Measuring Value

Measuring value

Most people believe that Economics is the study of money. No more so than physics is the study of ohms or watts. To an economist, money is a unit of measure (not the only one, but the most useful). Money is a convenient way to measure trade, but economics is not really a study of trade, either. Economics is really a study of how we allocate our finite resources. One of the most profound insights Economists have had was figuring out that resources are best allocated when they go first to the people who value them most. Sounds obvious, but no one understood that for a long time.

Money allows us to measure the value of one thing against another. If you took a hunk of lead to an alien civilization, it would be worth something. - maybe not much. They might have more lead than they can stand up there, but they could do something with it without question. If you took cash, it might be worth something as paper or artifact, but nothing as money. Whatever value money has is based on our faith in it.

The faith we do have in our money, however, has made trade a lot easier. Say you get paid five dollars for mowing a lawn in an hour. You spend those five dollars on a used CD at a garage sale. The garage salesman turns around and spends it on two bags of candy bars. That means that an hour of your work is worth a used CD, and a used CD is worth two bags of candy bars. Which means an hour of your work also happens to merit two bags of candy bars.

Here is what is so great about money. You didn’t have to think. “Let’s see, I want a used CD. Now I just need to find someone who needs their lawn mowed with two bags of candy bars to spare. Once I do it for them, all I’ve got to do is find someone with a sweet tooth selling CDs!” Thanks to money, you were able to trade the candy bars for the CD you wanted, without ever knowing the CD’s owner wanted candy bars, or even knowing that is what he ended up with! The time and energy this has saved the world is inestimable. While time and energy are both valuable, they are a lousy way to measure value. Too often people make the mistake of believing that the price you pay for an item is based on the cost of production. Not really so. If it were, everything would be all loused up and no one would have the stuff they needed.

Let’s go back to our alien civilization with all the lead. Imagine another civilization on the other side of the planet. They don’t have lead, they have helium, but they really need lead. They build their houses out of lead. Meanwhile, the lead people need helium. They are obsessed with balloons.

Now, lead is heavy and cumbersome. Helium is very easy to manage, especially if it all comes out of a nice little well, like it does in Helium Land. What if helium were really cheap all over the world and lead were really expensive? That would make sense. Lead is hard to collect and helium is easy. If that were the case, both the helium people and the lead people would be poor. The helium people would be poor because the lead people would not pay them anything for their helium. If they did not get paid anything for their helium, they wouldn’t have enough money to buy much expensive lead, so the lead people would be poor.

Instead, though, the market intervenes and makes the system work. In helium land, lead is expensive and helium cheap, while the opposite is true in lead land. This gives the helium people an incentive to get their helium to lead land and vice versa.

Now, in the helium-lead world, no one would need money. Everyone would just exchange helium for lead all the time and it would be easy. In our world, though, you can buy pencils, a magazine, a picture of Justin Timberlake and a new chair in the same day. That’s why we need money to make this complex barter system work. Money allows us to measure the values of all these items against each other. So that dollar in your pocket is worthless, but it stands in for three pencils, a fourth of a magazine, a tenth of a picture of Ricky Martin and a hundredth of a new desk chair.

We don’t actually know when this post was first posted online because it happened before we had a blog. It was originally written as a submission for Mental Floss magazine, however.