you go down here, I've ranked these first, second, third, dot, dot, dot, so on and so forth, 10th, 11th, 12th if I had room. And what that means is that at the very top of the scale is my first most valued and my first most valued thing that I would like to do are action. And then as I go down the scale, this is my second most valued activity or action, my third most valuable and blah, blah, blah. So for example, in this hour of time, your most highly valued use of this hour of time is attending this lecture. And I'm not making that up because you've demonstrated it to me through your demonstrated preference of showing up here. There was many things that you could have done during this hour of time or this 45 minutes, but you showed up, so thank you, by the way. Because instead of showing up for this lecture, you could have pursued your second most valued end, which was sleeping for an extra hour, fantastic. And, or you could have eaten even more breakfast, great, I guess, or dot, dot, dot, down the list. And I guess as you get down your list, eventually you get to, could have chatted it up with Professor Salerno for an hour, but you came here and listened to me instead, so that's great, I know you valued this more. But Joe should feel good about himself because at least that's above talking to David Gordon. Where is Dr. Gordon, is he here? He's not, so obviously on his value scale, his other activities are above attending this lecture, so I guess he got the final laugh on me. But we have this value scale where we go down, and there's a couple, like I said, there was a couple oddities or particulars that we wanted to talk about with this value scale, and the first is that it's a value ranking. It's like a race, the 100 meter dash, or the Americans call it 100 meter dash, or is it like the 90 yard dash, something like that. The 100 meter dash. We've got a first, second, third, and dot, dot, dot place winner, or losers I guess is the place may be. I didn't mean to circle David Gordon when I said loser. And in the race, we don't really care that the first place person, we don't say that they ran that race twice as well as the person in second, or we don't say that they ran the race five times better than the person in fifth or anything like that. The person came first, it's a qualitative statement. We know they did better than the person who came in second, and we know the person who came in second in the race did better than the person who came in third, and so on and so forth. So we have a qualitative ranking, and we can't really compare quantitatively these different rankings. So we can't say that you value attending this lecture twice as much as you value an extra hour of sleep, even though attending the lecture was your first place option, your first place alternative, or most highly valued alternative, and sleep was only the second. There's no quantitative comparison that we can actually make. Also, using the previous laws of utility, as we go down this value scale, we not only know that these will be less valuable uses of your time, or less valuable actions that you could pursue, we know that if you did these things, they would make you happier, but at a diminishing rate. That's the law of diminishing utility. So let's say you attend this lecture, first of all. Fantastic, you make yourself happier for it, hopefully. And then you decide to sleep for an extra hour. Okay, the extra hour of sleep would make you happier as well, but it would make you less happy than attending this lecture. So you'll be better off, but by a little bit less than just attending this lecture did. And then eating will also improve your lot. You'll be better off for it, but less than that extra hour of sleep increased your satisfaction or utility by, and so on and so forth. And then, of course, you get by down to Joe Salerno, and talking to Joe for an hour is great, but it's obviously not increasing your lot as much as eating for an hour, sleeping for an hour, attending this lecture for an hour. Now Joe is not on speaking terms with me, so I don't have to worry. I can strike this off my preference scale. And of course, we don't just have to have actions, activities on our value scale. We can put all sorts of economic goods on it. So for example, money. Now Rothbard and Man economy and state, I've used some notation that he makes use of. The hamburger is in parenthesis because it's something that you don't have. It's something that you can imagine yourself having and you can imagine where it would fit into this value scale relative to the things that you do have, which in this case or in this example are money since those are not in parenthesis. So in this particular value scale, you would first prefer to have $5 in your pocket, then you would prefer to have one hamburger, your first hamburger that you're gonna eat, then you would prefer to have $4 in your pocket, $3, and then you would prefer to have a second and so on and so forth. Actually, I'll give you an example. I went out for breakfast this morning. Don't judge me. I went to McDonald's and there's no interpersonal comparisons of utilities. So you can never judge people for these things. I went to McDonald's because they have Egg McMuffins and where I come from, they don't have Egg McMuffins. I don't know, it's the small things in life. And so I went there and they had a deal to, I don't know, it was like two for three bucks or something. I don't know if you saw that, great deal. So I bought two Egg McMuffins and then I went back, I valued them more than the money that I had available to me and I bought two of them and I ate my first Egg McMuffin and it was fantastic, to be honest with you. And then I was sizing up the second one. With each bite actually, it got a little bit less fantastic. Like the first bite was really great and you can imagine why that is through diminishing marginal utility because of course the first bite I was breaking my fast for the morning, so that's fantastic and then the second bite is like, oh, it tastes so good. And the third bite, so on and so forth. And then I finished off the whole thing and a whole series of wants had been satisfied and then I sized up the second one and it looked pretty disgusting. And I was, oh, why? And I still ate it because it was better than the alternatives that I was gonna do. I had some regret after the fact. Do you know you buy things and you have regret? And regret is a good example of the non-constancy of your values. When I bought these Egg McMuffins, not even 10 minutes prior, I valued the two of them more than I valued my money. And then after I ate the first, I had these pinches of regret. I was like, oh, what's it gonna look like when I get to the beach and oh, my wife's gonna yell at me and things like that. And I in a way wish that I didn't buy two, I still ate it so actually I'm lying to you that I wish I didn't buy two because I still ate it. I demonstrated to myself that I did value that second one. But my value scale had changed and my eyes were bigger than my stomach I guess at the moment when I bought. And of course I valued two very highly because I was very hungry. But then once I got through once my one Egg McMuffin, my value scale changed and all of a sudden having something to alleviate hunger was not so important to me. And so I changed my mind. Now, I don't wanna go into this in too much depth because Professor Herbener will look at this when he gives a lecture on time preference. But we can also place different goods or want satisfactions on this value scale in different inter-temporal periods or different temporal periods I should say. So for example, you could value having 10 bucks in your pocket right now more than you would value having $10 in your pocket one year from now. And Professor Herbener will explain why it is that this relationship of valuing $10 more now than in the future has to hold true. And then we can go down our value scale in the standard way of all the different things that we would rather have, of course, $10 now, 10 bucks in a year, $9 now is better than $8 now and so on and so forth. But maybe $8 right now is preferable to having $10 two years from now for whatever reason. So now we can start looking at inter-temporal values. I'm, like I say, not gonna go into too much detail with it. Actually, that's all the detail I'm gonna go into with it so that I don't steal Professor Herbener's thunder. Now, the values and the value scale is important. But what happens if you have things on your value scale that you think other people would like more than you do or would satisfy other people's wants more than they satisfy yours and you see that other people have things or goods that would satisfy wants that you have and they're also goods that you don't have so you need to obtain them? Well, in other words, to obtain happiness in life or to increase your satisfaction as much as you can, we partake in exchanges. And exchanges happen in many different forms. Some of them are permanent and some of them are temporary. So for example, I bought my two Egg McMuffins this morning and that was a thoroughly permanent exchange because I don't really think McDonald's wants me to go back and reverse the transaction. And some exchanges are temporary. So these are like loans. I'll give you something and you'll give me something back and then we'll just exchange it again in the future so there are temporary exchanges that we could partake in. In my lecture later on financial markets, I'll get into some of the details associated with temporary exchanges. And for an exchange to take place, we need economic goods. So we need to have things that abide by the criteria that Karl Manger laid out. We need to exchange goods or goods are the only things that we can exchange. We need a clearly defined set of property rights. We need to know what goods we own in order to trade with somebody else and we need to know what good somebody else owns that we know that we can obtain from them to increase our happiness. So some system of property rights and hopefully a pretty well-defined one will allow us to actually make exchanges. And then finally and most importantly, we need what are called reverse preferences. In other words, the things that you have, you have to value less than the things that somebody else has and vice versa. In other words, all exchanges rely on a disagreement of value. Example with my morning breakfast, which I wish I wasn't dwelling on so much. But when I exchanged my $5.61 to McDonald's for coffee and a couple of egg McMuffins, the reason that exchange took place was because McDonald's places a higher value on my money than they value their own goods and I value their goods more than I value my own money. And because we have a disagreement about these valuations, we can go into an exchange. And if you flip the example around a little bit, if nobody ever disagreed about value, like if we all thought that value that a good had was the exact same as everybody else, we would never exchange them with somebody else. If McDonald's thought that their egg McMuffins were worth the exact same as I did, why would they trade them to me? Or if they valued them the exact same as the money that I gave them, they would never get rid of the egg McMuffins, they'd be happy just staying with the money. So we need this disagreement of values. We need these reverse preferences to actually enable trades to take place. Now I wanna give you maybe a more deep example of how this process takes place. So imagine that you have three buyers or potential buyers of a good. We know they're gonna be buyers or they're potential buyers of coffee. Oh my little, oh there it is. We know they're potential buyers of coffee because the coffee is in parenthesis. So that's something that they don't have but they do have money. And these three people, buyers A, B and C, have the value scales as follows. So A would rather have $5 than one coffee but he'd rather have a coffee than $4. And so now you can see what he would be willing to pay to get a coffee. I mean he would never pay $5 for coffee because he values that more than the coffee. But if he could find a coffee for $4 he'd buy that. Or if he could find a coffee for less than $4 rather he would buy that because the coffee is more valuable than the $4. So for example if he went out and McDonald's was selling coffee, no McDonald's is cheaper than this. If he went to, who's got expensive coffee? Starbucks I guess. What's a Starbucks worth now? 550. 550. Ooh, yeah. Listening. The rest of you lot on the other hand. Let's say you go out and you find a coffee for $3.50 for this person, fantastic because they valued the coffee more than $4 so if they find one for $3.50, great. Scoop it up and buy it. And we have our three buyers and they have their value scales as follows. You can see that each of them is a little bit different. They're hard to compare but some things we do know and what we do know is what they'd be willing to pay for a coffee at a maximum. And at the same time these people are met by three sellers, X, Y, and Z. And the three sellers have coffee because coffee is not in parenthesis but they have reverse preferences to the buyers. At least some of them have reverse preferences to the buyers. So seller X here would rather have $3 to a coffee but he'd rather have $2 than a coffee at the same time. He'd rather have a coffee than $2. So if he could find somebody out there who would pay him more than $2 for a coffee, fantastic. He'd scoop it up $2.50, we've got a sale. And these three sellers in the marketplace can meet with these three buyers and see if there are mutually advantageous exchanges. In other words, see if there are exchanges where they have reverse preferences where one of these sellers can get rid of a coffee and give it to a buyer in exchange for money that the buyer has that they can pay the seller with. And maybe the easiest way to do this is to construct supply and demand schedules. Actually, just out of curiosity, who's taken an economics class? About two thirds, let's say. So this is pretty standard in economics classes but I'll note some differences later on in the lecture. So our quantity demanded is of course how many units of a good the buyers are going to demand at any given price. So notably, nobody is willing to buy a coffee for $5 since $5, the person who comes closest is buyer A but even he would rather have five bucks than a coffee so nobody wants to pay $5 for this. And as we go down the price scale over here we see more and more units of coffee are demanded. So when we get to $3 buyer A he prefers a coffee more than $3. Buyer B, she prefers a coffee more than $3. Buyer C does not since $3 is higher on the value scale so we're left with two buyers or two quantities demanded of coffee at that price of $3. And if we go down the sellers X, Y and Z we get the exact opposite relationship. So at a price of $5, how many sellers are willing to sell a coffee? All of them because all of them place that coffee that they have above a monetary value of $5 and the person who comes closest would be seller Z here but even he values, he would be willing to get rid of his coffee for $4 so he's in there. So all three of them are willing to sell their coffees for $5. And then as the price drops we see that more and more of these sellers remove units from offer or they remove some of the quantity that they have from being supplied. And when we get down to let's see $2 well only one of them wants to sell or is willing to exchange away their coffee if somebody offers them $2 and it's seller X since X is the only one who places that coffee above $2 on his value scale. And then if somebody came and offered $1 for coffee of course nobody values a coffee below $1 so we have zero quantity supplied here. And the nice thing about these two schedules the quantities demanded and supplied is that taken together they allow us to see the process of price formation. Now of all these prices only one can really exist on the market. If coffees were selling for $5 we'd have an economic problem and the economic problem is that many people all three want to be selling their coffees but nobody's willing to pay $5 nobody values coffee enough to actually go out there and buy it so all of these sales are not actually going to have buyers to go along with them. And of course if sellers don't have a buyer to go along with them no sale takes place so what do the sellers do in response? If you're smart you start lowering your price a little bit. So I wanna sell my coffee for $5 but I have no taker so I'll drop my price from $5 down to $4 and all of a sudden when I drop it from $5 down to $4 one of these buyers enters the market buyer A as the case may be but the price is still not right because there's too many quantities being supplied in this market still for the available amount of demanders so we have an excess of supply and the suppliers are going to keep dropping their price until the amount supplied on the market or the amount offered on the market is exactly equal to the amount demanded and at that price everybody's happy. At $3 here everybody who valued a coffee more than $3 traded their $3 to get a coffee that's buyers A and B incidentally since those are the two who value coffee above $3 on their value scale buyer C here does not and he's okay with it he's okay with the fact that he didn't buy coffee for $3 because he's happier with the $3 than he would have been with the coffee so that's fine and at the same time at the price of $3 all the sellers are happy as well because for example seller let's see seller X would rather have a coffee than no sorry here seller Y for example would rather get rid of it would rather get rid of his coffee than $3 and the same with X and so taken together we can see that the quantity of two is set equal to each other at that one market price of $3 and so we have the prices of price formation that stems directly from the value scales of all of the individual buyers and sellers interacting with one another in the market. Now this only raises the question of what the cost is that people actually had to pay when they exchange these goods and oftentimes it's simple to think about costs and strictly monetary terms like accountants if you ever took an accounting class costs are the historical monetary value incurred to buy something or to exchange for something but the Austrian economist has a much broader view of cost we consider it as the best foregone alternative that you couldn't pursue if you took, if you decided on one course of action and we call this the opportunity cost so for example it could have been money in nature when I bought my Egg McMuffins this morning and I paid $3 for them the $3 could have done something else like for what do you get for $3 almost a whole Starbucks coffee I guess you get a small one which is like what do they call it at all a small and for that $3 I could have went and got a coffee so the cost for me to go and get my two Egg McMuffins was I did not go and get a Starbucks coffee it's the money but it's really what that money could have done for me or how about things that don't have a monetary cost associated with them like you guys are all sitting here right now you didn't pay for it or you didn't pay to walk in this door anyway so what is the cost for you to sit here well it's whatever you could not have done and if we go back to that value scale at the beginning of the lecture that I showed you attending this lecture for 45 minutes that was your most highly valued alternative and then right under there was sleeping for an hour I guess so for you to attend this lecture the opportunity cost the thing that you could not do was sleeping for an hour and now all of a sudden we're able to value goods and determine costs much more comprehensively than if we just narrowly focused on money now we can value and assign costs to a whole slew of non-monetary transactions or exchanges the exchange taking place right now of me speaking and offering a lecture and you all listening and enjoying a lecture hopefully as the case may be now Professor Salerno commented briefly at the end about different orders of goods and one of Menger's great contributions was to assign an ordering system where we can refer to goods and where they exist relative to a final want satisfaction so for example Rothbard gives an example in man economy and state where he says imagine that you're hungry and you want a hand sandwich and the ham sandwich is the final good or what Menger would have called the lowest order good it's a consumer good that's going to alleviate your hunger but there's all sorts of input factors or higher order goods that are necessary in order to create this ham sandwich you need bread, you need lettuce, you need ham and butter if you're one of those people and things like that and you combine all of these higher order goods together in order to produce the lowest order good but the question becomes well how do we assign value to these higher order goods and Professor Salerno talked about this a little bit but I want to give you a different spin on it the value of a higher order good is a cost associated with it like if you're going out to buy a ham sandwich and you go to the grocery store the higher order goods are the bread, the butter and the ham and lettuce let's just say and those are costs that you're going to have to incur in order to produce the final good the lowest order good of the ham sandwich so how is it that we assign a cost or a value if you will to the input factors the higher order goods that actually produce the ham sandwich well through what we call value imputation so you value a ham sandwich according to where it falls on your value scale and according to that value you place on the final good you will have to impute back to all of the higher order goods that will allow you to realize that ham sandwich value to them and it's really a nice and very unique way of looking at the price process that the Austrian economists have it's drastically different than mainstream economists have and I wanna give you just to illustrate the point since quite a few of you have taken an economics class in economics if you've taken the class there's always this tension because economists mainstream economists they think they're subjective about value because every economics class if you take it starts with creating a demand curve very similar to the way that I derived our demand schedule here and it's subjective they say you value a good according to your wants that you have and you're willing to pay so much for a certain good and we were going to create a demand curve and that's your demand side of the model and then economists say well the supply side of the model is also important because suppliers have to meet demanders but what determines the supply side of a model in economics or is the supply of a good in economics cost it's the cost of production it's the marginal cost of production in particular and so we've got costs interacting with preferences in mainstream economics to determine prices and quantities bought and sold in the market and mainstream economists at least at the principles level would adhere to the fact that no I mean the price formation processes is subjective because your preferences are subjective but then they bring in these costs through the supply side and muddy the waters a little bit and then when you get to your intermediate microclass your intermediate economics classes if anybody's taken that level yet it becomes a thoroughly cost based theory of prices because preferences get thrown out they throw the baby out with the bathwater and they say well in the long run costs the price of a good the value that you place on it has to fall down to whatever the cost of production is for various reasons that I'm not going to get into but I'll give you an example of vignette maybe to illustrate it I live in Madrid Spain and Madrid is a city of six or seven million people I'm not going to build it up all that I'm on is a pretty great place six or seven million people financial one of the financial capitals of Europe definitely of the Iberian Peninsula people have pretty good salaries and the downside of all of these things is that goods are relatively expensive you go out for a meal in the restaurant it costs a little bit more than it would in other places and I come actually from I was born in a farm a small town in Ontario Canada and when I go home to visit my folks it's great because we go out to we'll go to a restaurant you know there's one restaurant in the town it's like a restaurant, a diner and the prices are really good and prices are expensive in Madrid and they're much cheaper where I come from why is that? the mainstream economists would look at this and they would say well of course prices are more expensive in Madrid in a restaurant because the restaurant owner has to cover higher rents and higher wages for employees and higher input price factors and things like this so of course it's more expensive to have a restaurant in a big city than it is in a small town so the output price the final price that they sell for has to be higher to compensate them for all of these higher costs but of course this doesn't make too much sense in fact it only pushes the problem back one level because what determines those costs? right they're not just given to us something had to actually determine the price of rent to make it expensive in Madrid and something had to determine the wages in Madrid to make them more expensive than the wages in the small town where I come from and so on and so forth there's a story that I like to use often in economics I don't know if anybody read Steven Hawking's a brief history of time is 1988 book and Hawking in there he gives a story of a lecture that was happening in the turn of the century attributed to Bertrand Russell where he's talking about gravity and planets moving and things like that and he says you know planets are suspended in space because of gravitational forces working on each other and at the end of a lecture Hawking says a little old lady put up her hand and she says that's a nice theory but of course it's all wrong because everybody knows because it's all wrong and Russell replies well what do you think suspends planets in space and the little lady says well everybody knows that the earth for example sits on the back of a giant turtle and then Russell says well what does that giant turtle what holds it in space and she says that's very clever young man but everybody knows it's turtles all the way down so it's turtles from here into infinity and it's a nice way to think about problems because okay we've solved the first problem what keeps the earth where it is well there's a turtle under it what keeps that turtle there turtles all the way down wipe your hands and go home for the night and mainstream economists do the exact same thing because they say well what determines the price oh it's the input cost it's rent plus labor and all those types of things and well what determines those prices well of course things that go into it rent is expensive in Madrid because land is very expensive well why is land expensive it's turtles all the way down while the Austrian economists have a much very unique and much more realistic and correct way of looking at the pricing process why is a trip to the restaurant more expensive in Madrid than it would be in the small town where I'm from well because people value a meal at the restaurant higher on their value scale than they do money why would that be well it could be that salaries are higher in Madrid than they are in my small town for various reasons and due to the law of diminishing marginal utility if you earn more money money will be further down on your value scale than other goods and services so they value a restaurant at higher price points than somebody in a small town would so people are willing to pay more why are wages for people who work in a restaurant higher in a city than they are in a small town well because people are willing to pay more for the restaurant meal why are rents higher for stores that could be used as restaurants in small towns again because people are willing to pay more they value more highly the final good produced by the restaurant so the rents are correspondingly higher and so we have value imputed all the way back from the final valuation on the good which will directly satisfy your want the good being the lowest order good in Karl Manger's typology back to the higher order goods which are the input factors necessary to produce those goods and I'll end my lecture here with a couple suggestions for further reading because it's a very complex comprehensive topic but if you ever wanted to read more Murray Rothbard and Man economy and state his first two chapters deal with the first one is wants and preferences in the basic economic problem and the second is this problem of exchange in the price formation process and Karl Manger about half of his whole principles is dedicated to this and of course Eugen von Bomberk has a very nice explanation of the pricing process and where value comes from in his positive theory of value they're all available in the bookstore or online at Mises org thank you