Subjective Preferences, Transaction Costs And The Free Market Economy
The free market economy is not a straightforwardly intuitive process. To understand it requires getting down in the weeds of what it is and how it works. Otherwise, it's too easy to resort to tired and misleading cliches and platitudes.
Elsewhere, I've defined the free market economy in a way that put the emphasis upon principles of voluntary exchange. The function of this quality is another matter. It has to do with the overall increase of social wealth. Understanding how a free market economy increases social wealth requires understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to social wealth.
How, then, does voluntary exchange provide this benefit to social wealth? Many people assume that there is no change in wealth brought about by an exchange. The assumption is that the items exchanged must be equally valuable or the traders would not have traded. (Or, at least, one would have to have benefited at the other's expense - so it all washes out.)
This is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
1) It's hard to see why a trader would bother making an exchange if he valued what he was buying equal to what he was selling. But even if he did do such a thing, for whatever whimsical reason, he would pay the price of a total loss in the process. This would be because, while the goods bought and sold were held as equally valuable, he would have to cover the transaction costs of the exchange.
Consider an example: imagine you're walking by the store front of your local grocer. If you valued the dollar in your pocket and the apple for sale in the store equally, you wouldn't care which you had. If you actually were so indifferent, would you detour from your journey to enter the store, find your way to the apple bin, peruse them in search of a ripe one, free of bruises, then walk over to the cashier and wait for the line to inch along until you reached the cashier and could pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) This observation leads us to the second commonly confusing point relevant to the claim that trades involve goods of equal value: subjective preferences. The difficulty seems to be an understanding how two people can exchange goods, with both successfully buying a good more valuable than the one they sold. It is in this way that both become wealthier and the social wealth increases. Understanding this requires understanding subjective preferences. The gist of it is simply that people have different values at any given moment in time.
Feeling hungry as you near the local grocery store could well have you value an apple more than a dollar in your pocket. Your greater valuation of the apple may be so much greater than the dollar that you'd happily incur the transaction costs (detour, perusal, waiting in line) to exchange dollar for apple.
It would be entirely erroneous to conclude though that this makes the apple objectively more valuable than the dollar. All we have here is the value of this one moment on this one day. Yesterday, passing the grocer's store you may not have been hungry at all - perhaps coming from a large lunch with a friend. In that case, your subjective valuing of dollar and apple would have been quite different, equally as legitimate and obviously no less thoroughly subjective as it was today.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
A useful lesson arises from thinking about how often at your local grocers that funny moment occurs when, at the conclusion of the exchange, you both say thank you. Is someone confused here? Not at all! You both say thank you because you are both thankful. Each of you received a good that you value more in exchange for one that you value less. They call that a win-win. You are both wealthier thanks to trading goods.
The total social wealth has increased. And it does so every time such a voluntary transaction occurs. Herein lays the magic of a free market economy. The freer it is, the more total social wealth is generated.
Elsewhere, I've defined the free market economy in a way that put the emphasis upon principles of voluntary exchange. The function of this quality is another matter. It has to do with the overall increase of social wealth. Understanding how a free market economy increases social wealth requires understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to social wealth.
How, then, does voluntary exchange provide this benefit to social wealth? Many people assume that there is no change in wealth brought about by an exchange. The assumption is that the items exchanged must be equally valuable or the traders would not have traded. (Or, at least, one would have to have benefited at the other's expense - so it all washes out.)
This is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
1) It's hard to see why a trader would bother making an exchange if he valued what he was buying equal to what he was selling. But even if he did do such a thing, for whatever whimsical reason, he would pay the price of a total loss in the process. This would be because, while the goods bought and sold were held as equally valuable, he would have to cover the transaction costs of the exchange.
Consider an example: imagine you're walking by the store front of your local grocer. If you valued the dollar in your pocket and the apple for sale in the store equally, you wouldn't care which you had. If you actually were so indifferent, would you detour from your journey to enter the store, find your way to the apple bin, peruse them in search of a ripe one, free of bruises, then walk over to the cashier and wait for the line to inch along until you reached the cashier and could pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) This observation leads us to the second commonly confusing point relevant to the claim that trades involve goods of equal value: subjective preferences. The difficulty seems to be an understanding how two people can exchange goods, with both successfully buying a good more valuable than the one they sold. It is in this way that both become wealthier and the social wealth increases. Understanding this requires understanding subjective preferences. The gist of it is simply that people have different values at any given moment in time.
Feeling hungry as you near the local grocery store could well have you value an apple more than a dollar in your pocket. Your greater valuation of the apple may be so much greater than the dollar that you'd happily incur the transaction costs (detour, perusal, waiting in line) to exchange dollar for apple.
It would be entirely erroneous to conclude though that this makes the apple objectively more valuable than the dollar. All we have here is the value of this one moment on this one day. Yesterday, passing the grocer's store you may not have been hungry at all - perhaps coming from a large lunch with a friend. In that case, your subjective valuing of dollar and apple would have been quite different, equally as legitimate and obviously no less thoroughly subjective as it was today.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
A useful lesson arises from thinking about how often at your local grocers that funny moment occurs when, at the conclusion of the exchange, you both say thank you. Is someone confused here? Not at all! You both say thank you because you are both thankful. Each of you received a good that you value more in exchange for one that you value less. They call that a win-win. You are both wealthier thanks to trading goods.
The total social wealth has increased. And it does so every time such a voluntary transaction occurs. Herein lays the magic of a free market economy. The freer it is, the more total social wealth is generated.
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New Unique Article!
Title: Subjective Preferences, Transaction Costs And The Free Market Economy
Author: Wallace Eddington
Email: honestoffers4u@gmail.com
Keywords: free market economy,economics,business,trade,exchange,commerce,money,social issues,wealth,ethics
Word Count: 932
Category: Business
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