Since the
utility concept is not a necessity, and the simpler the theory the better,
let’s do without it then. As aforementioned, the law of demand does not allow
the existence of the Giffen paradox, and this law is more powerful than the
convexity postulate in restraining behavior, we can therefore conclude that a
downward sloping curve from left to right alone already possesses more
extensive explanatory power than the whole utility analysis.
The law of
demand, as said before, does not require any content of utility. We only have
to assume that Jeremy Bentham had never existed before. Without Bentham, let’s
retrace the view on price back to economics towering originator, Adam Smith. In
his 1776 classic work, “The Wealth of
Nations”, Smith advocated two simple yet correct concepts of price.
Regrettably, these imperative concepts were wrongly analyzed from the outset,
resulting in little attention from later generations.
Correct
concept may be accompanied by incorrect analysis. And if we believe since
analysis is incorrect, then the concept is inherently incorrect, we are heaping
error on error. This is Logic 101 of the Vienna Circle.
Smith
pointed out that there are two types of values. The first one is use value,
exchange value being the second one. As the names imply, use value is the
highest value a good provides to its owner or consumer, or the highest-valued
option this person is willing to forgo. Exchange value is the option forgone in
getting the good. And in the market, exchange value is the good’s market price.
Smith made
an unfortunate mistake in quoting at the outset the paradox between diamond and
water. He said that a good with a high use value may have a very low exchange
value; and one with a high exchange value may have a very low use value. His
example was: water has a high use value, but its exchange value (market price)
is very low; diamond has a high exchange value, yet its use value is very low.
This is the famous “paradox of water and diamond”. However, three mistakes were
committed.
First, we
cannot compare diamond with water, since one gram of diamond is totally
different from one gram of water. Second, given Smith had never been married
(there are several versions whether he had ever fallen in love), he did not
seem to comprehend women’s tastes. To him, a professor who was well-known for
being absent-minded, diamond might not have any use value. But to women, the
use value of diamond can never be any higher. From the perspective of choice,
for a woman to voluntarily pay $10,000 (exchange value) for a diamond, its use
value to her must be no less than $10,000. Unless a person makes a wrong
choice, use value can never be lower than exchange value.
And third
– the most important one – is that Smith in those days did not have any concept
of “marginal” analysis. The use value of water is indeed very high; its
exchange value indeed very low. However, at the margin, the use value of water
is very low. At home these days, one extra glass of water (marginal quantity)
costs (exchange value) less than $0.01, while its use value is also less than
$0.01 – unlike the situation in a desert, the way we drink water at home is
until we want not another sip. What about diamond? Dearly loved by women for
its nobility, coupled with scarcity, its marginal use value is exceedingly
high.
Let wrong
be wrong, and right be right. Aside from the above fallacies, I have a very
high regard for Smith’s concepts of use value and exchange value. These simple
and easy-to-apprehend concepts, being non-abstractive, are an exactly fitting
to someone like me who insists on applying theory to explain behavior! A key
point to note is that the use value and exchange value advocated by Smith are
not castles in the air. They are not non-existent. Rather, in principle, any of
their changes are measurable by changes in option forgone or market price.
Unlike “utility” which is purely imaginary, these two values are observable. In
applying Smith’s concept of use value to replace the content of utility, I
consider it a giant leap forward in demand analysis.
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