by F. Bailey Norwood
(mostly finished, still working on typos)
The Price of Everything, by economist Russell Roberts, is a teaching novel, an attempt to entertain while you educate. It is a magnificent description of the role price plays in society; a role crucial for our well-being, a role that is poorly understood. Sterilized water is also crucial for our well-being. In the past, we understood it poorly. Our ancestors drank beer instead of water throughout the day because they knew beer was safer. If they had understood that it was the boiling process of brewing that made the water safe, they could have obtained safe water without going to the high cost of brewing, without staying tipsy all day. In similar respect, Dr. Roberts hopes to understand our understanding of prices, so that we can utilize prices to better serve our needs, much as today we consume safe water at a ridiculously low cost.
Our world spins off the extraction of nonrenewable resources. The profuse layers of coal beneath our feet heat our home, and the coal is removed from machines that consume oil from far-off lands with an alien culture and value system. These subterrian jewels provide energy, and that energy helps computers run and ambulances bolt. There are only so many of these dirty jewels, and while mankind will someday develop alternatives, the date of that event is kept secret by Providence. Thus, we have to be careful how much we use today, if we are to ensure our children will have some reserves to fuel their ambitions. These nonrenewable energy sources are rationed by price. Higher prices force us to conserve and lower prices say its okay to consume. Energy is an essential input into every good and service, and is built into their prices. Higher fuel prices imply higher transportation prices which imply higher Wal-Mart prices -- teling us that we must conserve more, back away from Wal-Mart, and be happy with what we have. Discoveries of new oil deposits allow us to consume more today without sacrificing our children's reserves, and the lower oil prices imply lower Wal-Mart prices, and that is how we know to consume more. The price of oil is the signal telling us how many toys we should consume today, in order that our descendants will also have these same toys.
If the price of everything depends on the price of energy, and if the price of energy is not set correctly, neither is any other good set correctly. Ask yourself: how could the energy price be set correctly? When will alternative energies be developed? We do not know. How many more oil deposits will be found? We do not know. How reliable and useful is shale oil? We don't know. Markets ramble about, attempting a guess at these questions, but it is just a guess. The guess is destined to be wrong, but the direction of the bias and the magnitude is unknown.
As energy prices are most certainly incorrectly set, so are all other prices. Prices are built on a shaky foundation of crude predictions about crude oil, and other predictions which are either wrong or extremely wrong. As our crystal ball into the future only shows a second crystal ball, the price of everything is almost certainly, despite its benevolent intention, the price of nothing.
But then, the price of energy does mean something to each individual, though not the same for each individual. I knew whether I was willing to drive into Oklahoma City on September 20, 2007 when the price of gas was over $3.00 per gallon. I know whether I am willing to drive tomorrow, at whatever price it will be tomorrow. My family will make some decision about the next car we purchase, and it will take into account gas prices.
Famed oilman T. Boone Pickens also knows what the price of oil means to him. It probably doesn't impact his driving, since he has a private jet. Billionare Pickens does own oil fields though, and knows where more oil may lie. Mr. Pickens also invests in wind energy, and knows where more wind can be found. As oil prices change, he will know what to do with his investments. He may feel uncertain, but he will make a decision.
Society as a whole, if such thing exists, is incapable of deciphering the signal sent by oil, natural gas, and coal prices. Each individual within that society does know what to do with energy prices though. Prices are not a public message; prices whisper something different into each person's ear.
If something can be studied, it exists. If price has any tenable meaning, it can be studied by economists. Our world consists of nominal prices, but to study them across region and time requires that we convert them to real prices. That picture of George Washington on a green bill is much less persuasive today than in past years. The journey from nominal to real prices requires the use of price indices, like the consumer price index. Wade Brosen is an esteemed economist at Oklahoma State University. I once asked Wade: when one studies price relationships, such as how beef prices behave in relation to corn prices, what price index should be used? He replied that your choice of price indice is important, because the analysis results are not robust to changes in index, but it is not at all clear which indice one should use.
Despite the intelligient economists and vast amounts of money reserved for creating price indices, they are rough approximations of real prices - very rough. As economists continue to deify price, never is price -- real price -- ever seen. The skeptic must wonder, then, if the price of everything is a thing at all.
The Christian God has not been directly seen by his people for thousands of years. Yet his followers are no less doubtful than those who did cast their eyes on that which is alpha and omega. The reason is that his followers do in fact "see" God in their own way, whether it be a sequence of events interpreted as a sign or a surge or emotion as service. Tis the same for price. People claim to have seen it, but they can never show it to you.
Economics is a study of wealth. The first economics book, published in 1776, is titled The Wealth of Nations. Naturally, economists like to measure wealth, and we do so using Gross Domnestic Product (GDP). The GDP calculation is simple: take every good and service consumed, multiply it by its price, and sum this product over all other consumer goods and services. Price, here, ensures we make a fair comparison. A car is more valuable than a candy bar, so one car is not added to one candy bar for a wealth of two. Instead, the price of the car is added to the price of the candy bar, for a wealth much different and more appropriate measure of wealth. If price fails in the GDP calculation, the GDP measure fails. Price does indeed fail to reflect value.
The government makes many purchases that enter into the GDP calculation. The government also makes many purchases that have no value to society. The Iraq War, as of 2008, provides no value to Americans, and much loss to some Americans, even their lives. Yet every bullet and every bomb counts as GDP; it counts an amount equal to its cost. Surely, that price does not always indicate value; it overestimates value. The total cost of the Iraq War may exceed $1 trillion. The exact cost is difficult to estimate and relies on controversial assumptions. Yet whether it is $1 billion or $1 trillion, the value of the war is much less.
In other instances price underestimates value. No one purchases a good for which they value less than its price. Otherwise, why would they make the purchase? In these cases, price underestimates true value. Approximately one-third of all goods and services are purchased by the government, and are vulnerable to being over valued by price, and two-thirds are purchased by private citizens, and will be under estimated by price. Given there is no reason to suspect the over- and under-predictions would cancel each other out, GDP is not a measure of total wealth.
Yet GDP remains a fixture for news stories and is tracked by economists like the surgeon tracks heart rates. The measure fails for the simple reason that there is no single heartbeat for society at large. Our hearts beat at our own unique time and place. No surgeon would propose using one heart monitor for two people. No measure of wealth exists for you and I collectively. Our hearts beat separately nevertheless, and we take delight in the thrill of our toys and the security of our financial instruments. We measure wealth because we are interested in wealth. Since we never know whether our measurements are correct or incorrect, our subjective delight in summing the numbers is the only reason we should calculate GDP.
Nonmarket valuation is the economic field of measuring the value individuals place on goods for which no price can be directly observed. When the Exxon oil tanker dumped gigantic volumes of oil into the Prince William Sound, the courts were interested in knowing the price U.S. citizens were willing to pay to have this oil cleaned. One can check the price of milk at the grocery store, but no such price tag exists for this good. Instead, the price must be measured through methods such as mail, phone, and in-person surveys of individuals across the country.
Many economists spend their careers learning how such survey questions should be asked, and the one lesson that keeps repeating is that any change in the survey question or setting in which the question is asked changes the answer. If a pretty girl administers the survey, the answer changes. If the person is asked their age before the price they are willing to pay, the answer changes. These survey administrators will tell you, in secret, that it often feels like there is no real "price" to measure at all.
The Heisenberg uncertainty principle in physics states that the mere fact of measuring the position of a particle makes the momentum of the particle harder to measure. The measurement alters the state of the object being measured, and the same thing happens with people. When you ask a subject the value they place on a good, you simultaneously change the value they place on the good, and every variation on how you ask the question changes the value in a different way. Indeed, it has even been shown that merely asking someone whether they would consider purchasing a good increases their propensity to purchase the good. Listen carefully, because that was a profound point: asking people about their preferences changes their preferences!
So what is this value if it is so susceptible to changes in context? How can one measure value when the measurement changes the value?
The answer is that you don't. Ask a survey question and one will receive a survey answer. Yet there is no survey question about price that reveals information about the price. Of course, a price does exist for the person. If the price of milk reaches $4.00 per gallon, Mary may discontinue its consumption while John may simply reduce consumption by one-half. Both Mary and John have a maximum price, and they probably know what it is. They just can't tell you what it is.
In a competitive economy, prices contain a wealth of information; they benevolently help us determine what we should and should not do. This is often noted by economists. Indeed, it is their mantra.
What is not often noted is the fact that this information is not written in a universal language, and that attempts to speak of prices negotiated by other individuals destroys that information prices contain. A single price reflects the property, expectations, and desires of millions of individuals, and that single price means something different to each face among these millions. It is this facet of price that is so wonderous and unintuitive.
Price is a necessarily personal number. It cannot be spoken of in news stories clearly or deciphered intelligently in magazines. It degrades from an institution to a blot of ink when it enters an econometric equation. Communist and socialist systems have failed heroically in every documented attempt manipulate prices. This failure is often attributed to the fact that governments do not have the competence or information to adequately set prices. The failure is more than this though. The problem is not just that a few individuals cannot set the many prices for the many people, but that when price is assumed to convey the same information to each person, that number ceases to be a price at all.
I believe that air is real matter, just like at rock, but I know it is to elusive to catch and hold in my hand. Similarly, I know that prices are the most important numbers for a societies with a penchant to truck and barter. Yet I have no desire to control the prices negotiated by others. This includes the rent between tenants and landlords, as well as the interest rate negotiated between banks. The inability of me to see, conceive, or understand the prices set by others implies that it is none of my business. Thus, I let prices be. Unless you are able to grasp the air and hold a unique collection of air molecules in your hand, you have no more business than I controlling prices.
For the buyer and seller, the price of everything is, well, the price of everything. To the outsider, the price of everything is the price of nothing.
