 Get ready with your pens and notebooks and all that sort of stuff. We've got a very important lecture coming up. It was really introduced by Dr. Salerno, the key distinguishing feature of the Austrian school. So be on your toes. Check your notes after we're done to make sure you know what you're going to be taught right here. Our next speaker is Dr. Jeffrey Herbner. Dr. Herbner is a professor of economics at Grove City College. He's a member of the Ludwig von Mises Institute senior faculty, and he is the director of the Austrian Student Scholar Association Conference. We have the Austrian Scholars Conference here in the springtime. Dr. Herbner directs the student version of that, which is held at Grove City College. And I think that some of you may be interested in participating in that or applying for that. His lecture this morning is on subjective values and market prices. Jeff? Thank you, Mark. Dr. Thornton last night in his remarks mentioned one of the distinguishing features of the Austrian school, which is that we take, as our beginning point, the action of real living flesh and blood human beings, as opposed to the mainstream, which tends to perform economic theorizing by abstractions, by modeling how the economy functions, with simplifying assumptions about economic agents, as opposed to real acting human beings. So we want to, in this lecture, build upon that comment by Dr. Thornton and just lay out the economic theory, first of subjective value, and then we'll talk about the prices of consumer goods. So we begin just with a definition of human action as purposeful behavior. We know that human action is directed toward the attainment of an end. Or we could say that the desire to attain an end is the motive that we have for engaging in action. We also notice right away that simply having an end that we desire to have attained is not synonymous with acting, because as human beings we're finite and we can't just will our ends to be attained, but we must identify means that we can bring the bear through our design to act and attain our ends. So we see that the basic distinction that finite beings make in human action is between ends and means. These are not the same, but of course it's the human mind in acting that brings them into a relationship. So with our intellect, we perceive that certain objects in the world are means to the attainment of our ends. And then through valuing, we integrate these means into our action to successfully attain our ends. Now we begin the process of economic theorizing about human action with the fundamental axiom of economics. And this could be stated in the following way, that human beings exist and they apply means to the attainment of ends. Or we could more simply say that persons act, individual persons engage in action. As Murray Rothbard points out in Man-Economy and State, this claim, this statement, this proposition is self-evidently true because any attempt to demonstrate that a person would take to demonstrate that human action does not exist is a human action that has the end of trying to show that this proposition is false and would be applying means to the attainment of that end, making a speech, writing a paper, sitting still in a corner pretending that that's not human action. So this is an axiom, a self-evident proposition. And this is always a good thing to begin a deductive reasoning process with an axiom, with something we can demonstrate is true. And Dr. Gordon in the next lecture will talk about the nature of praxeology. Now another thing to keep in mind when we begin theorizing about human action is that a lot of the beginning process of doing economic theory, what we're going to start on now, is really done by what Murray Rothbard calls reflection. We simply, because we are human beings, we simply think about the meaning of human action. We can do this because we are human, whereas we can't do this about tigers and bears and plants and so on, right? We can't get inside of their skin and think the way they do. But since we are human beings, we can actually understand by our own experience the meaning of human action. When we say we have an end, we have means, we have intellect to understand the connection between using means and attaining our ends, we value things and so on and so forth. Okay, so the very first conclusion that we want to state in this process of spinning out economic theory is a clarification of this fundamental axiom. We said the fundamental axiom is the person's act or the individual person's act. And as Rothbard is keen to point out, we can clarify this by saying that only individual person's act, in other words, the only agent of human action is the individual human person. Now this poses a particular problem for us in doing value theory because we cannot assert then something like a collective valuation. We know that what we're trying to analyze is the valuations made by individual persons who make their valuations in concert in society. This is much more difficult, of course, to theorize about and explain than if one were to start with the assumption that we have something like a collective agent that engages in action. We have society that engages in action or we have a central planner who can, in his own mind, design action for everyone in society. So we can't start this way. We have to start with individual persons valuing and assessing their action and then how they come into concert with one another. And perhaps you can see that market pricing, of course, is the quintessential economic concerted effort, right? Coming together and we're trading and prices emerge from this process. Now the second conclusion we want to point out when we think about valuation is the fact that means are scarce. I alluded to this already that as finite beings we can't will our ends to be attained. We have to observe the items in the world and discover through our intellect which ones are suitable means. We have to come to own these means. We have to extract them out of nature and apply them to the attainment of our ends. And this requires us to make values and choices. So we say in economics, means are scarce. Every time we apply means that we've acquired out of the world to attain some particular end or set of ends, it precludes us from simultaneously using those means to acquire other ends. For infinite beings, this wouldn't be a problem, right? If we were infinite, we would just will all of our ends to be satisfied immediately and synchronously and we wouldn't have this choice to make. So we must allocate our means. Since our means are scarce, we have more ends that we can attain than we have means available to us to attain them. It must be the case that when we engage in action, we're choosing to allocate our means to apply them to the attainment of some particular set of ends while simultaneously foregoing the attainment of another set of ends. So we recognize right away that the choice that we make in using our means is two dimensional. We always choose what we wish to attain and we set aside what we could have attained and are not choosing. Now, in order for this choice to be, according to our purposes, which is how we define human action, it must be made by what we'll call valuation and valuation is just the judgment that we make in our minds of the benefit, the value, the benefit, the utility that we would acquire from attaining different ends with a given set of means. So when we bring together the idea of choosing with the idea of valuing, we get the basic principle of economic theorizing which we call preference. So in every action, we establish in our minds a preference. We prefer one course of action to another. We prefer the chocolate ice cream cone to $4 and this then leads to our purchase of the chocolate ice cream cone or vice versa. We prefer the $4 to the ice cream cone and we choose not to purchase the ice cream cone. So in every action, we take the action by establishing in our minds a preference, the means that we have, the preference then that we have to use these means to acquire some particular end and set aside the attainment of another. Now notice preference then is bound up in the action. This is what Rothbard calls demonstrated preference. Our preference is part of our action. It's not abstracted from action. So we can't think of preference as a utility map or we can't just assume that we have this preference set over here like mainstream economists do that then sort of impels the economic agents to act. Now we're talking about our own valuations that we make in our mundane and actions every day. We establish the valuations of different options in our mind and we set them against each other and compare them, choosing one over another. So as Rothbard points out, preference can only be known by an outsider. Another person's preference can only be known by an outsider. By the action the person takes. Preference and action are always consistent. They're bound up together. This is how we define preference. Okay, now we want to point out two important principles about valuing. One of these is the title of the lecture indicates is the subjectivity of value. And here we run into the problem of ambiguity in this term. Subjective is used in different ways, in different contexts. But in economic theory, the word subjective refers to the fact that the valuations we make about our action, about our ends and our means are states of mind. They're judgments of our mind. They're subjective because they exist only within the human subject. They're not objective. They do not exist outside of our minds but exist only within our minds. Now because of this, certain things are implied. Something that exists only in my mind has no extensive property by definition. And therefore we can't measure it. So a state of mind cannot be subject to measurement because we cannot define a unit in which it would be measurable. To have a unit of something, at least a common unit that could be used by different people to simultaneously measure something and come to some objective standard of the measure of something, would have to have an extensive property. Would have to have weight, mass. It would have to have distance or color or something that two people could independently verify since it exists outside of themselves. But if my subjective value is just inside of my mind, then you cannot examine it directly. And therefore, if I were to say I get 10 units of value from consuming a chocolate ice cream cone, this would just be a nonsense statement to you. You don't know what I mean by a unit. And if you said, well, I get eight units of value from eating a vanilla ice cream cone, we'd have the same problem, right? Whatever your units are and whatever my units are, we don't have a common unit. We can't determine what a common unit might look like. And for this reason, not only can we not measure value, it's not a substance to be measured, but we can't interpersonally compare our valuations. We can't really know whether or not, at least directly, I get more utility from consuming the chocolate ice cream cone than you get from consuming the vanilla. Now, this sets up a difficult problem in explaining social life, which is if we want a division of labor in production, if we want to be producing for the consumptive ends of other people, and we want our production to be economizing, we want it to be efficient, we want it to be satisfying the higher-valued preferences of other people, we need an objective way of knowing that when we produce certain goods, we're satisfying more valuable ends that this group of people has, as opposed to using our factors of production to produce a different good for a different set of consumers who have different preferences. And we can't do this directly. This is the problem, right? Of course, it is through market prices that this is accomplished, as we'll talk about in a minute. Now, the second fundamental principle about valuation, the first being the subjectivity of value, and the second is that valuations are not constant. We cannot presume that our valuations have a quantitatively constant relationship between objective features in the world and our action. We just, we can't safely presuppose this. We understand, in other words, just by reflection that this is not the case for us as human beings. It isn't, for example, it isn't as if every time the price of gasoline goes down 5%, we must have necessity purchase an increase of 1%. No matter what other factors might exist in the world. There isn't that sort of constancy between external factors, quantitative external factors that affect our action and our action itself. By the way, we know this because we experience the principle of regret. We're in certain circumstances, we take an action. You go for that blind date, right? Doesn't work out. And we say, oh, you know, I wish I would have chosen differently, but of course we would never think of regret. It would never be a meaningful notion for us. If we weren't in fact able to have chosen differently, then we actually chose in those circumstances we were actually in. Okay, so this by the way is why in the Austrian view we cannot do functional analysis in economics. There are no functions. There's no such thing as a demand function. No function that's related to human choice at least. Because there are no constants. And so we can't establish equations like like a demand equation that's made up of constants and variables. As Mises like to put it, everything in economics is a variable. Everything in human action is variable. Okay, let me also point out along this line of valuing and these fundamental principles that not only is the option we choose in action according to our subjective value that is the value of it is subjective to us. It's chosen by our mental judgment. But it's also true of cost, right? The cost of our action is simply the best alternative that we forego when we apply our means to the choice that we prefer. In every action we take our means and we choose what we prefer and we forego what we prefer less. It's the subjective value of what we have foregone that is the cost of our action. Furthermore, it should be plain to you now that in every action we aim at a profit. We aim at what Robert called a psychic profit. We aim to establish a difference between the cost of our action and the value of it. In fact, we would never act toward any option unless we thought that it would render a subjective profit to us. That the alternative we've chosen is to be preferred to the alternative that we've given up. And this gets us to perhaps the central concept in all of economic theory at least at this level at this sort of introductory level which is the principle we call economizing. So we can see now that all action is economizing. All action takes a given means that we possess and applies it to the attainment of what we at least anticipate to be higher valued ends foregoing lesser valued. And for each end that we pursue, we also economize the use of our means. We strive to attain each particular end that we've chosen in a way that expends the least valuable means given that there are different alternative options for combinations of means to attain a given end. Okay, so this gets us up to the point now where we can make some distinctions between the Austrian view and other views. And let's begin with this idea of what we call value imputation. So far we've only pointed out that valuation is what we do when we decide on the judgment we make in our minds of the benefit of attaining an end. But we also know, of course, that means objects in the world have value as well. And the question arises then, where does this value come from? Why do we say that my house is valuable, my car is valuable, the food that I eat today is valuable to me and my clothing and so on? Well, there are only a limited number of possibilities. The Austrian view is on the top line that says value originates in our mind and then we place value on consumer goods that directly satisfy our ends. So the arrow of causality is moving to the right, from our mind to the consumer goods. I'm hungry and I want my hunger satisfied and so I value the ham sandwich. And then because I value the ham sandwich I value the producer goods that go into the production of that consumer good. I value the labor and the bread and the ham and the cheese and so on and so forth. Now the reason why, we won't go into elaborate detail about this, but the basic reason why value must be imputed to means and not intrinsic to the means or arising from some other source is as we said before that in human action all of our action is designed to attain an end. All the value of the action is sourced in the end that we have chosen to pursue and therefore the value of the means can only be derivative of this value as aids to the attainment of ends. So this is the idea of imputation, you perhaps may notice somewhat more subtly difficulty involved in this claim about value imputation. Sometimes this is called backwards imputation. And that sort of highlights this difficulty. Don't I need to know the value of the producer goods right now in order to choose them with respect to the value of the end that I'm only going to attain in the future? Don't I need to already know the value of my labor and the bread and the ham and so on right now in order to choose that particular combination to make the ham sandwich and then eat the ham sandwich in a few hours? Surely this is correct. So it can't be the realized value in my mind of attaining my end that I'm imputing back to the means. It has to be the anticipated value. So already at this stage, very early on in our reasoning process we hit upon the idea of entrepreneurship. Entrepreneurship is involved in every human action where we assess the value that we anticipate attaining through action to acquire this end in the future. It's that value that we're imputing to the factors of production and the consumer goods at the moment. Now notice the middle line we could call the cost of production theory of value. Made famous by the British Classical School which says that value originates somehow intrinsically in producer goods. Something like Karl Marx's claim about the labor theory of value. That value is an intrinsic property of labor. Every time you use a unit of labor it generates $10 of value or whatever the market value is. And then by production this value of the producer goods gets embedded into the value of the consumer good so the causal arrow moves to the left. And then our minds are sent to this value. Oh yes, I see that the iPad is worth $500 because there's $500 worth of producer goods that go into making it up. That idea. Now notice again, we won't go into an elaborate refutation of this. We'll just make the basic point. The basic point is as we said before that for human action all value originates in the attainment of the end. We can't conceive of it otherwise. The only point of engaging in action at all is to attain the end. And therefore all producer goods and consumer goods must derive their value as they're related to the attainment of the value of the end. Now the final line here is the neoclassical view, sort of Alfred Marshall view that the value of consumer goods is jointly determined by subjective value of our minds and the intrinsic value, the objective value, what do you wish to call this, producer goods. Now you notice again, this theory falters on the same claim that we've used already that unless you're going to claim that somehow the producer goods have value that's derived from using them to attain ends, then you have the same error here, right? You can't think that producer goods have an independent value from the attainment of an end if you're reasoning along the lines that we've suggested. So the neoclassical economists don't do this, right? They say that producer goods have value derived from the value of the ends they help attain. But you notice that that's true, then they're caught in a vicious circle, right? They're just engaged in the fallacy of circular reasoning. And again, we won't elaborate on these arguments, I suggest them just for your further consideration. Okay, now the next point that we want to move to is we see then this argument that we've made up to this point that the human mind organizes all aspects of human action. It selects the end, it says here are the different ends that are valuable to me. Here are the different means that are identified by this person in the world that might be suitable for the attainment of the ends. Here are the ways in which these means might be acquired by the person. Here's the valuing that the person does of these different means relative to the ends. The choosing between different alternative ends, the choosing between different alternative combinations of means to acquire the end. This is the Austrian view of things. The judgment of the human mind organizes all the different aspects of acting. This is much different from the mainstream view. Okay, so with that in mind, let's move on to this other point that I had alluded to earlier. When we think about economizing within society, we have this seeming difficulty. And the difficulty to state it once more is that in the social order, we're engaged in a division of labor. That means that each of us is producing to satisfy the consumptive ends of other people, not just our own. So Kim Cook is producing the iPads and satisfying our preferences, not just his own. So in order for Cook to economize, to choose to devote resources toward more highly valued ends and away from less highly valued ends, from among society at large, he has to have a way of objectively comparing the ends that exist in the minds of some people or the ends that exist in the minds of others. And some of you may recognize this problem was posed by, most famously by Mises in his book, Socialism. Where he pointed out that central planners, if we try to rely upon tippy top government officials to make these decisions, if they're gonna run the division of labor just by deciding what will be produced and then ordering people to produce it, they can never economize. This is because in order to economize in their system of central planning, they cannot appeal to our voluntarily expressed preferences in buying things and selling things in the array of prices that emerge. They can only guess at what our preferences might be. The central planner can't actually experience our preferences because our preferences are subjective. And so he can't rank order our preferences in his own mind. If somebody does this, they're just making it up. They're just sort of claiming such a thing, but there's no objective way for them to know this. Neither could the organization of the division of labor be done by people in some sort of democracy where we all get together and we just vote on how our resources should be allocated. Because once again, voting wouldn't express for us our preferences in some sort of objective comparable way as market pricing does. The same would be true about opportunity costs when we think about selecting the least cost method of production. In these cases too, in order for a central planner to be able to do this in his own mind, he would have to experience a personal experience with every alternative in the division of labor. He would have to undertake every task in the division of labor so that he could assess it personally and establish an opportunity cost for coal mining and brain surgery and teaching and garbage collection and so on and so forth. But of course this is impossible. No person can experience all the different activities in the division of labor. That's the beauty of the division of labor, right? Is that we can all do different things and combine our efforts into a concerted society where our ends are better met. Okay, so let's go on then to see how this is done in the market economy. So this is our full schematic, if you will, of the pricing structure, the argument that we use to explain the pricing structure in the market. So we start at the very top with our preferences. So we just start with our own preferences for goods and factors of production and so on. And then the value is, as we said, the causal arrows are moving in the direction indicated. I prefer a chocolate ice cream cone and so I purchase it relative to the price in the market. Somebody else has reverse preferences and so they're willing to supply the ice cream cone to me and receive the money in exchange. And so this is where most supply and demand come from, just our preference rankings, our valuations. And this is what we're gonna talk about for the rest of the time, just the top three lines in this diagram. How is it that, given our preferences, we establish our buying and our selling and then through our buying and selling, prices for consumer goods emerge. But the rest of the schematic, again, follows out from what we talked about with respect to imputation. Once we have prices of consumer goods that exist, those prices will generate revenue for the entrepreneurs in the division of labor who've produced these goods. So we have preferences or demands, I should say, for iPads and then this generates revenue for Apple in producing and selling these iPads to us. And the revenue that is generated for Apple then permits Tim Cook to demand the producer goods that will be used to construct the iPads. And so we can see how our preferences for the consumer goods are imputed directly into the prices of the factors of production. What's paid for the computer chips, the screens, the labor and so on is all determined by our buying and selling of the various goods that can be used or produced, I should say, with these different factors of production. Prices for the consumer goods also generate costs for us as consumers. And so we economize our expenditures with respect to buying one thing and buying another. So that's embedded in this schematic. And then you'll see, when we get to the prices of the consumer goods, we have demand for the producer goods by the entrepreneurs. And then the supply of producer goods is we go back to preferences, right? We have the owners of the producer goods, you have your labor that you own and you just establish in your mind a preference for taking this job and receiving the compensation that's paid in that job or taking a different job and receiving a different set of compensation and so on. So we all have preferences that we express in the supply of our producer goods. And then in the market, as supply and demand would be in concert and the prices of producer goods would emerge. And then the prices of producer goods generate costs for the entrepreneurs. So cook has to pay the wages for the labor and the prices for the chips and screens and so on and so forth and income for the people who own the producer goods. And so this gives us a full schematic of how we would theorize about the whole array of pricing in the market economy as well as production decisions and decisions we make as consumers by expending our income. Now there's certain things that are left off the diagram that we'll build in to our analysis during the week like time preference in the interest rate. So I didn't squeeze that on but you can see the basic flow of how the argument is proceeding. Now let me point out that on the right hand side of this where you see again the revenues to the entrepreneurs that are generated by the prices of the consumer goods, by our preferences for buying the consumer goods and the costs for the entrepreneurs by the prices of the producer goods are what generate what we call in economics economic calculation. And there are two basic forms of economic calculation. The first is net income. The net income from production is just revenue minus cost. This is just accounting net income. We're just talking about a net income statement that an entrepreneur would generate from the operation of his business. He incurs costs by buying the factors of production and then he earns revenue from selling the output and production decisions are obviously made with an eye toward the effect on net income. So Tim Cook isn't gonna generate the next iPhone and offer this iteration to us in the fall unless he anticipates that the revenue stream we generate from buying the product will more than compensate for the costs. Now again there are time dimensions involved in this that we won't refer to but we just want to see that what we're talking about here is decision making that's relying upon more than just subjective valuations. Now we have an objective information. We have objective results in the market that are generated by trade in the market that is an aid to entrepreneurial decision making in the division of labor. We have a guide for the entrepreneurs to make allocation decisions of resources by appealing to economic calculation. Now let me introduce one more term. Let's kind of complete this. We said before when thinking about valuation that we had this difficulty in reconciling at first the this imputation theory where we said we value something in our mind and then we impute this value to the consumer good and then back to the factors of production. We had this difficulty because it isn't obvious at first how exactly we can synchronously value the factors of production and the end, the realization of the end. And the answer is, well, we can't do those synchronously. What we're valuing when we value the factors of production is the expectation of the realization of the value of the end. And so it is with entrepreneurs in the market when they pay the prices for the factors of production today and incur the cost, they're only doing so under the anticipation that they'll recoup these costs with the revenues that will be generated in the future. Cook has already expended all sorts of resources to produce this new iPhone, right? R&D expenditures, he's set up supply chains with the producers of the bigger screen and the chips and so on. He's expending all of these, he's valuing these costs or valuing these factors and paying the cost today in anticipation of the value of the consumer good to us when it's offered to us hopefully soon. Okay, so this is the idea and when we add this idea of entrepreneurial anticipation to economic calculation, we call this appraisement. So once again, valuation refers to our anticipation of our own subjective valuation that we'll receive in the future that guides our action now, right? That we use to organize our action today. We set in motion all of the actions that we take under the anticipation of receiving the value at the end of our action. So you've done this by coming here this week. It's some anticipation of how valuable this will be once you realize, and you may not fully realize, of course, the value of what you're doing this week until the end of your life, who knows? But the point is you're anticipating a certain valuation that you'll get from this experience but you're expending the costs already. You've already given up certain alternatives that you could have engaged in that would have been valuable to you to devote your time and effort to come here. So this is the idea of valuation. And then appraisement again is we have the entrepreneurs, the specialized entrepreneurs in the market who do the same kind of thing. They make economizing decisions, but they do so by anticipating the monetary results of actions that they take in the division of labor, actions where they bring all of us into concerted effort. Okay, so as I mentioned, what we wanna talk about in the rest of the time, the second part of our discussion about market prices is just this, the first three lines here. We just wanna talk about the prices of consumer goods and we'll leave to other lecturers and other lecturers to fill in the rest of this about production and the prices of producer goods and so on. Okay, so let me start with which is an illustration to get us to our economic theory of pricing. And we do this by developing what Roppert calls the laws of utility. And as we'll see, the laws of utility are implications, they're logical implications of the principles that we've developed already, economizing and imputation. If we in fact economize when we allocate our means and we impute value to our means according to the value of the ends they help attain, then we can construct the laws of utility. The laws of utility would just fall out as logical implications. Now we do need though certain conditional statements in order to develop the laws of utility. So let's state these. And then we'll go through an illustration of how the laws of utility are the interface between what we've spoken about so far and the explanation of market pricing. First let's start with the idea of a unit of a good. So the unit of a good is the amount of a good a person chooses as suitable to the attainment of his end. So an example would be I wanna have water to drink during the day and I choose just because it's a judgment of my mind, it's what I want to do, I prefer to do it this way. I choose let's say a gallon of water. You might choose a half gallon, you might choose zero, right? You might not like water, that's fine. I'm just saying in every action a person chooses the amount of a good that they consider suitable to attain their end. The unit of the good is a choice variable. There's nothing in the technical features of the world that requires us to choose to be forced to accept a certain technical unit. We choose. Okay so if I choose to drink a gallon of water a day then economizing an imputation says this, if I happen to have a gallon of water and this was all the water that I had that I possessed during the day, I would allocate it, I would choose to use it to drink. And then I would impute the value of achieving that end to that gallon of water. I would value it very highly if that were all the water I had. Okay now we need to introduce the conditional statement. So in every action a person chooses the unit of the good that he or she will act with. The conditional statement we use to deduce the laws of utility is the idea of an equally serviceable unit. So equally serviceable units of a good are interchangeably useful in the attainment of different ends. So again if I have a gallon of water I can use the water to attain my drinking end during the day or I could use it to attain the end of watering the plants in my house. It's interchangeably useful to me. Or I could use it to wash my hands during the day. Maybe if I again choose that amount of water to perform that task. Notice we're not saying that a person always acts with equally serviceable units of a good that may or may not be the case. We're saying what if we consider action where a person possesses equally serviceable units of a good. The reason we conjecture this is because in markets which is what we're trying to explain right we're trying to explain market prices. Goods exist in equally serviceable units. You go to the gas station you fill up your car with 87 octane gasoline and gallons. Well it's interchangeably useful right. Whatever you're gonna use that gasoline for in your lawn mower, your car, your motorboat or whatever. Presumably it's interchangeably useful to you. In fact it's physically identical. Lows of Wonder Bread at the grocery store and pounds of grade A ground beef or whatever are all interchangeably useful to us. And therefore this is a realistic condition. It's a condition we face in the market continuously. So it's not like we're engaged in a pure abstraction here. Okay well anyway if it's true that we can conjecture that human action can take place with equally serviceable units. In order to develop the laws of utility we just ask in my hypothetical situation what if I had two gallons of water then? How would I now value a gallon of water? And the answer of course is I would value now a gallon of water less highly. That's because given that I've satisfied my drinking end with one gallon of water if I had a second gallon of water I would have to apply it to a less valued end. My second ranked end. And since I value the second ranked end less than the first ranked end I impute less value to that unit of water to that gallon of water. And so on if I had five gallons of water the marginal utility of a gallon would be lower than if I had four. This is the idea of diminishing marginal utility that you've heard in Dr. Salerno's lecture already. But notice here we're explicitly making the underlying conditions apparent. We want to explicitly state what they are. A lot of students when they first learn about diminishing marginal utility they get a completely wrong notion of it. They don't understand that it's a logical implication of acting and not a psychological stipulation of acting. So many economic textbooks, mainstream books use the example of eating slices of pizza or drinking glasses of beer. And so they say well you drink one glass of beer and then you get a certain utility from that. You drink the next one, certain utility. But eventually the sixth one or the eighth one or the 20th one or something the utility's diminishing. That's not the law of diminishing marginal utility at all or the first law of utility. That may be true, it may not be true. That's just a psychological question. Hopefully you've seen that the actual first law of utility, diminishing marginal utility is implied in the logic of acting itself. It cannot be false, there are no exceptions to it. Once we see how the proper way is to define a unit of the good. Okay, so the second law of utility, the first law of utility again is diminishing marginal utility. The second law of utility just says that a larger stock of a good is preferred to a smaller. More of a good is preferred to less. And again this must be true as long as another unit of the good is actually a good, it's valuable. It's still scarce and valuable to me. That's bound up in the definition of something being a good. A good is by definition a scarce means that is valuable. Okay, so given that, given the laws of utility we can then proceed to the derivation of demand and supply. So let me use this illustration. We have the preference rank on the left hand side of what I've called a generically a trader. And you can see that the rank orders are between sums of money and units of Honda Civics. So the story behind this would be, suppose we have this person and this person has a preference for owning a Honda Civic. Let's say it's a 2010 Honda Civic. And the person's preferences look like this. They look as I've sketched them here. So as I've sketched them they say that if the price in the market happened to be $16,000 for the Honda Civic this person would not purchase the Civic. He values keeping a $16,000 above obtaining the first, what I'm calling the first or highest ranked Honda Civic. However, if the price were instead 15,000 then this person would buy the Honda Civic. That's what that preference rank says. And of course it must follow since more of a good is preferred to less, it must follow that he would also purchase the Honda Civic if the price were below 15,000. If it were 14 or 13 or 12 or 11 and so on. And in fact, we can conjecture because of the second, excuse me, the first law of utility that there would be some price low enough that this person could be enticed to purchase a second Honda Civic as long as he considered that still a good to him. As long as he could think of a use to which he could put the Honda Civic. So let's say again to embellish the illustration a little bit. Let's say he intends to put the first Honda Civic to the use of commuting. And that's his most valued use. So he's gonna use it every day, commute to his job in the city and then back to his house. But he can think of a valuable use to put another Honda Civic that could be used simultaneously somehow, right? Not by him maybe, but by somebody else. He could lend it out to a friend or, right? Or he could have it sitting there to use for days when his primary car breaks down or something of the sort. I mean, rich people might be like this, right? David Rockefeller has a big stable of cars and he uses them interchangeably or whatever. Just has another Lamborghini sitting around just for parts, something like that. So because he values money much differently than we do, right? His preference rank doesn't look like this. Okay, so I'm just stipulating what the preference rank is, right? We just have some guys interested in buying a Honda Civic. The price happened to be 16. He wouldn't buy 15 or lower he would. Then we can conjecture of course that there would be a price low enough that he might be interested in buying too. And that gets us what we call the law of demand. You can see the law of demand is a direct implication then of the laws of utility. Only at lower prices will a person buy more of a good, say there's a pair of us, other things the same. Or given, we could say it stated this way. Given that a person purchases a certain amount of a good at a given price, given that a person's done that, let's suppose again this guy goes into the market, the price is 15, he actually buys a Honda Civic. The law of demand says only if the price would have been lower would he have purchased more. Or we could say it even more strictly. At a lower price he would have purchased at least as much. He would have purchased the unit he did purchase and maybe more. That's the law of demand. Now you notice the law of demand is not an empirical claim. It doesn't say next week when the price is lower this guy will buy more. It says right now the action that he's taken, whatever it is, we're assuming he's bought the Honda Civic and paid 15. We're saying right now for that action if the price would have been lower then yes he still would have bought the car, right? Because he prefers more money to less. And the price might have been low enough that he would have actually purchased two. But he didn't purchase the second one because of diminishing marginal utility. This is just like we go into the grocery store and we buy a loaf of bread. We don't buy all 20 loaves of identical bread that are sitting on the shelf even though the price of each one is the same. We only buy one. This must mean since the price is the same that the value we place on each of these loaves is diminishing. We value the first loaf we take more highly than the ones we leave on the shelf. This can only be explained by this principle of diminishing marginal utility. Okay, so then I sketch out, right? The quantity demand, the QD stands for the quantity of that the buyer or the demandor will purchase at the different prices. Now notice, we can use the same preference rank just by changing the conditions slightly to deduce supply. Remember, my example is a 2010 Honda Civic. So this guy who's gonna buy the Civic is buying it from another customer who owns it already. This is some other Joe who owns the Honda Civic. He's not buying it as a new Honda Civic from Honda, right? He's just buying it from somebody else. We'll see why that's important in a minute. So let's suppose, contrary to our first case where we deduce demand, let's suppose that we have a person who owns two Civics. He starts out that way. Two equally serviceable Civics. So they have to be sort of interchangeably useful. Same model, same configuration, same year, roughly the same mileage and so on. If they're not, they'll have different prices, right? And what we're trying to explain is why one particular unit or units of a good would have a particular price. Okay, maybe he got the second one as inheritance from his uncle who died or something, right? So he winds up with two. Now, if he starts with two then, and he's given opportunities to trade, we can sketch out his supply relationship. We would see, for example, that if the price in the market were 10,000, he would keep both of his cars. He values them in whatever uses he puts them to more highly than 10,000. But if the price were 11, he'd sell the second Civic. He'd sell the one that he'd sell away the use that's not very valuable to him. You know, letting his friend borrow it and he'd keep commuting or whatever he uses the more valuable one for. And so his supply, his quantity supplied is one at 11. And of course, it must be true that if he supplies one at 11, he would also supply one at 12 or if the price were 13 or if the price were 14, he'd still be happy to sell that one unit because he prefers more money to less, money is a good to him. And there might be a price high enough that he would sell both. But the reason why he doesn't sell the first Civic and the second one at 11,000 is because of diminishing marginal utility. He values that unit that he holds onto at the low price more highly than the money, the price itself. But if we raise the price high enough conceptually we could get a price maybe high enough to bid this unit away from him too. And so we get the law of supply. Only at higher prices is the quantity supplied larger, other things the same. Or again, we could say it more strictly for a given sale, if the price would have been higher the person would have sold at least as much. Now you notice if you're following this argument up to this point that these two conditions of the law of supply and demand are not synchronous with each other, right? As prices go up and up and up the quantity demand will be reduced and the quantity supplied will increase. And as prices go down and down and down the quantity demand will increase but the quantity supply will be reduced. So only at some prices would people come into concert with each other. So that's how the argument proceeds. Why is the price of the Honda Civic end up where it actually ends up at 15,000 or at 13,000 or wherever the price winds up? Why is the price of a gallon of gasoline $3.20? Why isn't it $5? Why isn't it a dollar? And the argument that we present here is it gravitates to this level because at this level of price the market clears. The buyers and the sellers are brought into perfect concert with each other. And after all, it's the whole point of engaging in action is to have our in satisfied, right? Okay, so let's go on to see this. Let's suppose we have a fully developed market and we have three buyers and three sellers and you'll notice these buyers are stratified just like they would be in the real world where A is a more eager buyer than B. He could outbid B for the Honda Civic. Buyer A is willing to pay 15,000 but buyer B is willing only to pay 13. All right, and buyer C is the least eager of the buyers. And likewise, we stratified the preferences of the sellers, they're different from each other. Seller X is the most likely to sell. He's the most eager. He's willing to sell a Civic for 11,000. And so he could undercut seller Y or seller Z. Seller Y won't sell until the price goes to 13,000 or above and seller Z would only sell at prices of 15,000 or above. So we can see when we have different people in the market competing with each other, right? Buyers are competing against the other buyers, offering bids to the sellers and the sellers are competing against the other sellers asking different prices. As we said before, what emerges in the market is this concert of the buyers and the sellers only at certain prices. And we call this wonderful price, this price of 13,000 in our example where the quantity demand and quantity supply are equal. We call this the market clearing price. By the way, just to point to terminology here, Austrians use the word equilibrium price for other constructs. So they're different notions of market adjustment, if you will. So here, when we're just talking about prices as they exist in the market, we call that market clearing prices. Equilibrium prices are something else. We leave them for other, usually the terminology is left for other constructs. What we're saying in other words is that if there really were a market like this, the price actually in the market would be 13,000. Why? Because at 13,000, all of the preferences of the traders are satisfied. Everybody's satisfied at this price. A and B get to buy cars, they're satisfied. X and Y get to sell cars, they're satisfied. Buyer C does not want to buy a car at this price and he doesn't. And seller Z does not want to sell at this price and he doesn't. So everybody's satisfied. At any other price, somebody is dissatisfied. And of course we don't engage in action to be dissatisfied. The economizing solution would be to create the greatest degree of satisfaction. So at higher prices, there'd be excess supply and some of the sellers would be dissatisfied. They wouldn't be able to have their preferences satisfied. They could not find buyers at those prices. So what they do is they, in fact, they anticipate that the market will clear at the lower price. And even in advance of having their expectations dashed, they ask that price. And the same thing for prices too low, right? People don't trade at prices too low but precisely because if they bid these prices, if a buyer went in and bid a price of 11, he would find no sellers. And if he wants to buy and is willing to pay the market clearing price, that's what he does. He simply anticipates that this price will clear the market and he asks that price instead. So let me close just by reiterating what I said about this construct. This is the explanation of actual prices as they exist in markets. We're not trying to explain here general equilibrium prices that exist in some sort of abstract model. We're not trying to explain where prices will be in the long run, you know, after adjustment takes place in production and so on. Those are different questions. The reason why this is important as we mentioned before is this is the starting point for entrepreneurs to do economic calculation. When they want to do appraisement of production decisions, they need to know the array of existing prices in markets and this explains where that array comes from. It comes from our preferences for these goods. Okay, thank you very much. Thank you.