Sunday, July 02, 2006

Everybody wins, during a free-market economy

Have you ever noticed how often both sides to a free-market transaction say "thank you" to each other? For example, when the cashier at the grocery store says to the customer, "Thank you," more often than not the customer responds, "Thank you," rather than, "You're welcome."

Why is this so?

The reason has to do with what is called the subjective theory of value. The theory is based on the following principle: in every economic exchange, each side gains because each side gives up something one values less for something one values more.

Therefore, each side to an exchange is grateful for being given something that, in one's mind, is more valuable than what one surrenders in order to receive it.

Consider a simple example of the subjective theory of value. Suppose one person has 10 oranges and another person has 10 apples. What would be a fair exchange between the two people?

It's impossible to say, because there is no objective value of the oranges and apples. Their value, like beauty, lies in the eyes of each beholder. Their value is entirely subjective.

Suppose the two fruit owners enter an exchange in which 3 oranges are traded for 5 apples. Has the orange owner taken advantage of the apple owner? Can we consider the orange owner to be the winner in this transaction and the apple owner to be the loser?

The answer is "no" to both questions. Actually both the apple owner and the orange owner are winners. Both sides have gained from the transaction, each from one's own individual perspective. The orange owner has gained because one has given up something one values less (3 oranges) for something one values more (5 apples).

The apple owner is a winner, too, despite the fact that one has given up 5 things and receive only 3 things in return. Why? Because in one's mind--and according to one's personal ranking of values--the apple owner too has given something one values less (5 apples) for something one values more (3 oranges). Maybe there is an apple abundance, or a lack of orange trees--whatever the case, they both improve during the transaction.

In the grocery store, the principle of subjective value is the same, even though people are using money. Let's say the groceries cost $50. At the moment of the exchange, the customer is receiving items that are worth more to one than the $50 one's given the grocery store in return. By the same token, the grocery-store owner has given up something one values less (the groceries) for something one values more (the $50).

The theory of subjective value applies not only to the purchase of goods but to all economic transactions, including employment contracts. When an employer and an employee enter into an employment agreement, there is no winner and a loser, but instead two winners. The employer is giving something one values less (the money the employer's paying the employee) for something one values more (the employee's labor). By the same token, the employee is giving up something one values less (the time and labor) for something one values more (the money).

How do we know that both sides benefit from every exchange? Because if they didn't, at least one of them--and possibly both--would not enter into the exchange. After all, why would anyone into an exchange if one side was receiving something one valued less for something one valued more?

An important corollary to the subjective theory of value is that people's standard of living rises through the simple act of exchange. Both the owner of the apples and the owner of the oranges, for example, have raised their standard of living as a result of their exchange because they have both improved their own personal well-being, from their own individual perspective.

Thus, it stands to reason that the wider the ambit of opportunities to enter into economic exchanges with others, the easier it is for people to raise their standard of living.

So the next time you're at a grocery store and the cashier says, "Thank you," tell the cashier, "And thank you too. We both are winners!"

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